Advanced Issues in International and European Tax Law 9781849466950, 9781474202428, 9781849469548

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ADVANCED ISSUES IN INTERNATIONAL AND EUROPEAN TAX LAW This book examines recent developments and high-profile debates that have arisen in the field of international tax law and European tax law. Topics such as international tax avoidance, corporate social responsibility, good governance in tax, matters harmful tax competition, state aid, tax treaty abuse and the Financial Transaction Tax are considered. The OECD/G20 project on Base Erosion and Profit Shifting (BEPS) features prominently in the book. The interaction with the European Union’s Action Plan to strengthen the fight against tax fraud and tax evasion is also considered. Particular attention is paid to specific BEPS deliverables, exploring them through the prism of European Union law. Can the two approaches be aligned or are there inherent conflicts between them? The book also explores whether, when it comes to aggressive tax planning, there are internal conflicts between the established case law of the Court of Justice and the emerging policy of the European Union institutions. By so doing it offers a review of issues which are of constitutional importance to the European Union. Finally, the book reflects on the future of international and European tax law in the post-BEPS world.

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Advanced Issues in International and European Tax Law

Christiana HJI Panayi

OXFORD AND PORTLAND, OREGON 2015

Published in the United Kingdom by Hart Publishing Ltd 16C Worcester Place, Oxford, OX1 2JW Telephone: +44 (0)1865 517530 Fax: +44 (0)1865 510710 E-mail: [email protected] Website: http://www.hartpub.co.uk Published in North America (US and Canada) by Hart Publishing c/o International Specialized Book Services 920 NE 58th Avenue, Suite 300 Portland, OR 97213-3786 USA Tel: +1 503 287 3093 or toll-free: (1) 800 944 6190 Fax: +1 503 280 8832 E-mail: [email protected] Website: http://www.isbs.com © Christiana HJI Panayi 2015 Christiana HJI Panayi has asserted her right under the Copyright, Designs and Patents Act 1988, to be identified as the author of this work. Hart Publishing is an imprint of Bloomsbury Publishing plc. All rights reserved. No part of this publication may be reproduced, stored in a retrieval system, or transmitted, in any form or by any means, without the prior permission of Hart Publishing, or as expressly permitted by law or under the terms agreed with the appropriate reprographic rights organisation. Enquiries concerning reproduction which may not be covered by the above should be addressed to Hart Publishing Ltd at the address above. British Library Cataloguing in Publication Data Data Available ISBN: 978-1-84946-954-8 Typeset by Compuscript Ltd, Shannon

To my family, Zak, Maria & Nicholas Palexas and my parents Nikos & Chrystalla HJI Panayi

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FOREWORD

International tax law and European tax law have become ever more complex: this book sets out to discuss some of the most complex, recent issues in the fields of international and European tax law. It analyses the background and the development of these issues, and offers the views of the author and of other academics. The focus of the book is largely on corporate taxation, mostly of multinational companies. The dominating theme of the last few years has been the work of the Organisation for Economic Co-operation and Development on base erosion and profit shifting (‘the BEPS Project’). Following on from the work of the OECD, there have been various developments within the European Union, some of them targeted at similar issues, such as the state aid investigations. This book explains both the BEPS Project and the recent developments within the European Union. Some books have only a short-term value: this book is likely to have both a short-term and a long-term value. In the short term, the book is an up-to-date explanation of recent trends and projects. It will be extremely useful for students starting courses on international tax law or European tax law in the next few years. However, this is not simply a student textbook: there are many coming to discussions of international taxation for the first time who would benefit significantly from reading this book. In the longer term, as matters move forward—with the BEPS Project reaching implementation and the EU projects either going somewhere or going nowhere—this book will become useful as an aide memoire as to the position reached by the middle of 2015. At present, nobody could predict with absolute certainty what impact the BEPS Project will have—though I think one can predict confidently that politicians will announce that it has been a success, whether it has actually been a success or not. Similarly, nobody could, with any confidence, anticipate whether some of the European Union’s projects, such as the introduction of a Financial Transaction Tax, will ever see the light of day. Books like this provide an important record for the future historian of international taxation to see where we went wrong, or where we might have done better. Intriguingly, the book starts with a discussion of CSR—Corporate Social Responsibility—which, quite rightly, provides the backdrop for much of the recent discussion of the tax system for multinational companies. This is an intriguing approach; not many tax books would begin with issues of social responsibility, rather than traditional questions of jurisdiction, tax and international tax principles. The following three chapters explain in summary form the BEPS Project and the outcomes that have been reached by the summer of 2015. Of course, d ­ evelopments

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Foreword

in international and European Union tax law are continuous, and there is no perfect point in time where one can stop the camera, freeze the frame, and show the current position. Choosing the middle of 2015 means that the book cannot deal with the outcomes expected in September/October/December 2015. Nor can the book predict what will happen with the discussions about the multilateral instrument. However, one has to write the book as at some point in time, and two-thirds of the way through the BEPS Project is likely to be as good a point as any. After the outline of the BEPS Project, the book turns from international tax law developments to EU developments. This is where the author’s background in EU tax law is evidenced most strongly. Chapter 5 discusses concepts of tax avoidance under EU law. It discusses both developments in direct and indirect taxation through the Court of Justice, as well as work by the European Commission. Chapter 6, which discusses the compatibility of the BEPS proposals with EU law, contains an especially interesting analysis. Here the author brings together her knowledge, both of European taxation and of international taxation, to raise queries as to the possibility of implementing some of the potential BEPS outcomes in EU Member States. This discussion is particularly significant, though in an ideal world the discussion of EU limits on potential BEPS outcomes would have taken place before the BEPS Project got underway. One of the justified criticisms that many people have voiced over the BEPS Project is that it began with a number of assumptions—the degree of base erosion and profit shifting being one of them— which should have been tested before work was undertaken to try to find solutions to this problem. In a similar way, it would have been helpful if the Member States of the European Union had known what they could or could not do before they participated in the BEPS Project. Chapter 7 on state aid and tax matters is written at a crucial point in the investigations by the Competition Directorate in the European Commission. At present, there is relatively little in the public domain on this topic other than the opening decisions with which the Commission began its investigations. The outcome of these investigations may have an even greater impact than the work of the OECD on BEPS, and may advance or derail the future course and form of agreement in this area. The chapter is particularly good in analysing from a critical perspective what is currently known about the position of the Competition Directorate on these matters. What comes out from this chapter is the total irrationality of approaching issues relating to international taxation through rules that have not been developed with those principles in mind, and with investigations carried out by people who do not have a strong background in these principles. The last substantive chapter, chapter 8, may end up being a record of an historical aberration: it discusses efforts of the European Commission supported by some EU Member States only, to introduce a Financial Transaction Tax. Only time will tell whether agreement is ever reached on such a tax, or whether it will eventually be abandoned as a pointless exercise. The appearance of a book devoted purely to advanced issues of international and EU tax law gives testimony to the complexity of the issues that are now under

Foreword

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discussion. A book like this is a well-designed guide for those coming to the area for the first time, as well as a record for the future of the point at which these discussions have reached by the middle of 2015. It is a very welcome addition to the literature in the fields of both international taxation and EU direct taxation. PHILIP BAKER QC FIELD COURT TAX CHAMBERS August 2015

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PREFACE

I started writing this book perhaps at the most challenging time in recent tax history—the summer of 2013 when the BEPS project was launched. Most of the chapters of this book had to be completely rewritten with the passing of time and the hurricane of developments that followed. It was not just the quantity of materials that were produced as deliverables of the 15 Actions of the BEPS project. The European Union has also been very active in the area, releasing several important measures and proposals, with the promise of more to come. This book covers all these developments, up to 1 June 2015. Special thanks are due to a number of people for their help and support. I would like to thank Philip Baker, Joy Svasti-Salee, Margarita Liasi and Luca Cerioni for their invaluable insights and comments on earlier versions of this manuscript. All errors are mine, of course. This book would not have been written had it not been for my family. I am deeply indebted to my parents for their unconditional love and unwavering support throughout the years. I would like to thank my father for his continuous inspiration and encouragement. I am who I am because of his vision and sacrifices. I would also like to thank my husband and his family for their support. A good amount of baby-sitting and endless hours of watching Peppa Pig had to be endured to enable me to concentrate on my research and write this book in the short timeframe provided. Most of all, I would like to thank my children Maria and Nicholas, for all their sacrifices and the tolerance they have shown, even at this young age, towards the complexities of BEPS and reforming the international and European tax systems.

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CONTENTS

Foreword������������������������������������������������������������������������������������������������������������������ vii Preface����������������������������������������������������������������������������������������������������������������������� xi Table of Cases��������������������������������������������������������������������������������������������������������� xvii Table of Legislation�������������������������������������������������������������������������������������������������xxv Table of International Instruments������������������������������������������������������������������������xxix

Introduction���������������������������������������������������������������������������������������������������������������1 1. Aggressive Tax Planning, Good Governance in Tax Matters and Corporate Social Responsibility: The New Themes�����������������������������������4 1.1. Harmful Tax Competition, Tax Havens, Base Erosion and Profit Shifting�������������������������������������������������������������������������������������4 1.2. Aggressive Tax Planning of Multinationals: The Politics of the Debate�����������������������������������������������������������������������11 1.3.  Good Governance in Tax Matters����������������������������������������������������������22 1.4. Corporate Social Responsibility and Aggressive Tax Planning��������������������������������������������������������������������������������������������28 1.5.  Tax in the Boardroom�����������������������������������������������������������������������������41 1.6. Conclusion����������������������������������������������������������������������������������������������45 2. The OECD/G20 Base Erosion and Profit Shifting Project: Actions 1–5��������������������������������������������������������������������������������������������������������47 2.1.  Addressing Base Erosion and Profit Shifting�����������������������������������������48 2.2. The BEPS Action Plan�����������������������������������������������������������������������������50 2.3. Action 1: Addressing the Tax Challenges of the Digital Economy��������������������������������������������������������������������������������������51 2.4. Action 2: Neutralise the Effects of Hybrid Mismatch Arrangements������������������������������������������������������������������������59 2.5.  Action 3: Strengthen CFC Rules�������������������������������������������������������������66 2.6. Action 4: Limit Base Erosion via Interest Payments and Other Financial Payments����������������������������������������������������������������������72 2.7. Action 5: Counter Harmful Tax Practices More Effectively, Taking into Account Transparency and Substance��������������������������������76 3. Tax Treaty Abuse, Permanent Establishments and Transfer Pricing Rules: Actions 6–10���������������������������������������������������������������85 3.1.  Action 6: Prevent Treaty Abuse���������������������������������������������������������������85 3.2.  Action 7: Prevent the Artificial Avoidance of PE Status������������������������99

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Contents 3.3.  Action 8: Intangibles�����������������������������������������������������������������������������106 3.3.1.  Transfer Pricing Aspects of Intangibles����������������������������������107 3.3.2.  Cost Contribution Arrangements�������������������������������������������113 3.4. Actions 9 and 10: Risks and Capital and Other High Transactions���������������������������������������������������������������������������������117 3.4.1.  Low Value-Adding Intra-Group Services��������������������������������118 3.4.2.  The Profit Split Discussion Draft��������������������������������������������120 3.4.3.  The Commodities Discussion Draft����������������������������������������122 3.4.4. Risk and Re-Characterisation Discussion Draft on Actions 8, 9 and 10��������������������������������������������������������������124

4. Procedural Rules, Country-by-Country Reporting, Dispute Resolution, Multilateralism and Developing Countries: Actions 10–15��������������������������������������������������������������������������������������������������130 4.1. Action 11: Establish Methodologies to Collect and Analyse Data on BEPS and the Actions to Address it��������������������������130 4.2. Action 12: Require Taxpayers to Disclose their Aggressive Tax Planning Arrangements�����������������������������������������������133 4.3.  Action 13: Re-Examine Transfer Pricing Documentation������������������138 4.4. Action 14: Make Dispute Resolution Mechanisms More Effective���������������������������������������������������������������������������������������147 4.5.  Action 15: Develop a Multilateral Instrument�������������������������������������153 4.6.  BEPS and Developing Countries����������������������������������������������������������157 5.  International Tax Avoidance and European Union Law�������������������������������162 5.1.  The Judicial Development of A Principle of Abuse of Tax Law����������162 5.2.  The EU Policy on Tax Abuse and Aggressive Tax Planning����������������167 5.2.1.  Commission Communication on Anti-Abuse Measures�������167 5.2.2.  From Double Taxation to Double Non-Taxation�������������������170 5.2.3.  The EU Pre-Action Plan Communication������������������������������173 5.2.4. Action Plan to Strengthen the Fight Against Tax Fraud and Tax Evasion������������������������������������������������������175 5.3.  The Aftermath of the Action Plan��������������������������������������������������������180 5.3.1.  Improving Standards and Soft Law�����������������������������������������180 5.3.2.  Amendments to Direct Tax Directives������������������������������������183 5.4.  The Tax Transparency Package�������������������������������������������������������������188 5.5.  The Group on Digital Economy�����������������������������������������������������������192 5.6.  The Code of Conduct Group on Business Taxation���������������������������195 6. The Compatibility of the BEPS Proposals with European Union Law��������������������������������������������������������������������������������������201 6.1. Rules on the Determination and/or Allocation of Taxing Rights: BEPS Actions 1, 7–10���������������������������������������������������201 6.2. Unilaterally-Imposed and Mechanical Linking Rules: BEPS Action 2�����������������������������������������������������������������������������203

Contents

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6.3. Rules Targeting Wholly or Partly Artificial Arrangements: BEPS Action 3����������������������������������������������������������������������������������������208 6.4. Group-Wide Rules and Comparability Issues: BEPS Action 4����������������������������������������������������������������������������������������211 6.5. Modified Nexus Approach and Economic Substance: BEPS Action 5����������������������������������������������������������������������������������������213 6.6.  Double Non-Taxation, LOBs and PPTs: BEPS Action 6���������������������219 6.7. Country-By-Country Reporting, Dispute Resolution and Multilateralisation of Tax Treaties: Actions 13, 14 and 15������������������231 7.  State Aid, Taxation and Aggressive Tax Planning������������������������������������������237 7.1. Introduction������������������������������������������������������������������������������������������237 7.2.  The Role of the Commission����������������������������������������������������������������240 7.3.  Litigation Avenues—European Courts and National Courts�������������243 7.4. The Rights of Interested Parties, Competitors and Third Parties������������������������������������������������������������������������������������������246 7.5.  Differences Between Fundamental Freedoms and State Aid��������������249 7.6.  State Aid and Taxes�������������������������������������������������������������������������������252 7.7.  Themes from Recent Case Law�������������������������������������������������������������256 7.7.1.  Autonomous Powers and Regional Selectivity�����������������������256 7.7.2. Inherent Consistency with the Logic and General Scheme of a Tax System���������������������������������������������261 7.7.3. The Spanish Amortisation Case—Being Selective About Selectivity����������������������������������������������������������������������265 7.8.  Tax Rulings, Advance Pricing Agreements and State Aid��������������������267 8. Unanimity, Enhanced Cooperation and the Financial Transaction Tax: Challenging the European Union’s Tax Traditions�����������282 8.1.  The Enhanced Cooperation Procedure�����������������������������������������������282 8.2.  The Financial Transaction Tax�������������������������������������������������������������287 8.3. The Financial Transaction Tax and Enhanced Cooperation: The UK Reaction�����������������������������������������������������������������������������������295 8.4.  The Future of the Financial Transaction Tax���������������������������������������300 9.  International and European Union Tax Law in the Post-BEPS World��������303

Index�����������������������������������������������������������������������������������������������������������������������319

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TABLE OF CASES

United Kingdom R v Commissioners of Customs and Excise, ex parte Lunn Poly [1999] EuLR 653���������������������������������������������������������������������������������������������������������������265 Court of Justice of the European Union Case 25/62, Plaumann v Commission [1963] ECR 95��������������������������������������������������������243 Cases 10/68 and 18/68, Eridania Zuccherifici and others v Commission [1969] ECR 459������������������������������������������������������������������������������������������243 Case C–120/73, Gebrüder Lorenz GmbH v Germany [1973] ECR 1471���������������������������������������������������������������������������������������������������������������241 Case 74/76, Iannelli & Volpi SA v Meroni [1977] ECR 557����������������������������������������237, 250 Case 78/76, Steinike und Weinlig v Germany [1977] ECR 595������������������������������������������237 Case 91/78, Hansen GmbH & Co v Hauptzollamt Flensburg [1979] ECR 935�����������������������������������������������������������������������������������������������������������������250 Case 177/78, Pigs and Bacon Commission v McCarren & Co Ltd [1979] ECR 2161���������������������������������������������������������������������������������������������������������������237 Case C–73/79, Commission v Italy [1980] ECR 1533���������������������������������������������������� 250–1 Case C–730/79, Philip Morris Holland BV v Commission [1980] ECR 2671�������������������������������������������������������������������������������������������������������239, 243 Case 84/82, Germany v Commission [1984] ECR 1451�����������������������������������������������������241 Case C–323/82, Intermills v Commission [1984] ECR 3809����������������������������������������������237 Case 270/83, Commission v France (‘Avoir Fiscal’) [1986] ECR 273���������������������������������202 Case 18/84, Commission v France [1985] ECR–1339���������������������������������������������������������251 Case C–234/84, Belgium v Commission [1986] ECR 2263������������������������������������������������239 Case 67/85, Van Der Kooy and others v Commission [1988] ECR 219�����������������������������������������������������������������������������������������������������������������243 Case C–216/87, The Queen v Ministry of Agriculture, Fisheries and Food, ex parte Jaderow [1989] ECR 4509�����������������������������������������������������������������216 Case C–21/88, Du Pont de Nemours Italiana SpA v Unit à sanitaria locale No 2 di Carrara [1990] ECR I–889������������������������������������������������������������������������251 Case C–221/89, The Queen v Secretary of State for Transport, ex parte Factortame Ltd and others [1991] ECR I–3905������������������������������������������������216 Case C–313/90, CIRFS v Commission [1993] ECR I–1125������������������������������������������������243 Case C–354/90, Féderation National de Commerce Extérieur des Produits Alimentaire (FNCEPA) et al v France [1991] ECR I–5505���������������������������������������������������������������������������������������������������237, 245 Case C–198/91, Cook v Commission [1993] ECR I–2487�������������������������������������������������243 Case C–333/91, Sofitam SA (anciennement Satam SA) v Ministre chargé du Budget [1993] ECR I–3513��������������������������������������������������������������218

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Table of Cases

Case C–387/92, Banco de Crédito Industrial SA, now Banco Exterior de España SA v Ayuntamiento de Valencia [1994] ECR I–877�������������������������������������������������������������������������������������������������������������252 Case C–1/93, Halliburton Services BV v Staatssecretaris van Financiën [1994] ECR I–1137�����������������������������������������������������������������������������������227 Case C–39/94, Syndicat français de l’Express international (SFEI) v La Poste [1996] ECR I–3547������������������������������������������������������������������������������238 Case C–55/94, Gebhard v Consiglio dell’Ordine degli Avvocati e Procuratori di Milano [1995] ECR I–4165�����������������������������������������������������������216, 224 Case T–67/94, Ladbroke Racing v Commission [1998] ECR II–1�������������������������������������238 Case C–80/95, Harnas & Helm CV v Staatssecretaris van Financiën [1997] ECR I–745��������������������������������������������������������������������������������������������218 Case C–241/95P, Tiercé Ladbroke v Commission [1997] ECR I–7007�����������������������������������������������������������������������������������������������������������238 Case C–367/95, Commission v Sytraval and Brink’s France [1998] ECR I–1719�����������������������������������������������������������������������������������������������������������247 Case C–176/96, Lehtonen et al v Fédération Royale Belge des Sociétés de BaskeT–ball ASBL [2000] ECR I–2681��������������������������������������������������218 Case C–264/96, Imperial Chemical Industries plc (ICI) v Kenneth Hall Colmer (Her Majesty’s Inspector of Taxes) [1998] ECR I–4695���������������������������������������������������������������������������������������������������221, 224 Case C–336/96, Gilly v Directeur des services fiscaux du Bas-Rhin [1998] ECR I–2793�������������������������������������������������������������������������������������������202 Case C–75/97, Belgium v Commission [1999] ECR I–3671�����������������������������������������������262 Case C–119/97P, Ufex and others v Commission [1999] ECR I–1341������������������������������246 Case C–212/97, Centros Ltd v Erhvervs-og Selskabsstyrelsen [1999] ECR I–1459�����������������������������������������������������������������������������������������������������������222 Case C–254/97, Société Baxter, B Braun Médical SA, Société Fresenius France and Laboratoires Bristol-Myers-Squibb SA v Premier Ministre, Ministère du Travail et des Affaires sociales, Ministère de l’Economie et des Finances and Ministère de l’Agriculture, de la Pêche et de l’Alimentation [1999] ECR I–4809����������������������������������������������199, 214 Case T–288/97, Regione Autonoma Friuli Venezia Giulia v Commission [2001] ECR II–1169������������������������������������������������������������������������������������238 Case C–294/97, Eurowings Luftverkehrs AG v Finanzamt Dortmund-Unna [1999] ECR I–7447����������������������������������������������������� 168, 204, 212, 221 Cases T–298, 312, 313, 315 & 600–607/97, Alzetta Mauro v Commission [2000] ECR II–2319������������������������������������������������������������������������������������238 Case C–307/97, Compagnie de Saint-Gobain, Zweigniederlassung Deutschland v Finanzamt Aachen-Innenstadt [1999] ECR I–6161�������������������������������221 Case C–372/97, Italy v Commission [2004] ECR I–3679���������������������������������������������������263 Case C–35/98, Staatssecretaris van Financiën v BGM Verkooijen [2000] ECR I–04071���������������������������������������������������������������������������������������������������������204 Case C–156/98, Germany v Commission [2000] ECR I–6857�������������������������������������������252 Cases C–180/98 to C–184/98, Pavlov and Others [2000] ECR I–6451������������������������������218 Case C–332/98, France v Commission [2000] ECR I–4833�����������������������������������������������245 Case C–466/98, Commission v UK [2002] ECR I–9427���������������������������������������������227, 236 Case C–467/98, Commission v Denmark [2002] ECR I–9519�����������������������������������227, 236

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Case C–468/98, Commission v Sweden [2002] ECR I–9575��������������������������������������227, 236 Case C–469/98, Commission v Finland [2002] ECR I–9627��������������������������������������227, 236 Case C–471/98, Commission v Belgium [2002] ECR I–9681�������������������������������������227, 236 Case C–472/98, Commission v Luxembourg [2002] ECR I–9741�����������������������������227, 236 Case C–475/98, Commission v Austria [2002] ECR I–9797���������������������������������������227, 236 Case C–476/98, Commission v Germany [2002] ECR I–9855�����������������������������������227, 236 Case T–35/99, Keller SpA v Commission [2002] ECR II–261��������������������������������������������238 Case C–110/99, Emsland-Stärke GmbH v Hauptzollamt Hamburg-Jonas [2000] ECR I–1569��������������������������������������������������������������������������������163 Case C–142/99, Floridienne SA and Berginvest SA against the Belgian State [2000] ECR I–9567�������������������������������������������������������������������������������218 Case C–143/99, Adria-Wien Pipeline GmbH and Wietersdorfer & Peggauer Zementwerke GmbH v Finanzlandesdirektion für Kärnte [2001] ECR I–8365������������������������������������������������������������������������������������ 237–8 Case C–53/00, Ferring SA v Agence centrale des organismes de sécurité sociale (ACOSS) [2001] ECR I–9067������������������������������������������������������������239 Case C–55/00, Gottardo v Instituto Nazionale della Previdenza Sociale���������������������������227 Cases T–92/00 and T–103/00, Territorio Histórico de Alava—Diputación Foral de Álava [2002] ECR II–1385������������������������������������������������252 Case C–136/00, Rolf Dieter Danner [2002] ECR I–8147������������������������������������204, 212, 221 Case T–198/01R, Technische Glaswerke Ilmenau GmbH v Commission [2002] ECR II–2153������������������������������������������������������������������������������������247 Case C–208/00, Überseering BV v Nordic Construction Company Baumanagement GmbH (NCC) [2002] ECR I–9919�����������������������������������������������������222 Case C–324/00, Lankhorst-Hohorst GmbH v Finanz Steinfurt [2002] ECR I–11779�������������������������������������������������������������������������������������������������212, 224 Case C–385/00, FWL de Groot v Staatssecretaris van Financiën [2002] ECR I–11819���������������������������������������������������������������������������������������������������������221 Case C–436/00, X & Y v Riksskatteverket [2002] ECR I–10829�����������������������������������������224 Case C–77/01, Empresa de Desenvolvimento Mineiro SA v Fazenda Publica (EDM case) [2004] ECR I–4295��������������������������������������������������� 218–19 Case C–308/01, GIL Insurance Ltd v Commissioners of Customs and Excise [2004] ECR I–4777�����������������������������������������������������������������������������������������265 Case C–422/01, Försäkringsaktiebolaget Skandia (publ) and Ola Ramstedt v Riksskatteverket [2003] ECR I–6817�����������������������������������������������������221 Case C–9/02, Hughes de Lasteyrie du Saillant v Ministere de l’Economie, des Finances et de l’Industrie [2004] ECR I–2409��������������������������������202 Case C–66/02, Italy v Commission [2005] ECR I–10901���������������������������������������������������252 Case C–174/02, Streekgewest Westelijk Noord-Brabant v Staatssecretaris van Financiën [2005] ECR I–85�������������������������������������������������������������248 Case T–210/02, British Aggregates Association v Commission [2006] ECR II–278������������������������������������������������������������������������������������������������������������264 Case C–255/02, Halifax plc, Leeds Permanent Development Services Ltd and County Wide Property Investments Ltd v Commissioners of Customs & Excise [2006] ECR I–1609���������������������������������163–6, 186 Case C–315/02, Anneliese Lenz v Finanzlandesdirektion für Tirol [2004] ECR I–7063�����������������������������������������������������������������������������������������������������������204

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Case C–08/03, Banque Bruxelles Lambert SA v The Belgian State, Minister of Finance, Department of administration of value added tax, registration and public property [2004] ECR I–10157���������������������������������218 Case C–88/03, Portugal v Commission [2006] ECR I–7115����������������������������������������� 255–8 Joined Cases C–182/03 and C–217/03, Belgium and Forum 187 v Commission [2006] ECR I–5479�������������������������������������������������������������������269, 279 Case C–276/03P, Scott SA v Commission [2005] ECR I–8437�������������������������������������������240 Case C–376/03, D v Rijksbelastingdienst (D case) [2005] ECR I–5821���������������������������������������������������������������������������������������156, 202, 224–7 Case C–446/03, Marks & Spencer plc v Halsey (HM Inspector of Taxes) [2005] ECR I–10837�����������������������������������������������������������������������������������������224 Case C–513/03, Heirs of MEA Van Hilten-van der Heijden v Inspecteur van de Belastingdienst/Particulieren/Ondernemingen buitenland te Heerlen [2006] ECR I–1957����������������������������������������������������������������������202 Case C–39/04, Laboratoires Fournier SA v Direction des vérifications nationales et internationals [2005] ECR I–2057�����������������������������������������������199, 214–15 Case C–148/04, Unicredito Italiano v Agenzia della Entrate, Ufficio Genova 1 [2005] ECR I–11137��������������������������������������������������������������������238, 263 Case C–196/04, Cadbury Schweppes plc and Cadbury Schweppes Overseas Ltd v Commissioners of Inland Revenue [2006] ECR I–7995������������������������������������������������������������������������������������ 67, 165, 168, 206, 208–11, 216, 222–3, 229 Joined Cases T–211/04 and T–215/04, Government of Gibraltar and United Kingdom v Commission [2008] ECR II–3745��������������������������������������� 258–9 Case C–222/04, Ministero dell’Economia e delle Finanze v Cassa di Risparmio di Firenze SpA [2006] ECR I–289�������������������������������������������218, 252 Case C–265/04, Bouanich v Skatteverket [2006] ECR I–923����������������������������������������������202 Joined Cases C–266/04 to C–270/04, C–276/04 and C–321/04 to C–325/04, Casino France and Others [2005] ECR I–9481�����������������������������������������248 Case C–374/04, Test Claimants in Class IV of the ACT Group Litigation v Inland Revenue Commissioners (ACT GLO case) [2006] ECR I–11673���������������������������������������������������������������������������������������������202, 225–7 Joined Cases C–393/04 and C–41/05, Air Liquide Industries Belgium SA v Ville de Seraing and Province de Liège [2006] ECR I–5293�����������������������������������������������������������������������������������������������������������248 Case C–446/04, FII Group Litigation case [2006] ECR I–11753����������������������������������������225 Case C–470/04, N v Inspecteur van de Belastingdienst Oost/Kantoor Almelo [2006] ECR I–7409��������������������������������������������������������������202, 224 Case T–475/04, Bouygues SA v Commission [2007] ECR II–2097������������������������������������246 Case C–513/04, Mark Kerckhaert and Bernadette Morres v Belgian State [2006] ECR I–10967�����������������������������������������������������������������������������������220 Case C–524/04, Test Claimants in Thin Cap Group Litigation Order [2007] ECR I–2107������������������������������������������������������������ 67, 209–10, 212, 225, 229 Case C–101/05, Case A [2007] ECR I–11531����������������������������������������������������������������������225 Case C–170/05, Denkavit Internationaal BV v Ministre de l’Economie, des Finances et de l’Industrie [2006] ECR I–11949�������������������204, 207, 228 Case C–201/05, Test Claimants in the CFC and Dividend Group Litigation v Commissioners of Inland Revenue (CFC GLO) [2008] ECR I–2875���������������������������������������������������������������������������������������������������210, 225

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Case T–211/05, Italy v Commission [2009] ECR II–2777��������������������������������������������������238 Case C–231/05, Oy AA [2007] ECR I–6373����������������������������������������������������������67, 210, 224 Case C–321/05, Hans Markus Kofoed v Skatteministeriet [2007] ECR I–5795�����������������������������������������������������������������������������������������������������������166 Case C–379/05, Amurta SGPS v Inspecteur van de Belastingdienst/Amsterdam [2007] ECR I–9569��������������������������������������������204, 207, 228 Case C–199/06, Centre d’exportation du livre français (CELF) and Ministre de la Culture et de la Communication v Société internationale de diffusion et d’édition (SIDE) [2008] ECR I–469������������������248 Case C–414/06, Lidl Belgium GmbH & Co KG/Finanzamt Heilbronn [2008] ECR I–3601�������������������������������������������������������������������������202, 224, 227 Case C–425/06, Ministero dell’Economia e delle Finanze, formerly Ministero delle Finanze v Part Service Srl, company in liquidation, formerly Italservice Srl [2008] ECR I–897����������������������������������������������164 Cases C–428/06 to C–434/06, Unión General de Trabajadores de La Rioja (UGT-Rioja) and Others v Juntas Generales del Territorio Histórico de Vizcaya and Others [2008] ECR I–6747�����������������������������������257 Case C–487/06P, British Aggregates Association v Commission [2008] ECR I–10515�������������������������������������������������������������������������������������������������255, 264 Case C–105/07, NV Lammers and Van Cleeff [2008] ECR I–173��������������������������������������212 Case C–214/07, Commission v France [2008] ECR I–8357�����������������������������������������������246 Case C–540/07, Commission v Italy [2009] ECR I–10983�������������������������������������������������225 Case C–67/08, Block v Finanzamt Kaufbeuren [2009] ECR I–0883����������������������������������220 Joined Cases C–78/08, C–79/08 and C–80/08, Ministero dell’Economia e delle Finanze and Agenzia delle Entrate v Paint Graphos Soc coop arl; Adige Carni Soc coop arl, in liquidation v Agenzia delle Entrate and Ministero dell’Economia e delle Finanze; Ministero delle Finanze v Michele Franchetto [2011] ECR I–7611��������������������������������������������������������������255, 261–3 Case C–128/08, Damseaux v État belge [2009] ECR I–6823��������������������������������������202, 220 Case C–169/08, Presidente del Consiglio dei Ministri v Regione Sardegna [2009] ECR I–10821���������������������������������������������������������������������������251 Case C–182/08, Glaxo Wellcome GmbH & Co KG v Finanzamt München II [2009] ECR I–8591�����������������������������������������������������������224, 227 Case C–279/08P, Commission v Netherlands (NOx) [2011] ECR I–7671�����������������������������������������������������������������������������������������������������������255 Case C–311/08, Société de Gestion Industrielle (SGI) v Belgian State [2010] ECR I–0487�������������������������������������������������������������������������67, 209–10 Case C–352/08, Modehuis A Zwijnenburg BV v Staatssecretaris van Financiën [2010] ECR I–4303�����������������������������������������������������������������������������������166 Joined Cases C–436/08 and C–437/08, Haribo & Österreichische Salinen [2011] ECR I–305���������������������������������������������������������������������220 Case C–103/09, Commissioners for Her Majesty’s Revenue & Customs v Weald Leasing Ltd [2010] ECR I–13589�������������������������������������������������������164 Joined Cases C–106/09P and C–107/09P, Commission and Spain v Government of Gibraltar and UK [2011] ECR I–11113��������������������������������������������������������������������������� 254, 258–61, 267, 280

xxii

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Case C–277/09, Commissioners for Her Majesty’s Revenue & Customs v RBS Deutschland Holdings GmbH [2010] ECR I–13805���������������������������������������������������������������������������������������������������������164 Case C–397/09, Scheuten Solar Technology GmbH v Finanzamt Gelsenkirchen-Süd [2011] ECR I–6455��������������������������������������������������������211 Case C–458/09P, Italy v Commission [2011] ECR I–00179�����������������������������������������������239 Joined Cases C–465/09P to C–470/09P, Comunidad Autónoma de La Rioja v Territorio Histórico de Álava—Diputación Foral de Vizcaya and Others [2011] ECR I–83������������������������������252 Case C–124/10P, Commission v EDF, ECLI:EU:C:2012:318����������������������������������������������252 Case C–126/10, Foggia—Sociedade Gestora de Participações Sociais SA v Secretário de Estado dos Assuntos Fiscais [2011] ECR I–10923���������������������������������������������������������������������������������������������������������166 Joined Cases T–219/10 and T–399/11, Autogrill España SA v Commission, and Banco Santander SA and Santusa Holding SL v Commission, judgment of 7 November 2014, EULI:T:2014:939, not yet reported����������������������������������������������������������������������������������265 Case C–318/10, Société d’Investissement pour l’Agriculture Tropicale SA (SIAT) v Belgian State [2013] ECR I–0000������������������������������������������������230 Case C–417/10, Ministero dell’Economia e delle Finanze, Agenzia delle Entrate v 3M Italia SpA [2012] ECR I–184������������������������������166, 179, 252 Case C–452/10P, BNP Paribas v Commission, judgment of 21 June 2012, ECLI:EU:C:2012:318���������������������������������������������������������������������������������252 Case C–18/11, Commissioners for Her Majesty’s Revenue & Customs v Philips Electronics UK Ltd [2012] ECR-I 532����������������������������������������������205 Case C–73/11P, Frucona Košiceas v Commission, ECLI:EU:C:2013:32�����������������������������������������������������������������������������������������������������������252 Joined Cases C–295/11 Italy v Council of the European Union and C–274/11 Spain v Council of the European Union ECLI:EU:C:2013:240����������������������������������������������������������������������������285 Case T–512/11, Ryanair Ltd v European Commission, judgment of 25 November 2014��������������������������������������������������������������������������������� 247–8 Case C–653/11, HM Revenue & Customs v Paul Newey, trading under the business name Ocean Finance [2013] ECR I–409�������������������������������������������������������������������������������������������������165, 228–9 Case C–47/12, Kronos International Inc v Finanzamt Leverkusen [2014] ECR I–0000�����������������������������������������������������������������������������������������������������������216 Case C–80/12, Felixstowe Dock & Railway Co Ltd v HM Revenue & Customs [2014] ECR I–0000�������������������������������������������������������������������������221 Case C–282/12, Itelcar v Fazenda Publica [2013] ECR I–0000����������������������������209–10, 230 Case C–375/12, Margaretha Bouanich v Directeur des services fiscaux de la Drôme (Bouanich II) [2014] ECR I–0000�������������������������������������������������216 Case T–473/12, Aer Lingus Ltd [2014] nyr��������������������������������������������������������������������������248 Case C–209/13, United Kingdom v Council [2015] ECR I–0000����������������������������� 299–300 Case C–522/13, Ministerio de Defensa and Navantia SA v Concello de Ferrol ECLI:EU:C:2013:240�������������������������������������������������������������������������239 Case C–112/14, Commission v United Kingdom [2014] ECR I–0000���������������������������������������������������������������������������������������������������� 209–10

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xxiii

Joined Cases C–20/15P and C–21/15P, Commission v Autogrill España; Commission v Banco Santander SA and Santusa Holding SL�������������������������267 Open Skies cases see Cases C–466/98 to C–469/98, C–471/98 to C–472/98 and C–475/98 to C–476/98 Commission v UK, Denmark, Sweden, Finland, Belgium, Luxembourg, Austria and Germany EFTA Court Joined Cases E–3/13 and E–20/13, Fred Olsen and Others and Petter Olsen and Others v The Norwegian State, represented by the Central Tax Office for Large Enterprises and the Directorate of Taxes����������������������������������������������������������������������������������������������������������������210, 216–17

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TABLE OF LEGISLATION

United Kingdom Companies Act 2006, s 172(1)������������������������������������������������������������������������������������������������33 Finance Act 2015�������������������������������������������������������������������������������������������������������������������312 European Union Treaties Charter of Fundamental Rights and Freedoms of the European Union����������������������������������������������������������������������������������������������������������������247 Art 41���������������������������������������������������������������������������������������������������������������������������������247 Art 41(1)����������������������������������������������������������������������������������������������������������������������������247 Art 47���������������������������������������������������������������������������������������������������������������������������������247 Treaty of Amsterdam������������������������������������������������������������������������������������������������������������283 Treaty establishing the European Community (TEC)����������������������������������������168, 216, 283 Arts 11–11A�����������������������������������������������������������������������������������������������������������������������283 Art 87(1)����������������������������������������������������������������������������������������������������������������������������260 Art 92���������������������������������������������������������������������������������������������������������������������������������241 Art 93�������������������������������������������������������������������������������������������������������������������������241, 250 Art 163�������������������������������������������������������������������������������������������������������������������������������215 Treaty on European Union (TEU)���������������������������������������������������������������������������������������283 Art 2�����������������������������������������������������������������������������������������������������������������������������������261 Art 20�������������������������������������������������������������������������������������������������������������������������283, 299 Art 20(2)–(3)���������������������������������������������������������������������������������������������������������������������283 Art 20(4)����������������������������������������������������������������������������������������������������������������������������284 Art 40���������������������������������������������������������������������������������������������������������������������������������283 Arts 43–45�������������������������������������������������������������������������������������������������������������������������283 Treaty on the Functioning of the European Union (TFEU)�������������������������������199, 203, 242 Art 63���������������������������������������������������������������������������������������������������������������������������������295 Art 106(3)��������������������������������������������������������������������������������������������������������������������������280 Art 107���������������������������������������������������������������������������������������������������������������241, 248, 280 Art 107(1)����������������������������������������������������������������������������������������� 237, 240, 244, 246, 253, 255, 260, 264, 267 Art 107(2)������������������������������������������������������������������������������������������������������������������238, 271 Art 107(3)������������������������������������������������������������������������������������������ 238, 241, 248, 264, 271 Art 108�������������������������������������������������������������������������������������������������������������������������� 240–1 Art 108(1)��������������������������������������������������������������������������������������������������������������������������240 Art 108(2)��������������������������������������������������������������������������������������������������������������241, 243–4 Art 108(3)��������������������������������������������������������������������������������������������������������������241, 244–5 Art 109�������������������������������������������������������������������������������������������������������������������������������241

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Table of Legislation

Art 113�����������������������������������������������������������������������������������������������������������������������288, 292 Art 115�������������������������������������������������������������������������������������������������������������������������������282 Arts 258–260���������������������������������������������������������������������������������������������������������������������243 Art 263�������������������������������������������������������������������������������������������������������������������������������243 Art 267�������������������������������������������������������������������������������������������������������������������������������246 Art 326�����������������������������������������������������������������������������������������������������������������������283, 299 Arts 327–328���������������������������������������������������������������������������������������������������������283–4, 299 Art 329�����������������������������������������������������������������������������������������������������������������������283, 299 Art 329(1)������������������������������������������������������������������������������������������������������������������284, 286 Art 330�������������������������������������������������������������������������������������������������������������������283–4, 299 Art 331�����������������������������������������������������������������������������������������������������������������������283, 299 Art 332�������������������������������������������������������������������������������������������������������������������283–4, 299 Art 333���������������������������������������������������������������������������������������������������������������283, 285, 299 Art 334�����������������������������������������������������������������������������������������������������������������������283, 299 Art 349�������������������������������������������������������������������������������������������������������������������������������238 Art 352�������������������������������������������������������������������������������������������������������������������������������282 Treaty of Lisbon����������������������������������������������������������������������������������������������������238, 283, 285 Treaty of Nice������������������������������������������������������������������������������������������������������������������������283 Directives Directive 76/308/EEC�����������������������������������������������������������������������������������������������������������296 Directive 77/388/EEC (6th VAT Directive)��������������������������������������������������������������������� 163–5 Directive 78/660/EEC�����������������������������������������������������������������������������������������������������������182 Directive 83/349/EEC�����������������������������������������������������������������������������������������������������������182 Directive 90/435/EEC�����������������������������������������������������������������������������������������������������������166 Directive 2002/87/EC������������������������������������������������������������������������������������������������������������182 Directive 2003/48/EC (Savings Directive)��������������������������������� 25, 174, 181, 184, 186–7, 190 Directive 2003/49/EC (Interest and Royalties Directive)��������������������������������������������171, 211 Directive 2003/123/EC (Parent-Subsidiary Directive)����������������������������������������� 91, 166, 177, 184–6, 198, 207–8, 220, 228–30, 236, 316 Art 1(2)������������������������������������������������������������������������������������������������������������������������� 184–5 Art 4(1)(a)�������������������������������������������������������������������������������������������������������������������������184 Directive 2004/39/EC, Annex I���������������������������������������������������������������������������������������������289 Directive 2005/60/EC������������������������������������������������������������������������������������������������������������183 Directive 2006/43/EC������������������������������������������������������������������������������������������������������������182 Directive 2006/48/EC������������������������������������������������������������������������������������������������������������182 Directive 2006/49/EC������������������������������������������������������������������������������������������������������������182 Directive 2006/70/EC������������������������������������������������������������������������������������������������������������183 Directive 2006/112/EC on the common system of value added tax as regards a standard VAT return�������������������������������������������������������������������������������184 Directive 2007/36/EC (Shareholders’ Rights Directive)������������������������������������������������������183 Directive 2008/7/EC��������������������������������������������������������������������������������������������������������������288 Directive 2009/65/EC, Art 1(2)��������������������������������������������������������������������������������������������289 Directive 2009/133/EC (Merger Directive)��������������������������������������������������������������������� 165–6 Directive 2010/24/EU (Mutual Assistance Directive on Recovery of Taxes)�������������������������������������������������������������������������������������������������������296

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xxvii

Directive 2011/16/EU (Mutual Assistance Directive on Exchange of Information)������������������������������������������������������������ 25, 174, 182, 187–90, 281 Preamble����������������������������������������������������������������������������������������������������������������������������190 Art 3�����������������������������������������������������������������������������������������������������������������������������������190 Art 8(1)������������������������������������������������������������������������������������������������������������������������������177 Art 9(1)������������������������������������������������������������������������������������������������������������������������������188 Art 17(4)����������������������������������������������������������������������������������������������������������������������������190 Directive 2011/61/EU, Art 4(1)(a)���������������������������������������������������������������������������������������289 Directive 2013/34/EU (Accounting Directive)������������������������������������������������������������182, 232 Arts 30–32�������������������������������������������������������������������������������������������������������������������������182 Directive 2013/36/EU (Capital Requirements Regulation Directive)������������������������182, 232 Directive 2015/849/EU (4th Anti-Money Laundering Directive)��������������������������������������182 VAT Directives�����������������������������������������������������������������������������������������������������������������������218 Regulations General Block Exemption Regulations (GBER)������������������������������������������������������������� 241–2 Regulation (EC) No 994/98��������������������������������������������������������������������������������������������������241 Regulation (EC) No 659/1999 Art 4�����������������������������������������������������������������������������������������������������������������������������������241 Art 14(2)����������������������������������������������������������������������������������������������������������������������������245 Art 14(3)����������������������������������������������������������������������������������������������������������������������������244 Regulation (EC) No 794/2004, Art 11(2)�����������������������������������������������������������������������������245 Regulation (EU) No 648/2012����������������������������������������������������������������������������������������������183 Regulation (EU) No 733/2013����������������������������������������������������������������������������������������������241 Regulation (EU) No 1407/2013��������������������������������������������������������������������������������������������241 Regulation (EU) No 651/2014����������������������������������������������������������������������������������������������241 United States of America Foreign Account Tax Compliance Act (FATCA)�����������������������������������������������������181–2, 312 Model Tax Treaty�������������������������������������������������������������������������������������������������������������������315

xxviii

TABLE OF INTERNATIONAL INSTRUMENTS

Arbitration Convention��������������������������������������������������������������������������������������������171, 233–5 Art 1�����������������������������������������������������������������������������������������������������������������������������������233 Art 2(2)������������������������������������������������������������������������������������������������������������������������������234 Arts 4–5�����������������������������������������������������������������������������������������������������������������������������234 Art 6�����������������������������������������������������������������������������������������������������������������������������������234 Art 6(2)������������������������������������������������������������������������������������������������������������������������������234 Art 7�����������������������������������������������������������������������������������������������������������������������������������234 Art 8(1)–(2)�����������������������������������������������������������������������������������������������������������������������234 Arts 9–10���������������������������������������������������������������������������������������������������������������������������234 Art 14���������������������������������������������������������������������������������������������������������������������������������234 Belgium-Netherlands Tax Treaty������������������������������������������������������������������������������������������225 Convention 90/436/EEC of 23 July 1990 on the Elimination of Double Taxation in Connection with the Adjustment of Profits of Associated Enterprises��������������������������������������������������������������������������������������������������233 see also Arbitration Convention EEA Agreement Art 31�������������������������������������������������������������������������������������������������������������������������� 216–17 Art 34���������������������������������������������������������������������������������������������������������������������������������217 European Convention on Human Rights, Art 6������������������������������������������������������������������247 Germany-Netherlands Tax Treaty����������������������������������������������������������������������������������������225 Multilateral Convention on Mutual Administrative Assistance in Tax Matters������������������������������������������������������������������������������������� 89, 145, 148, 154, 235 Nordic Convention on Income and Capital 1983�������������������������������������������������������155, 235 Soft law instruments Code of Conduct for Business Taxation���������������������������������������� 25–6, 176, 191, 196–9, 215 Code of Conduct for the effective implementation of the Arbitration Convention����������������������������������������������������������������������������������������������������235 Code of Conduct on the transfer pricing documentation for associated enterprises in the European Union 2006�������������������������������������������231–2, 235 para 6���������������������������������������������������������������������������������������������������������������������������������232 Annex, para 18������������������������������������������������������������������������������������������������������������������232 Model Agreement on Exchange of Information on Tax Matters�������������������������������������������6 Model inter-governmental agreement for the implementation of FATCA������������������������182 OECD Guidelines for Multinational Enterprises��������������������������������������������������������40, 42–3 OECD Model/ OECD Model Tax Convention����������������������������������������� 53, 59, 61–2, 88–89, 94, 96–98, 99, 104–5, 201, 209, 219, 309, 311, 315

xxx

Table of International Instruments

Preamble����������������������������������������������������������������������������������������������������������������������������219 Art 1�����������������������������������������������������������������������������������������������������������������������65, 92, 228 Art 1(2)��������������������������������������������������������������������������������������������������������������������������������62 Art 4(3)��������������������������������������������������������������������������������������������������������������������������������62 Art 5�����������������������������������������������������������������������������������������������������������������������������������103 Art 5(3)������������������������������������������������������������������������������������������������������������������������������101 Art 5(4)��������������������������������������������������������������������������������������������������������������100–1, 104–5 Art 5(4)(a)–(b)������������������������������������������������������������������������������������������������������������������100 Art 5(5)����������������������������������������������������������������������������������������������������99–100, 104–5, 305 Art 5(6)��������������������������������������������������������������������������������������������99–100, 102, 104–5, 305 Art 5(7)������������������������������������������������������������������������������������������������������������������������������104 Art 7�����������������������������������������������������������������������������������������������������������������������������62, 105 Art 9(2)������������������������������������������������������������������������������������������������������������������������������148 Art 10�����������������������������������������������������������������������������������������������������������������������������������87 Art 13(4)������������������������������������������������������������������������������������������������������������������������������93 Art 24�����������������������������������������������������������������������������������������������������������������������������������62 Art 25���������������������������������������������������������������������������������������������������������������������������������148 Art 25(3)����������������������������������������������������������������������������������������������������������������������������149 Art 26�����������������������������������������������������������������������������������������������������������������������������������81 Commentary���������������������������������������������������������������������� 62, 64–5, 89, 91–3, 96–8, 101–2, 104–5, 150, 156, 228, 315 OECD Principles of Corporate Governance���������������������������������������������������������������40, 42–3 OECD Transfer Pricing Guidelines����������������������������������������������������������� 46, 110, 113, 120–1, 181, 209, 269–70, 272–5, 277–8, 306, 315 Chapter I���������������������������������������������������������������������������������������������������������������������������114 Section D�����������������������������������������������������������������������������������������������������������������������124 Chapter II����������������������������������������������������������������������������������������������������������123, 125, 306 Chapter III�������������������������������������������������������������������������������������������������������������������������125 Chapter V��������������������������������������������������������������������������������������������������������������139, 143–4 Annex II�������������������������������������������������������������������������������������������������������������������������143 Chapter VI���������������������������������������������������������������������������������������������������������109, 116, 306 Chapter VII���������������������������������������������������������������������������������������������������������117–19, 306 Chapter VIII����������������������������������������������������������������������������������������������������������������������113 Chapter IX�������������������������������������������������������������������������������������������������������������������������125 para 3.55����������������������������������������������������������������������������������������������������������������������������273 para 6.16����������������������������������������������������������������������������������������������������������������������������275 para 9.163��������������������������������������������������������������������������������������������������������������������������273 United Nations Model Double Taxation Convention between Developed and Developing Countries�����������������������������������������������������������������������������100

Introduction The author started writing this book a few months before the launch of the OECD/G20 Base Erosion and Profit Shifting (BEPS) project. Unsurprisingly, both the structure and contents of the book are significantly different from what was originally envisaged. This is understandable given that we are currently in the midst of a large-scale review of the international tax system in an attempt to tackle international tax avoidance, or tax abuse, or aggressive tax planning, or however else it is described. The effort is much more coordinated than ever and the level of political commitment unprecedented. Both of these variables are likely to be short-lived, hence the ambitious agenda of the OECD and the G20 in the BEPS project. The BEPS project features prominently in this book. It is shown that the project, although ambitious, remains somehow realistic. There is an attempt to capture the parameters of this project and consider its impact not only in the wider international tax community, but also in the European tax community. The interaction with the European Union’s Action Plan to strengthen the fight against tax fraud and tax evasion is also considered. Particular attention is paid to specific BEPS deliverables, exploring them through the prism of European Union law. This book also examines other recent developments and high-profile debates that have arisen in the field of international tax law and European tax law. Topics such as corporate social responsibility, good tax governance, state aid and aggressive tax planning, and the Financial Transaction Tax are also considered. In Chapter one, there is an overview of the various factors and events that led to the launch of the BEPS project. The rhetoric against harmful tax competition and tax havens is examined. Following that, reported cases of aggressive tax planning by multinationals are considered and the aftermath of these cases in some jurisdictions is reviewed. What seems to be emerging from some of the hearings and investigations that have taken place is the overarching inadequacy of existing principles of international tax law to deal with the internationalisation of business. Standards of morality and fairness are increasingly becoming relevant, sometimes to the detriment of legal certainty. What is also apparent is that notions of corporate social responsibility—as far as companies are concerned—and good governance in tax matters—as far as countries are concerned—are becoming prevalent. Both of these concepts are examined. The link between corporate social responsibility and aggressive tax planning is considered, both internationally and within the European Union. It is questioned whether companies that engage in aggressive tax planning are socially irresponsible. Although there is no conclusive answer to this from the brief overview of some of the important literature on the topic,

2

Introduction

it is argued that corporate social responsibility implications are likely to become increasingly entrenched in the whole debate. In Chapters two to four, the BEPS project is considered in greater detail. Actions 1 to 5 are considered in Chapter two, Actions 6 to 10 are considered in Chapter three and Actions 11 to 15 are considered in Chapter four. In these chapters, there is an overview of the various discussion drafts and reports produced in the context of these Action items, their merits and demerits. As will be shown in these chapters, the aim of most of the Action items is to address—or at least to attempt to address, either for the first time or for the umpteenth time—some of the most contentious areas in international tax law. Notwithstanding the expectations that had been raised at the inception of the BEPS project, the OECD does not carry out a holistic review of the international tax regime and does not make drastic recommendations. Most of the deliverables produced are very much imbued with pragmatism. In Chapter four, there is also a review of the OECD’s engagement with developing countries. Developing countries have consistently recognised the importance of addressing BEPS as part of wider measures to increase domestic resource mobilisation and promote stable economic growth. It is questioned whether the BEPS agenda prejudices developing countries and whether their interests are properly reflected in the Action Plan. Steps taken by the OECD to address these concerns are considered. The next chapters examine the measures taken by the European Union to tackle international tax avoidance, many of which share similarities with the BEPS proposals. In the first part of Chapter five, the judicial response to the concept of tax abuse by the Court of Justice is considered. This is then juxtaposed with the Commission’s initiatives and most importantly its Action Plan as a newly-formed policy on international tax avoidance. This chapter sets the background against which, in the next chapter, Chapter six, there is an analysis of the compatibility of the various items of the BEPS Action Plan with European Union law. In Chapter seven, there is a detailed analysis of the state aid prohibition with an emphasis on fiscal state aids. The role of the Commission and of national tax authorities is considered, as well as the rights of competitors and third parties. There is a review of recent important cases in the area of tax law, as well as the latest legislative and quasi-legislative developments. Finally, the use of the state aid prohibition in tackling some (perceived) examples of aggressive tax planning is examined. The Commission’s state aid investigations into Apple, Fiat, Starbucks and Amazon are critically reviewed and thoughts are offered as to the legal credentials of the Commission’s ‘prudent independent market operator’ test. Chapter eight explores another angle of the debate which preceded the BEPS project—the proposal for a Financial Transaction Tax. There is a consideration of the ongoing efforts by the Commission and Member States to introduce the Financial Transaction Tax. The original Commission proposal and the subsequent proposal to be adopted through enhanced cooperation are analysed. The ­suitability of the enhanced cooperation procedure as a mechanism of adopting

Introduction

3

legislative proposals and especially tax proposals is examined and the future of the Financial Transaction Tax considered. In Chapter nine, the author concludes the book with a general discussion on the themes developed previously and offers some thoughts on the development of international and European Union tax law in a post-BEPS world. The contents of this book are based on materials available up to 1 June 2015.

1 Aggressive Tax Planning, Good Governance in Tax Matters and Corporate Social Responsibility: The New Themes Increasingly, the international tax community is dominated by a high-level debate on topics such as tax avoidance, aggressive tax planning, corporate social ­responsibility, tax governance, transparency and exchange of information. Among others, the European Commission, the OECD and G8/G20 countries have become involved in this debate. The most important recent development has been the launch of the OECD/G20’s Action Plan to combat base erosion and profit shifting (BEPS). This chapter examines some of the factors and events that led to the BEPS project.

1.1.  Harmful Tax Competition, Tax Havens, Base Erosion and Profit Shifting Globalisation has increased the possibilities for erosion of the national tax base. The global economic crisis has exacerbated this and placed heavy burdens on government budgets.1 In recent years, the tax practices of some well-known multinational enterprises (MNEs) have attracted attention for their aggressive tax practices,2 which although legal, they often lead to very low effective tax rates. The ability to shift profits into low or no tax jurisdictions with little corresponding change in business operations has also been criticised for distorting the allocation of capital and eroding national tax bases, especially of developed countries. 1  Amir Pichhadze, ‘Exposing Unaddressed Issues in the OECD’s BEPS Project: What About the Roles and Implications of Contract Interpretation Law and Private International Law in the Transfer Pricing Arm’s Length Comparability Analysis?’ (2015) 7 World Tax Journal 99–167, 103. 2  The term ‘aggressive tax planning’ was first described in the OECD’s 2008 Intermediaries report, although the definition has now evolved. See OECD Study into the Role of Tax Intermediaries (OECD, 2008), available on: www.oecd.org/tax/administration/39882938.pdf. See Glossary to the report, p 87: ‘Aggressive tax planning. This refers to two areas of concern for revenue bodies: Planning ­involving

Harmful Competition, Tax Havens and BEPS

5

Aggressive tax practices are also thought to have led to a phenomenon coined as stateless income. Stateless income has been described as income derived for tax purposes by a multinational group from business activities in a country other than the domicile of the group’s ultimate parent company but which is subject to tax only in a jurisdiction that is neither the source of the factors of production through which the income was derived, nor the domicile of the group’s parent company.3

In an era when many countries, even those with advanced economies, face a fiscal crisis and budget deficits, stateless income is often criticised for leading to a decline in corporate tax collection. However, MNE behaviour does not occur in vacuum. Stateless income could be construed as the result of tax competition between nations.4 Base erosion and profit shifting by MNEs would be largely ineffective ‘without countries offering preferential tax rules, including low/no tax regimes for particular taxpayers or income categories and benign provisions on profit measurement’.5 To an extent, MNE tax avoidance is just the flipside of harmful tax competition.6 When one talks about harmful tax competition, traditionally, tax havens and harmful tax practices come into mind. The OECD has already spent a considerable amount of time dealing with the phenomenon of harmful tax competition in the late 90s. The OECD project on harmful tax practices was launched in 1996. The initiative was carried out through the Forum on Harmful Tax Practices. In 1998, the Forum produced its first major report, entitled Harmful Tax Competition: An Emerging Global Issue.7 The report only covered ­geographically mobile

a tax position that is tenable but has unintended and unexpected tax revenue consequences. Revenue bodies’ concerns relate to the risk that tax legislation can be misused to achieve results which were not foreseen by the legislators. This is exacerbated by the often lengthy period between the time schemes are created and sold and the time revenue bodies discover them and remedial legislation is enacted. Taking a tax position that is favourable to the taxpayer without openly disclosing that there is uncertainty whether significant matters in the tax return accord with the law. Revenue bodies’ concerns relate to the risk that taxpayers will not disclose their view on the uncertainty or risk taken in relation to grey areas of law (sometimes, revenue bodies would not even agree that the law is in doubt)’. 3  Edward D Kleinbard, ‘Through a Latte Darkly: Starbucks’s Stateless Income Planning’ (2013) 139 Tax Notes 1515, 1517 (24 June 2013). The mechanics of stateless income tax planning include earnings stripping, particularly aided by the US check-the-box rules, transfer pricing with an emphasis on abuses in cost sharing arrangements, aggressive contractual terms in transfer pricing and legal system arbitrage etc. For an analysis of the tax policy issues surrounding stateless income, see Edward Kleinbard, ‘Stateless Income’ (2011) 11 Florida Tax Review 699. Also see article by the same author, ‘The Lessons of Stateless Income’ (2011) 65 Tax Law Review 99. 4  For a generic analysis, see Mindy Herzfeld, ‘The Power of a Name: Stateless Income and Its Failings’ (2015) 77 Tax Notes International 1019 (23 March 2015). Also see an ACCA report produced by Sinclair Davidson, entitled ‘Multinational corporations, stateless income and tax havens’, available on: www.accaglobal.com/content/dam/acca/global/PDF-technical/tax-publications/tech-tp-mcsith.pdf. 5  Hugh J Ault, Wolfgang Schön and Stephen E Shay, ‘Base Erosion and Profit Shifting: A Roadmap for Reform’ (2014) 68 Bulletin for International Taxation 275, 276. 6  Ibid. 7 OECD, Harmful Tax Competition: An Emerging Global Issue (OECD Publications, 1998).

6

New Themes in Taxation

activities such as financial and other service activities, including the ­provision of intangibles. Special tax incentives directed at manufacturing and foreign direct investment were outside the scope of the report. The concept of harmful tax competition was not defined but its harmful effects were raised.8 The report targeted tax havens and preferential tax regimes, though no definitions were given.9 Criteria were used to identify both tax havens and harmful preferential tax regimes10 and harmful tax regimes.11 A number of recommendations were made for domestic legislation, tax treaties and international co-operation. The Forum was responsible for supervising the implementation of the standstill and roll back provisions. The publication of the report led to intense dialogue aimed at eliminating preferential tax regimes within OECD and non-OECD countries. This report and subsequent reports12 encouraged—rather forcefully—OECD and non-OECD jurisdictions to strengthen their commitments to the principles of transparency and effective exchange of information. These standards were developed by the Global Forum on Taxation13 but not all jurisdictions showed the same willingness. Following the 2001 Progress Report, in 2002, the Model Agreement on Exchange of Information on Tax Matters was created and used as the basis for the ­negotiation 8  These were: the distortion of investment flows; the threat to the integrity and fairness of the tax systems; the discouragement of taxpayers’ compliance; the redesign of the appropriate balance between revenue and public spending; the shift of tax burden to other bases (labour, consumption); and the increase of administrative compliance costs. Ibid, pp 22–25. 9  As far as tax havens were concerned, the report referred to ‘countries that are able to finance their public services with no or [only] nominal income taxes and that offer themselves as places to be used by non-residents to escape tax in their country of residence’ and those that ‘raise significant revenues from their income tax but whose tax system has features constituting harmful tax competition’. The report described harmful preferential tax regimes as countries collecting a significant level of revenue from individual and/or corporate income tax but whose tax systems have preferential features that allow the relevant income to be subject to low or no taxation. It could be both tax havens and high-tax jurisdictions: ibid, p 20. 10  (a) no or only nominal tax (generally or in special circumstances) and self-promotion (or appearance of self-promotion as a place to be used by non-residents to escape their residence country taxes); (b) lack of effective exchange of information; (c) lack of transparency; (d) no substantial activities. Ibid, pp 22–34. 11  (a) no or low effective tax rates; (b) ring-fencing; (c) lack of effective exchange of information; (d) lack of transparency. Also, the artificial definition of the tax base and failure to comply with internationally accepted transfer pricing rules. Ibid, pp 22–34. 12  See, for example, OECD, Towards Global Co-operation: Report to the 2000 Ministerial Council Meeting and Recommendations by the Committee on Fiscal Affairs: Progress in Identifying and Eliminating Harmful Tax Practices; OECD, Consolidated Application Note: Guidance in applying the 1998 Report to Preferential tax regimes; OECD, The OECD’s project on Harmful Tax Practices: The 2001 Progress Report; OECD, The OECD’s project on Harmful Tax Practices: The 2004 Progress; OECD, The OECD’s project on Harmful Tax Practices: The 2006 Progress Report; OECD, The OECD’s project on Harmful Tax Practices: The 2007 Progress Report. 13  The Global Forum had established a Sub-Group on Level Playing Field Issues to develop a set of proposals which were endorsed at a Global Forum meeting in Berlin in June 2004. At this meeting the representatives of 42 OECD and non-OECD jurisdictions approved a joint report on how to achieve their common objective of a global level playing field based on high standards of transparency and effective exchange of information. The report contemplated actions of an individual, bilateral and a collective nature.

Harmful Competition, Tax Havens and BEPS

7

of many Tax Information Exchange Agreements. Even though the US gradually became less supportive of the OECD’s project insisting on certain changes,14 the project was quite successful and by 2006 all regimes which were identified as generating harmful tax competition were abolished, the last one being the Luxembourg 1929 holding company regime. In the 2006 Progress Report,15 it was claimed that the project had fully achieved its initial aims and the mandate given by the OECD Council on dealing with harmful preferential tax regimes in member countries was met. It was announced that future work in this area would focus on monitoring any continuing and newly introduced preferential tax regimes identified by member countries. Much of the discourse on the OECD’s harmful tax competition project was eventually linked to the benchmarks of transparency and exchange of information. In the G20 meeting of finance ministers and central bank governors, there was a call ‘on financial centres and other jurisdictions within and outside the OECD which have not yet adopted these standards to take the necessary steps, in particular in allowing access to bank and entity ownership information’.16 Whilst the general feeling was that the OECD’s project on harmful tax competition was being wound up, the global financial crisis which started around 2008 led to a renewed ‘attack’ on tax havens, and later on to jurisdictions that were perceived as facilitating aggressive tax planning. The G20 Communiqué issued at the London 2009 Summit stated that major failures in the financial sector and in financial regulation and supervision were fundamental causes of the financial crisis. The G20 leaders agreed to take action against non-cooperative jurisdictions, including tax havens, and if necessary to deploy sanctions to protect their public finances and financial systems.17 The era of banking secrecy was declared to be over and countries were called upon to adopt and implement the international tax standards of transparency and information exchange—standards which had assumed top priority by then. This message was reinforced at the G8 meeting in July 2009 and subsequent G8 and G20 meetings, though no sanctions have yet to be taken. Since 2009, the OECD has been publishing progress reports on the implementation of the internationally agreed tax standard18 by jurisdictions surveyed by the 14  The project was initially supported by the USA. In 2001, the Bush administration acting through its Secretary of the Treasury, Paul O’Neil, raised objections. The OECD project was accused of lacking focus, destroying otherwise beneficial tax competition, interfering with the tax sovereignty of foreign nations etc. 15  See OECD, The OECD’s project on Harmful Tax Practices: The 2006 Progress Report. 16  G20 meeting of Financial Ministers and Bank Governors, Berlin, 20–21 November 2004, para 9. Also see, Jan Wouters and Katrien Meuwissen, Global Tax Governance: Work in Progress?, Working Paper No 59—February 2011 (Leuven Centre for Global Governance Studies). 17  G20 London Summit—Leaders’ Statement—2 April 2009, para 15. 18  This is set out in footnote 1 of the Progress Report on the Jurisdictions Surveyed by the OECD Global Forum in Implementing the Internationally Agreed Tax Standard, on the progress made as at 2 April 2009. ‘The internationally agreed tax standard … requires exchange of information on request in all tax matters for the administration and enforcement of domestic tax law without regard to a domestic tax interest requirement or bank secrecy for tax purposes. It also provides for extensive safeguards to protect the confidentiality of the information exchanged’. www.oecd.org/ctp/42497950.pdf.

8

New Themes in Taxation

Global Forum. In these progress reports, there were three lists of jurisdictions: the white list,19 the grey list20 and the black list.21 In the April 2009 progress report, there were four jurisdictions on the black list22 and numerous jurisdictions on the grey list. This list has been regularly updated and there are now no countries on the black list. All jurisdictions covered by Global Forum have now committed to the international tax standards and more than half have implemented them. Furthermore, a peer review process has begun to monitor jurisdictions, reviewing the legal and regulatory framework, the actual implementation of standards, their tax treaties and tax information exchange agreements. Notwithstanding the self-declared successful conclusion of the OECD’s harmful tax competition project, tax havens still exist—many mostly reconfigured and with different characteristics. It is a widely made assertion that the existence of tax havens has contributed to the financial crisis and has had a major impact on the fiscal sustainability of countries.23 Other criticisms focus on the impact of tax havens on developing countries and measure the loss of revenues to such countries only and not on developed countries.24 These claims are not easily proven though. One of the endemic problems of the tax havens discourse is that it is still beleaguered by definitional uncertainty. Its scope is also uncertain and ever changing— notwithstanding the work of the OECD, or perhaps because of the work of the OECD in this area. In a report commissioned by the Norwegian government in 200825 the damaging effect of tax havens was examined. It was argued, inter alia, that tax havens increase the risk premium in international financial markets, that they undermine the tax system and public finances and they increase the inequitable distribution of tax revenues. It was also reported that tax havens reduce the efficiency of resource allocation in developing countries and generally reduce their revenues and damage their growth. They also make economic crime more profitable. Not much empirical evidence was shown to support these conclusions though. Instead, it was conceded that ‘economic literature cites a number of positive aspects related to tax havens’.26

19  This list included countries that had substantially implemented the internationally agreed tax standard. 20  This list included countries committed to the internationally agreed tax standard but that had not yet substantially implemented it. 21  This list included countries that had not committed to the internationally agreed tax standard. 22  Costa Rica, Malaysia, Philippines, Uruguay. 23 See, for example, Sol Piccioto, ‘How tax havens helped to create a crisis’, Financial Times, 5 May 2009 at: www.ft.com/cms/s/0/96ec9414-39a6-11de-b82d-00144feabdc0.html#axzz2uzMLkQmw. 24  See below. 25  Commission on capital flight from developing countries: Tax Havens and Development—Status, Analyses and Measures. Report from the Government Commission on Capital Flight from Poor Countries. Appointed by Royal Decree of 27 June 2008. Submitted to Erik Solheim, Minister of the Environment and International Development, on 18 June 2009 (henceforth, the Norwegian study). 26 See ibid p 71 et seq.

Harmful Competition, Tax Havens and BEPS

9

In this report, it was emphasised that ‘the classic tax havens are not alone in promulgating systems that cause loss and harm to public and private interests in other states’.27 In other words, tax haven regimes are not the prerogative of small sunny islands with minimal tax rates. High-tax countries could also have regimes which are akin to those of tax havens. In any case, as commented, while offshore financial centres may be relevant to the discredited international financial system, their role tends to be exaggerated or misconstrued.28 Advocacy groups, non-governmental organisations (NGOs) and civil society in general have also had an important role in raising public awareness on tax havens as well as on what they perceive to be illegitimate tax planning practices and tax dodgers. For example, the UK Uncut movement, a grass-roots activist group, has conducted demonstrations across the UK targeting alleged tax dodgers. On 25 November 2013, the Tax Solidarity Week of Action took place. This formed part of the Europe-wide ‘Stop Tax Dodging’ initiative—‘an initiative bringing together the voices of civil society in 15 countries across Europe, united in a desire to see an end to tax dodging by multinational companies and more action by European leaders to tackle this problem’.29 There were actions in Denmark, Finland, Sweden, France, Belgium, Italy, Spain, the UK, Czech Republic, Hungary, Slovenia and Poland, ranging from stunts and petitions to film showings, TV spots and public meetings. Also, reports and briefing papers were published by several NGOs discussing links between tax evasion and tax havens. In a report published by the Tax Justice Network, it was suggested that US$21 to $32 trillion were hidden in tax havens worldwide.30 In 2011, ActionAid had published information showing that 98 of the UK’s biggest companies, most of which operate in the developing world, were using tax havens. This information was reviewed in May 2013, where it was shown that little had changed.31 In 2013, Christian Aid published a report on the profit-shifting ‘lure’ of tax havens for multinationals.32 The authors of the report ­concluded that MNEs with connections to tax havens engage in profit shifting

27 

Norwegian study, n 25 above, p 21. Geoffrey Loomer and Giorgia Maffini, Tax Havens and the Financial Crisis (2009) Project Report. Centre for Business Taxation. Available on: www.sbs.ox.ac.uk/sites/default/files/Business_ Taxation/Docs/Publications/Policy_Papers/TaxHavensandtheFinancialCrisis.pdf. 29 www.christianaid.org.uk/ActNow/blog/november-2013/stop-tax-dodging-campaign-acrosseurope.aspx. 30  See James S Henry, ‘The Price of Offshore Revisited’, Tax Justice Network, July 2012. Available on: www.taxjustice.net/cms/upload/pdf/Price_of_Offshore_Revisited_120722.pdf. This was believed to be a conservative estimate. See p 5. 31  See www.actionaid.org.uk/campaign/ftse-100-tax-haven-tracker. It has been claimed that these figures are misleading as UK companies mostly use Delaware companies, which pay US federal tax at 35%. See Bill Dodwell’s testimony at the Public Accounts Committee proceedings, reported in ‘This Week’, Tax Journal, Issue 1156, p 8 (8 February 2013). 32  See Christian Aid Occasional Paper Number 9: Multinationals and the Profit-Shifting Lure of Tax Havens by Petr Janský and Alex Prats, Principal Economic Justice Policy Adviser, Christian Aid (March 2013). Available on: www.christianaid.org.uk/Images/CA-OP-9-multinational-corporationstax-havens-March-2013.pdf. 28  See

10

New Themes in Taxation

more intensively than those MNEs with no tax haven links, due to the greater incentives, mostly low tax rates, and other opportunities on offer such as secrecy provisions.33 The rhetoric against tax havens, especially from some NGOs’ perspective,34 is often linked with that of tax dodging and the depletion of resources of developing nations. It is often claimed that tax dodging entrenches poverty,35 weakens the economies of developing countries and deprives the locals from investment in health, education, infrastructure and good quality basic services.36 Oxfam37 and Global Financial Integrity38 have released reports estimating that developing countries lose an estimated US$100 billion to $160 billion annually to corporate tax dodging. Christian Aid estimates that trade mispricing and false invoicing costs developing countries US$160 billion a year.39 This is thought to be significantly more than the total aid given to them by the developed countries and much more (thought to be three times more) than the amount required to end hunger on an annual basis.40 Whatever the legitimacy of these claims and the definition and scope of a rather elusive underlying problem—either tax havens, or harmful tax competition, or tax avoidance, or tax dodging, or aggressive tax planning—as will be shown in this book, an incredible momentum has built up. This much is undeniable. What the final result will be remains to be seen.

33 

Ibid, p 10. for example, information on Christian Aid’s website (www.christianaid.org.uk/resources/ policy/tax.aspx), on Actionaid’s website (www.actionaid.org.uk/campaign/tax-justice-policy), a press release by Eurodad (www.eurodad.org/Entries/view/1546115/2013/12/16/Press-Release-Giving-withone-hand-and-taking-with-the-other-CSOs-urge-European-leaders-to-take-action-against-taxdodging) etc. 35 See, for example, the report entitled Tax Abuses, Poverty and Human Rights released on 8 October 2013 by the International Bar Association’s Human Rights Institute task force. Available on Tax Analysts Document Service, Doc 2013-23604. 36  See, eg www.healthpovertyaction.org/policy-and-resources/tax-and-health/tax-dodging-globalhealth/;www.actionaid.org.uk/campaign/tax-justice-policy#gsFxWtrI3VxFUsoJ.99. 37 www.oxfam.org/en/pressroom/pressrelease/2013-09-01/tax-evasion-damaging-poor-countryeconomies. 38 See ‘The Implied Tax Revenue Loss from Trade Mispricing’, by Ann Hollingshead, February 2010: www.gfintegrity.org/storage/gfip/documents/reports/implied%20tax%20revenue%20loss%20 report_final.pdf. 39  The accuracy of the 160 billion figure has been questioned. See, for example, written evidence to the House of Commons International Development Committee by the Head of Tax of Rio Tinto, an international mining group. The evidence which was given in February 2012 is available on. www. publications.parliament.uk/pa/cm/201213/cmselect/cmintdev/130/130vw23.htm. Also see statements by Heather Self that ‘[Christian Aid’s] continuing use of unreliable and out of date figures, which exaggerate the extent to which behaviour by multinationals contributes to the problem, harms their case; they require transparency and accuracy from companies and should meet that standard themselves … If reliable estimates are simply not available, they should acknowledge this’. News, Tax Journal, Issue 1201, p 2 (24 January 2014). 40  See Tax Justice Toolkit, Understanding Tax and Development (Christian Aid, 2013) p 8, available on: www.christianaid.org.uk/Images/Tax-toolkit-1-understanding-tax-development-September-2013. pdf. 34  See,

Aggressive Tax Planning of MNEs

11

1.2.  Aggressive Tax Planning of Multinationals: The Politics of the Debate As discussed in the previous section, the polemic against tax havens and/or low tax regimes is not something new. It has certainly been ongoing at least since the OECD’s 1998 harmful tax competition project. However, it would seem that the focus appears to be shifting away from tax havens—something foreign, afar and difficult to influence. Arguably, even the OECD in the course of its 1998 project began to focus on benchmarks such as transparency and exchange of information, rather than interfering (further) with the sovereignty of alleged tax havens. Lately, some of the world’s largest multinationals, such as Vodafone, Amazon, Google, Starbucks and Microsoft have been scrutinised for their (technically) legal but highly aggressive tax planning practices, using transfer pricing, intercompany lending, royalty payments for licencing agreements, cost sharing agreements, group losses etc. Fuelled by media attention,41 the reporting of these practices has in some countries led to public outcry. It should be pointed out that the issue is of concern to both residence countries and source countries. To put it simplistically, residence countries are concerned that profits held offshore—which appear to belong to resident companies or controlled foreign entities—remain untaxed. By contrast, source countries are concerned that profits which could be perceived to arise within their jurisdiction go untaxed or are seriously depleted/eroded before being taxed. A combination of inadequate and/or antiquated rules in both the countries of residence and source has led to very low effective tax rates and often stateless income, a concept discussed above. Although this concept has been criticised,42 it has become a catchy phrase and is often used in describing the desired end-result of some MNE tax practices. In any case, stateless income, however defined and whatever it actually encompasses, faces broader conceptual issues of efficiency, tax-base protection and ultimately, fairness. Politicians (and governments) in many jurisdictions seemed to have jumped on this bandwagon. In the last few years, senior executives of major multinationals were called upon in the UK to give evidence to Parliament’s Public Accounts Committee. This was because despite huge profits generated by these multinationals, very little or nothing was paid as UK corporation tax. This is, arguably, the source country perspective to this problem. A brief analysis of selected hearings will be given in this chapter.

41  See, for example, a few references: www.theguardian.com/business/taxavoidance, www.mirror. co.uk/news/uk-news/tax-avoidance-soars-35billion-under-2362328, www.independent.co.uk/news/ uk/politics/revealed-47bn-corporation-tax-lost-through-evasion-and-avoidance-as-royal-mail-issold-for-650m-less-than-it-is-worth-8874873.html. 42  See analysis in 1.1 above.

12

New Themes in Taxation

Starbucks had paid no income taxes in the UK since 2009. At a Public Accounts Committee hearing in November 2012, Troy Alstead, the Starbucks CFO, had argued, inter alia, that high rental costs and a very competitive market had generated losses for the firm for 14 out of the 15 years it had been operating in the UK. Although investors were told that the UK operations were profitable and business was growing, no income tax had in fact been paid to the UK Exchequer since 2009. It was also reported that Starbucks had paid just £8.6 million in corporation tax in the UK over 14 years.43 The Committee members challenged these figures, arguing it was highly improbable that anyone running a business would keep it going if it was not making any money.44 Alstead acknowledged that the UK company had made a number of payments to related companies, reducing the taxable base. The taxable base was further reduced through the use of intercompany loans and the company’s transfer pricing practices.45 Although there was no illegality involved, nevertheless, fearing a boycott by the public, Starbucks pledged to pay £20 million in UK corporate tax over the next two years (2013 and 2014) regardless of its economic performance.46 This move has been criticised as reducing corporate tax obligations to voluntary charitable donations.47 It has also been criticised that the social licence to operate has now expanded beyond labour and environmental issues.48 In fact, it appears to be above that required by current law and rather governed by vague extra-legal standards. Arguably, ‘[f]or multinationals, that makes for an uncertain future: one in effect shaped by activist vigilantism’.49 The Starbucks case illustrates this very well. Following its pledge, UK Uncut staged a number of protests at more than 40 Starbucks shops, ‘transforming’ Starbucks stores into refuges, crèches and

43  See special four month investigation reported on Reuters (Special Report: How Starbucks avoids UK taxes, by Tom Bergin, available on: uk.reuters.com/article/2012/10/15/us-britain-starbucks-taxidUKBRE89E0EX20121015. Also see www.bbc.com/news/business-20288077. For a similar investigation in Greece, see www.forologoumenos.gr/permalink/23636.html. 44  See Julie Martin, ‘UK Puts Executives in Hot Seat Over Transfer Pricing Practices’, 2012 WTD 221-24 (15 November 2012). 45  For example, it paid annual royalties for intellectual property up to 6% of sales. Half of that royalty was paid to Starbucks’ European headquarters in the Netherlands, which had few employees but which was subject to a private low tax arrangement with the Netherlands government. See Stephanie Soong Johnston, ‘UK to Investigate Starbucks’s Tax Affairs’, 2012 WTD 202-2 (18 October 2012); Hans van den Hurk, ‘Starbucks versus the People’ (2014) 68 Bulletin for International Taxation 27–34. 46  See Randall Jackson, ‘Starbucks’s U.K. Tax Payment Pledge Reduces Corporate Tax to a Charitable Donation, Critics Say’ 2012 WTD 237-3 (10 December 2012). Also see www.telegraph.co.uk/finance/ newsbysector/banksandfinance/9727048/Starbucks-to-start-paying-more-UK-tax-Kris-Engskovspeech-in-full.html. Technically, Starbucks is thought to have deferred deductions for 2013 and 2014 expenses. 47  For an overview, see Allison Christians, ‘The Big Picture: How Starbucks Lost Its Social License— and Paid £20 Million to Get It Back’ (2013) 71 Tax Notes International 637 (12 August 2013). 48  Ibid, p 638. 49  Ibid, p 639.

Aggressive Tax Planning of MNEs

13

­homeless shelters.50 On 16 April 2014, Starbucks announced that it would move the regional head office representing its European, Middle Eastern and African business from Amsterdam to London at the end of 2014. As a result of the move, Starbucks was expected to pay more tax in the UK. However, it did not specify what kind of additional tax it would pay or how much.51 Amazon was faced with similar controversies. In the UK, Amazon’s public policy director Andrew Cecil was also asked to appear in the Public Accounts Committee. Amazon was able to minimise its tax liability by transferring ownership of its UK business to Amazon EU SARL, a Luxembourg company, in 2006. This was part of corporate restructuring which took place in 2005–06, to lower the company’s effective tax rate over time. Following the reorganisation, Amazon was able to classify its UK business as a sales company. As such, sales made in the UK were billed to Luxembourg and profits made from those sales were taxed in Luxembourg and not in the UK. Nevertheless, there was great disparity in the number of people employed by the Luxembourg office and the UK business, as well as in the turnover of these companies.52 Also, notwithstanding the claim that the UK business was merely a service facility, books, staff payroll and customers were all based in the UK. Cecil was accused of being evasive in his responses to the Public Accounts Committee. He claimed no information was available to show the proportion of Amazon’s European sales into the UK and in any case such information could not be disclosed publicly. Cecil also claimed he did not know who owned the holding company which owned Amazon EU SARL in Luxembourg. Unsurprisingly, the Public Accounts Committee was not very impressed with his responses.53 In any case, caving to international pressure, it has been recently reported that Amazon has changed its EU business structure so that from 1 May 2015 it would record retail sales made to customers in the UK and some other EU jurisdictions in those jurisdictions rather than Luxembourg.54 Incidentally, with this move, Amazon might also avoid the UK’s diverted profits tax which is higher than the normal tax due.55

50  See reports on www.telegraph.co.uk/finance/newsbysector/retailandconsumer/9731618/ Starbucks-branches-hit-by-tax-protests.html, www.theguardian.com/business/2012/dec/09/ starbucks-stores-uk-uncut-protest and many more news outlets. 51  Stephanie Soong Johnston, ‘Starbucks to Pay More UK Tax After Moving Regional Headquarters to London’, 2014 WTD 74-1 (16 April 2014). Starbucks attributed the reduced sales and the drop in turnover to the closure of several unprofitable stores. See Stephanie Soong Johnston, ‘Starbucks Denies U.K. Sales Drop Related to Tax Controversy’, 2014 WTD 80-4 (25 April 2014). 52  Kristen A Parillo, ‘HMRC Targeting Amazon’s U.K. Operations’, 2012 WTD 67-4 (6 April 2012) 53  It has been reported that the Public Accounts Committee branded Cecil’s responses as ‘pathetic’, ‘insulting to everyone’s intelligence’ and ‘not acceptable’. See report available on: www.thebookseller. com/news/amazon%E2%80%99s-corporation-tax-slammed-hoc-committee.html. 54  Stephanie Soong Johnston, ‘Amazon Changes EU Structure to Book Profits in Local Countries’, 2015 WTD 101-1 (27 May 2015). 55  For a discussion on the UK’s diverted profits tax, see Ch 9.

14

New Themes in Taxation

Google’s encounters with the Public Accounts Committee were encapsulated in a report entitled Tax Avoidance—Google (henceforth, the Google Report).56 The Committee questioned how Google, which generated US$18 billion revenue from the UK between 2006 and 2011, could only pay the equivalent of just US$16 million of UK corporation taxes in the same period. It was argued that there was an overwhelming disparity between where the profit was generated and where tax was paid. Google used the now defunct ‘double Irish’ structure. Such a structure was commonly used and allowed companies to shift profits to low or no tax jurisdictions by taking advantage of mismatches in corporate residency rules.57 Google’s subsidiaries in Europe, the Middle East and Africa paid royalties to an Irish limited company which made deductible royalty payments to a Dutch BV. In turn, the Dutch BV made a deductible royalty payment to a dual-resident Irish/Bermuda company. The latter company was only taxable in Bermuda which in fact imposed no corporate income tax. Therefore, effectively, profits earned by Google in royalty-paying jurisdictions remained largely untaxed. Kleinbard described Google’s structure as the archetypal example of stateless income.58 Google defended its tax position by claiming that its sales of advertising space to UK clients took place in Ireland. The Public Accounts Committee found this argument deeply unconvincing on the basis of evidence that, despite sales being billed from Ireland, most sales revenue was generated by staff in the UK. According to the committee: It is quite clear to us that sales to UK clients are the primary purpose, responsibility and result of its UK operation, and that the processing of sales through Google Ireland has no purpose other than to avoid UK corporation tax.59

According to the Public Accounts Committee, this elaborate corporate construct had damaged Google’s reputation in the UK and undermined confidence in the effectiveness of HMRC. The use of a Bermuda company to ultimately shelter the profits was also criticised.60 56 See Google Report published in 17 June 2013, available on: www.parliament.uk/business/ committees/committees-a-z/commons-select/public-accounts-committee/news/tax-avoidancegoogle/. 57  On October 2014, the Irish Finance Minister Michael Noonan announced that from 1 January 2015, Ireland would eliminate the ability of new companies to use the double Irish tax arrangement, by changing residency rules to require all companies registered in Ireland to be Irish tax residents as well. It was also announced that a ‘knowledge development box’ would be introduced in 2016 or when the EU Code of Conduct Group (Business Taxation) completed its review of EU patent box regimes. See Antony Ting, ‘Old Wine in a New Bottle: Ireland’s Revised Definition of Corporate Residence and the War on BEPS’ [2014] British Tax Review 237–47; Margaret Burrow, ‘Ireland to Stop New “Double Irish” Arrangements in 2015’ (2014) 145 Tax Notes 279 (20 October 2014); David D Steward, ‘Ireland Targets “Stateless” Companies in 2014 Budget’, 2013 WTD 200-1 (16 October 2013). 58  Edward Kleinbard, ‘Stateless Income’, n 3 above, 700. 59  Google Report, n 56 above, para 1, p 5. 60  As Bermuda does not impose corporate income taxes, the profits channelled to the Bermuda shell company would not be taxed. See http://www.bloomberg.com/news/articles/2012-12-10/ google-revenues-sheltered-in-no-tax-bermuda-soar-to-10-billion.

Aggressive Tax Planning of MNEs

15

It was argued that Google’s tax structure was highly artificial and primarily served to avoid UK taxes rather than to reflect the substance of the way the business was actually conducted. The Public Accounts Committee found that public confidence in Google would only be restored when it established a corporate structure that ensured Google would pay tax where it generated profit.61 This had to be addressed as a matter of urgency by Google and other companies with a similar corporate structure. The Public Accounts Committee stated it would continue to pursue this issue over the course of Parliament. HMRC and HM Treasury were also criticised by the Public Accounts Committee in the Google Report. It was argued that HMRC had not sufficiently challenged the ‘manifestly artificial tax arrangements’ of multinationals.62 HMRC was hampered by the complexity of existing laws and international tax treaties that allowed for aggressive exploitation of loopholes. It was acknowledged that international tax rules were complicated and had not kept pace with the way businesses operate globally and through the internet. This was not the first time that HMRC had been scrutinised for its efforts to tackle tax avoidance.63 The Public Accounts Committee recommended that HMRC and HM Treasury should push for an international commitment to improve tax transparency, including by developing specific proposals to improve the quality and credibility of public information about companies’ tax affairs, and use that information to collect a fair share of tax from profits generated in each country.64

This data should include full information from companies based in tax havens. In the Google Report, the Public Accounts Committee also emphasised that the reputation of the big accountancy firms in the UK had suffered from their substantial role in advising their clients on corporate structures and tax planning which served only to help them avoid UK taxes. ‘We expect the big accountancy firms to recognise that the public mood on tax avoidance has changed’.65 It was recommended that these accountancy firms should provide responsible advice to ensure that corporate arrangements reflect the substance of transactions in the UK and to enable their clients to be more transparent about where they make profits and pay taxes.66 It was also recommended that HM Treasury introduce a

61 

Google Report, n 56 above, para 1, p 5. Ibid, para 2, p 5. 5 November 2012, Lin Homer, the HMRC chief executive, appeared before the Public Accounts Committee to defend the tax authority’s performance in collecting taxes from multinational corporations. She argued that taxes were collected under laws set by governments, not on the basis of morals. See Julie Martin, ‘HMRC Chief Executive Defends U.K. Transfer Pricing Enforcement’, 2012 WTD 215-3 (6 November 2012). Also see subsequent hearing on 28 October 2013, where HMRC representatives faced fierce questioning on their efforts to curb tax avoidance and the failure to include corporate tax avoidance in their report on the tax gap for 2011-2012. See David D Stewart, ‘UK Public Accounts Committee Grills HMRC Over Tax Gap, Avoidance’, 2013 WTD 209-1 (29 October 2013). 64  See Google Report, n 56 above, conclusions, para 3. Also see p 11, para 17. 65  Ibid, para 4. 66  Ibid. 62 

63 On

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New Themes in Taxation

code of conduct for tax advisers, setting out what it and HMRC consider acceptable in terms of tax planning.67 As regards the role of large accountancy firms in aggressive tax planning, similar concerns had been raised a few months earlier by the Public Accounts Committee. In a report published in April 2013,68 the Public Accounts Committee argued that HMRC was fighting a battle it could not win, due to lack of resources compared to the large accountancy firms.69 In fact, firms and tax avoiders appeared to take advantage of HMRC’s constraints.70 What exacerbated the situation was the fact that due to the complexity of the system, there was no clarity over where to draw the line between acceptable tax planning and tax avoidance.71 Simplicity was the key to fighting tax avoidance. Furthermore, greater transparency over companies’ tax affairs would increase the pressure on multinationals to pay a fair share of tax in the countries where they operate.72 It would also help restore the people’s trust in the fairness of the tax system.73 In a follow-up report on tax avoidance and the role of large accountancy firms published in February 2015, it was concluded that PwC’s activities represented nothing short of the promotion of tax avoidance on an industrial scale.74 This was relevant to the tax advisory industry and its clients as a whole. It was suggested that the UK Government should introduce a code of conduct for all tax advisers. This follow-up report came out after the Luxembourg leaks.75 In November 2014, the International Consortium of Investigative Journalists (ICIJ) had published ­correspondence between PwC and the Luxembourg Inland Revenue, showing

67  Ibid, para 17. Also see: www.kpmg.com/us/en/issuesandinsights/articlespublications/ taxnewsflash/pages/beps-taxnewsflash.aspx. 68  House of Commons Committee of Public Accounts, Tax Avoidance: The Role of Large Accountancy Firms (Forty-fourth Report of Session 2012–13), April 2013. 69  As also mentioned in the main conclusions, the government had to ensure that HMRC was properly resourced to challenge the advice given by the firms to companies and individuals seeking to aggressively avoid tax: ibid, p 6. A similar conclusion was drawn in another report. See House of Commons Committee of Public Accounts, Tax Avoidance: Tackling Marketed Avoidance Schemes (Twentyninth Report of Session 2012–13, HC 788), February 2013. 70  Tax Avoidance: The Role of Large Accountancy Firms, n 68 above, pp 3–4. 71  Ibid, p 3, 5. 72  Ibid, p 5. 73  Ibid, p 13. 74  See House of Commons Committee of Public Accounts, Tax Avoidance: The Role of Large Accountancy Firms (Follow-Up), (Thirty-eighth Report of Session 2014–15). Available on: www.publications. parliament.uk/pa/cm201415/cmselect/cmpubacc/1057/1057.pdf. 75  For details of the Luxembourg leaks project, see www.icij.org/project/luxembourg-leaks. It is thought that two people have been charged for the disclosure, one being a former employee of PwC. See William Hoke, ‘Second Suspect Charged in ‘Lux Leaks’ Case’, 2015 WTD 17-1 (27 January 2015); ‘PwC Releases Update on Luxembourg Leaks Case’, 2015 WTD 8-16 (9 January, 2015). Following the publication of the Luxembourg leaks, the newly appointed European Commission President JeanClaude Juncker faced demands for an investigation into his role and for his resignation. He had been Luxembourg’s Prime Minister at the relevant time. However, on the 27 November 2014 he survived a no-confidence vote in the European Parliament. See Amanda Athanasiou, ‘Juncker Facing Calls for Resignation’, 2014 WTD 224-2 (20 November 2014); Kristen A Parillo, ‘Juncker Survives No-Confident Vote in European Parliament’, 2014 WTD 230-4 (1 December 2015).

Aggressive Tax Planning of MNEs

17

that between 2002 and 2010 PwC secured deals with the Luxembourg tax authorities for 343 MNEs. Many of these MNEs were household names: Amazon, IKEA, Vodafone, Pepsi etc. Some of the documents indicated that many companies had effective tax rates of less than one per cent on profits channelled into Luxembourg. The Public Accounts Committee argued that the Luxembourg leaks contradicted the evidence PwC had given in 2013 that it was not in the business of selling schemes. In fact, the Luxembourg leaks suggested that ‘PWC had advised many multinational firms to adopt similar complex financial structures for the purposes of avoiding tax’.76 The fact that PwC’s promotion of these schemes was permitted by its own code of conduct showed a need for the Government to take a more active role in regulating the tax industry, ‘as it evidently cannot be trusted to regulate itself ’.77 A new code of conduct for tax advisers was needed. The Public Accounts Committee called on HMRC to challenge the nature of the advice being given by accountancy firms to their clients, so as to ensure that tax liabilities reflect the substance of where companies conduct their business. In response to the report,78 PwC stood by the evidence given to the Public Accounts Committee in the past and disagreed with the committee’s conclusions. However, it was recognised that ‘we need to do more to explain the positive role we play in the tax system and in helping businesses to operate successfully’. The complexity of the tax system was raised, as well as the fact that governments competed for investment and tax revenues. ‘We take our responsibility to build trust in the tax system seriously and will continue to support reform’.79 The banking giant HSBC has also found itself the subject of investigation by the ICIJ.80 In February 2015, the ICIJ released information on almost 60,000 files from the bank’s Swiss private banking branch, which (allegedly) showed that the bank profited from holding over US$100 billion in accounts on behalf of arms dealers, corporate executives, entertainers, politicians, religious leaders, and royalty worldwide. The files, the contents of which were not fully disclosed or completely accurate, included account information for more than 100,000 individuals and offshore entities from more than 200 countries for the years 1988 to 2007. As criticised by the ICIJ, HSBC repeatedly reassured clients that it would not disclose details of accounts, even if evidence suggested that the accounts were undeclared to tax authorities in the home country. It was also alleged that bank employees discussed with clients a range of measures that would ultimately allow clients to avoid paying taxes in their home countries.81

76 

Tax Avoidance: The Role of Large Accountancy firms (Follow-Up) Report, n 74 above, para 3. Ibid, p 3. 78  See PwC statement on the 38th report of the Public Accounts Committee, available on: pwc.blogs. com/press_room/2015/02/my-entry.html. 79  Ibid. 80  See ICIJ Swiss leaks project page available on: www.icij.org/project/swiss-leaks. 81 See Key Findings section in: www.icij.org/project/swiss-leaks/new-countries-seek-hsbc-dataand-undeclared-cash. 77 

18

New Themes in Taxation

In a statement obtained by the ICIJ, HSBC admitted that at the time, the c­ ompliance culture and due diligence standards of the bank, as well as the industry in general, were significantly lower than they are today. This was no longer the case because the bank had undergone a radical transformation. HSBC was expected to be called to give evidence at the Public Accounts Committee. Recently, an online group has announced its plans to challenge HMRC for failing to prosecute UK taxpayers whose names were included in a list based on stolen HSBC data and for allowing them to participate in a tax amnesty.82 It is not just UK taxpayers (or any source country taxpayers) that are losing out as a result of the depletion of their tax base due to the tax practices of MNEs. Local competitors are also affected. An increasing number of UK businesses have expressed their concerns about the aggressive tax planning of MNEs.83 The Confederation of British Industry has also issued a set of tax principles for its members, ‘to advance the debate on the responsible management of tax by UK business’.84 These are the Tax Planning principles85 and the Transparency and Reporting ­principles.86 Broadly, pursuant to these principles, UK businesses are 82  Stephanie Soong Johnston, ‘Group Challenges UK Tax Authority on HSBC Tax Scandal’, 2015 WTD 85-5 (4 May 2015). 83  For example, the managing director at John Lewis has complained that UK businesses are at a disadvantage compared to those of multinationals. He called on the Treasury to conduct a closer examination on the way foreign multinational corporations pay taxes in the UK. See Stephanie Soong Johnston, ‘Government to Tackle “Systematic Abuse” of U.K. Tax System, Business Secretary Says’ (2012) 68 Tax Notes International 813 (26 November 2012). The CEO of J Sainsbury plc, Justin King, has voiced similar concerns. See interview in The Daily Telegraph where he called on the Government to follow the US by introducing a ‘marketplace fairness tax’ for online retailers. Available at: www. telegraph.co.uk/finance/newsbysector/retailandconsumer/10116437/Sainsburys-boss-Justin-Kingcalls-for-new-online-sales-tax.html. Furthermore, speaking at the Confederation of British Industry’s annual conference in London, Justin King expressed his disagreement with business leaders who suggest that corporations should pay their taxes only based on the letter of the law. He emphasised that his company pays an effective tax rate of 59 per cent, including corporate tax, VAT, and business rates. See Stephanie Soong Johnston, ‘UK Business Leader Calls for Transparency, Morality in Corporate Taxation’, 2013 WTD 215-1 (6 November 2013). In addition, the CEO of Morrisons, Dalton Philips, has argued that the tax imbalance between internet and high street retailers is illogical and is damaging Britain’s high streets. He has joined other top retailers in demanding a sales tax on online retailers. See interview in The Daily Telegraph, available at: www.telegraph.co.uk/finance/newsbysector/ retailandconsumer/10178768/Philips-takes-the-bull-by-the-horns-in-drive-to-modernise-atMorrisons.html. 84  See Confederation of British Industry: Statement of principles, available as of 5 November 2013, at: www.cbi.org.uk/media/2051390/statement_of_principles.pdf. 85  The principles listed are the following: ‘UK businesses should only engage in reasonable tax planning that is aligned with commercial and economic activity and does not lead to an abusive result; UK businesses may respond to tax incentives and exemptions; UK businesses should interpret the relevant tax laws in a reasonable way consistent with a relationship of “co-operative compliance” with HMRC. In international matters, UK businesses should follow the terms of the UK’s Double Taxation Treaties and relevant OECD guidelines in dealing with such issues as transfer pricing and establishing taxable presence, and should engage constructively in international dialogue on the review of global tax rules and the need for any changes’. Ibid. 86  Inter alia, it is stipulated that: ‘[UK businesses] should consider how best to explain more fully to the public their economic contribution and taxes paid in the UK. This could include an explanation of their policy for tax management, and the governance process which applies to tax decisions, together with some details of the amount and type of taxes paid’. Ibid.

Aggressive Tax Planning of MNEs

19

urged to engage only in reasonable tax planning that is aligned with commercial and economic activity and does not lead to an abusive result. They are further encouraged to seek to increase public understanding in the tax system in order to build public trust in that system. The hearings in the UK Parliament’s Public Accounts Committee and other investigations in other jurisdictions87 so far reflect primarily the source country perspective. The residence country perspective88 is depicted very accurately in numerous hearings in the US Senate where executives from, inter alia, Microsoft, Hewlett-Packard,89 Apple90 and Caterpillar91 were questioned. An overview of the hearings relating to US technology giant Apple illustrates the problems in this area very well. Apple was questioned at the US Senate for the company’s complex tax practices that reportedly led it to successfully shelter US$44 billion from taxation anywhere in the world.92 This was the result of a variety of offshore structures, arrangements and transactions to shift billions of dollars in profits away from the United States and into Ireland, where Apple had negotiated a special corporate tax rate of less than two per cent.93 Their strategy was explained at the US Senate hearings. Overall, the double non-taxation of profits was a result of a combination of ­factors:94

87  See reports of investigations into Apple’s tax planning in both France and Italy. See Teri Sprackland, ‘France Joins List of Countries Investigating Apple’, 2015 WTD 72-2. Also, in October 2014, the Australian Senate Economics References Committee started an inquiry into corporate tax avoidance and is to report back in June 2015. Numerous MNEs, such as Apple, Microsoft and Google, have made representations. See information available on: www.aph.gov.au/Parliamentary_Business/Committees/­Senate/ Economics/Corporate_Tax_Avoidance Also see several reports of the Australian Senate ­committee inquiries into corporate tax avoidance, eg by Google Australia (2015 WTD 82-15), Apple (2015 WTD 82-17) etc. The testimony of the various MNE representatives was recently disputed by the Australian Taxation Office Commissioner. See David D Stewart and Stephanie Soong Johnston, ‘Australian Tax Chief Challenges Multinationals’ Claims’ (2015) 78 Tax Notes International 327, 27 April 2015. 88 See Jane G Gravelle, Tax Havens: International Tax Avoidance and Evasion (Congressional Research Service, 7-5700, dated 23 January 2013). 89  US Senate Permanent Subcommittee on Investigations of the Committee on Homeland Security and Government Affairs, Hearing on Offshore Profit Shifting and the US Tax Code—Part 1 (Microsoft and Hewlett-Packard), 112th Congress Second Session (20 September 2012). 90  US Senate Permanent Subcommittee on Investigations of the Committee on Homeland Security and Government Affairs, Hearing on Offshore Profit Shifting and the US Tax Code—Part 2 (Apple Inc) (21 May 2013) (Apple Hearings). 91  US Senate Permanent Subcommittee on Investigations of the Committee on Homeland Security and Government Affairs, Hearing on Caterpillar’s Offshore Tax Strategy (1 April 2014); US Senate Permanent Subcommittee on Investigations of the Committee on Homeland Security and Government Affairs, Caterpillar’s Offshore Tax Strategy, Majority Staff Report Permanent Subcommittee on Investigations United States Senate—Released in conjunction with the Permanent Subcommittee on Investigations 1 April 2014 Hearing. For commentary, see Jaime Arora, ‘Caterpillar and PwC come under Fire at US Senate Hearing’ 2014 WTD 63-1 (2 April 2014). 92  For a review of Apple’s tax strategy, see Antony Ting, ‘iTax: Apple’s International Tax Structure and the Double Non-Taxation Issue’ [2014] British Tax Review 40–71. 93  Apple Hearings, n 90 above, p 17. 94  See Apple Hearings, n 90 above, p 5 and Ting, n 92 above, pp 46–55.

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New Themes in Taxation

namely, the definition of corporate residence in Ireland and the US,95 transfer pricing rules on intangibles and cost sharing agreements,96 the US Controlled Foreign Corporations rules97 and the check-the-box regime,98 and the low taxes at the source jurisdiction.99 As Professor Stephen Shay testified: ‘Our international tax rules are out of balance. They are too generous to foreign income and not strong enough in protecting against US base erosion by foreign companies investing in the United States. The losers are domestic business’.100

95  This is because a company incorporated in Ireland with central management and control in the US is not tax resident in Ireland, which relies on a central management and control test, nor in the US, which relies on the place of incorporation test. On corporate residency rules, also see Christiana HJI Panayi, ‘UK Corporate Residence’ in Residence of Companies under Tax Treaties and EC Law, EC and International Tax Law Series, vol 5 (IBFD Publications, 2009) pp 817–54. The Apple structure made use of the notorious double Irish tax arrangement which was commonly used to enable companies to shift profits to low or no tax jurisdictions by taking advantage of mismatches in corporate residency rules. It has now been abolished. Also see text in n 57 above. 96  This is because of the transfer of economic rights of Apple’s intellectual property to a low tax jurisdiction under a cost sharing agreement, even though the R&D activities were carried out in the US. See Ting, n 92 above, p 47; Apple Hearings, n 90 above, p 16. Also see Stephen Shay, Hearing before the Permanent Subcommittee on Investigations of the Committee on Homeland Security and Governmental Affairs United States Senate, 112th Congress Session, Testimony before the US Senate Permanent Subcommittee on Investigations—Hearing on Offshore Profit Shifting and the Internal Revenue Code (20 September 2012). 97  This was because of the manufacturing exception of the US CFC regime, whereby CFC income was exempt from immediate taxation if the CFC itself was a manufacturer that added value to the goods. A CFC qualified if it also made a substantial contribution to the goods, without being a manufacturer. Ting, n 92 above, pp 50–51; Apple Hearings, n 90 above, p 16. 98  The check-the-box rules allowed certain business entities to choose their classification for Federal tax purposes under an elective regime. This allowed Apple to maximise their tax savings. ‘By using check-the-box disregarded entities, intercompany transactions within the group of companies that are classified as disregarded entities simply disappear’. Stephen Shay, Hearing before the Permanent Subcommittee on Investigations, n 96 above, p 12. Also see Ting, n 92 above, pp 51–54; Apple Hearings, n 90 above, pp 13–15. 99  See Apple hearings, n 90 above, p 17. ‘One of Apple’s more unusual tactics has been to establish and direct substantial funds to offshore entities that are not declared tax residents of any jurisdiction. In 1980, Apple created Apple Operations International, which acts as its primary offshore holding company but has not declared tax residency in any jurisdiction. Despite reporting net income of $30 billion over the four-year period 2009 to 2012, Apple Operations International paid no corporate income taxes to any national government during that period. Similarly, Apple Sales International, a second Irish affiliate, is the repository for Apple’s offshore intellectual property rights and the recipient of substantial income related to Apple worldwide sales, yet claims to be a tax resident nowhere and may be causing that income to go untaxed … Apple makes use of multiple U.S. tax loopholes, including the check-the-box rules, to shield offshore income otherwise taxable under Subpart F. Those loopholes have enabled Apple, over a four year period from 2009 to 2012, to defer paying U.S. taxes on $44 billion of offshore income, or more than $10 billion of offshore income per year. As a result, Apple has continued to build up its offshore cash holdings which now exceed $102 billion’. 100  Ibid, p 12. At a later article, Stephen Shay argued that the lockout of unrepatriated offshore earnings of US MNEs does not necessarily lead to such economic harm as to justify shifting to a territorial tax system. See Stephen E Shay, ‘The Truthiness of “Lockout”: A Review of What We Know’ (2015) 146 Tax Notes 1393–99 (16 March 2015) and studies cited therein. Under US law, these offshore earnings can be invested in the stock or debt of any unaffiliated US company or in a deposit of any unaffiliated US bank, without triggering a distribution. On the basis of the scant evidence available, he argues

Aggressive Tax Planning of MNEs

21

At the US Senate hearings, Apple’s CEO Tim Cook emphasised that everything the company did was legal and all taxes owed were paid. As noted in the Subcommittee’s report, ‘Apple executives told the Subcommittee that the company has no intention of returning those funds to the United States unless and until there is a more favourable environment, emphasizing a lower corporate tax rate and a simplified tax code’.101 Senator Carl Levin, the Subcommittee Chairman and the Senator who had proposed the ill-fated Stop Tax Haven Abuse Act in 2007102 called Apple’s quest for lower corporate taxes the Holy Grail of tax avoidance. Arizona Senator and former presidential candidate John McCain, praised Apple for its innovations and for being a major US corporation and taxpayer. However, he argued that Apple had violated at least the spirit if not the letter of the law. McCain stressed Congress was at fault for not simplifying the tax code.103 Notwithstanding these statements, it should be stressed that the attitude of the US government over its MNEs is considered rather indulgent, especially after the launch of the BEPS project. The general approach seems to be that if the MNE’s double non-taxed income were to be taxed somewhere, then the US, which facilitated its creation, should collect the tax revenue.104 Nevertheless, to a large extent, the comments of the Committee members in all these investigations, whether from a source country or a residence country perspective,105 reflect public opinion. What underpins them is the idea that multinationals should follow the spirit and not just the letter of the law—and pay taxes according to that. This is buttressed by an overriding concept of tax m ­ orality or tax justice which trumps black letter law. By contrast, what underpins the

that lockout ‘is a problem principally for a small number of the largest multinationals, grouped predominantly in the technology and healthcare sectors, that may be engaging in profit shifting’. Ibid, p 1399. Referring to a 2011 Senate Permanent Subcommittee on Investigations report which conducted a survey of 27 US MNEs, almost half of undistributed earnings were held in US financial institutions (Permanent Subcommittee of Investigations, Offshore Funds Located Onshore, Majority Staff Addendum (14 December 2011)). Also see Lee A Sheppard, ‘Debunking the Overseas Cash Meme’ (2015) 78 Tax Notes International 700, 25 May 2015. 101 

Apple Hearings, n 90 above, p 5. See www.govtrack.us/congress/bills/113/hr1554. 103  See, press reports in www.theguardian.com/technology/2013/may/20/apple-accused-taxavoidance-billions-scheme, www.huffingtonpost.com/2013/05/21/apple-senate-hearing-irish-taxloophole_n_3312575.html, www.usatoday.com/story/money/business/2013/05/21/apple-tax-hearing/ 2344351/. 104  See discussion in Ch 9 of this volume. Also see Antony Ting, ‘The Politics of BEPS—Apple’s International Tax Structure and the US attitude towards BEPS’ (2015) 69 Bulletin for International Taxation 410–15. Ting argues that this lenient approach is evident in the Caterpillar hearing held on 1 April 2014, n 91 above. 105  Some jurisdictions could encounter aggressive tax planning on the basis of both perspectives. For example, according to a policy brief by the Progressive Policy Institute, although European politicians have complained that US MNEs are taking advantage of loopholes in foreign countries’ tax laws to reduce their liability, foreign companies operating in the US also benefit by paying lower taxes than their American counterparts. Reported in Tax Analysts, 2015 WTD 96-22 (18 May 2015). 102 

22

New Themes in Taxation

c­ omments of those chosen or asked to defend the tax planning practices of these ­multinationals is the idea that legality and illegality is determined according to the letter of the law. Compliance with it should be sufficient. If people disapprove of tax planning practices, whether perceived to be aggressive or not, but still legal, then they (or better, their governments unilaterally or in a coordinated manner) should change the relevant tax laws. Another issue emerging from these and other hearings is the adequacy and suitability of existing principles of international tax law to deal with the internationalisation of business.106 Some argue that existing tax rules on jurisdiction to tax, in particular, need to be adapted to new business models such as the digital model. Others argue that the existing principles are sufficient but there is discord as to how tax authorities ought to apply them in some cases. As shown in the following chapter, the OECD, in the development of the BEPS project, has the unenviable task of trying to find solutions to some of these issues. While the traditional concept of legality as the determining factor of what is acceptable and what is not remains—with the OECD endeavouring to shed light on this through its BEPS project—the reputational question, as vague as it may be, is coming to the fore and in some cases becoming all-pervasive, to the detriment of legal certainty and sometimes efficiency. Arguably, the injection of notions of morality into the debate has added further complexity and uncertainty to an already complicated field. Moreover, whether standards of morality and fairness have a place in corporate taxation is still very much debated.107 Nevertheless, when advising on or designing the optimum (legal) tax structure, tax advisers are now faced with additional questions. How might this structure be perceived by the public? What will the reputational risk be? Some tax savings may have to be foregone so as not to attract criticism and to ‘appease’ the public. Overall, tax arrangements are being assessed on an increasingly ill-defined set of criteria.108 This has led to the development of notions of corporate tax responsibility—as far as companies are concerned—and good governance in tax matters—as far as countries are concerned. These are examined next.

1.3.  Good Governance in Tax Matters Good governance in tax matters is a concept that is acquiring increasing importance and institutional backing, both internationally and, especially, in the European Union.

106 

Also Ault, Schön and Shay, n 5 above. See comments of a Canadian tax judge reported by Stephanie Soong Johnston, ‘Fiscal Morality a “Nonstarter” for Tax Court Decisions, Canadian Judge Says’, 2014 WTD 111-3 (10 June 2014). 108  David D Stewart, ‘The Fight Against Tax Avoidance and the Uncertainty of Morality’ (2013) 72 Tax Notes International 99 (14 October 2013). 107 

Good Governance in Tax Matters

23

The OECD and the UN have called for measures to improve governance through tax reform.109 In a report published in 2010,110 the OECD recognised the role of taxation as an important catalyst for state capacity development. The report explored how taxation could improve governance. This was to be done first, by developing a shared interest for economic growth. It was argued that governments which depend on taxes have stronger incentives for promoting economic growth.111 As a second measure, there should be a development of the state apparatus and tax collection through an improved and functioning administration as well as other agencies. Thirdly, notions of accountability and responsiveness ought to be cultivated further,112 by improving equity in tax enforcement and administration, as well as improving transparency and strengthening civil society engagement with tax issues.113 As noted, taxation engages taxpayer-citizens in politics; ‘[g]overnments which rely on taxes have incentives to improve governance in order to ensure tax compliance’.114 The report examined the implications of the latter two processes for tax reform in the developing world. The impact of foreign aid on domestic revenue generation and collection, as well as on the dependence of governments on tax revenue were also considered. It was questioned whether reliance on aid instead of taxation could undermine all three processes listed above. By reducing the dependence of governments on tax revenue, aid could reduce political pressures for greater responsiveness and accountability.115 Recommendations were made to governments to manage the provision of foreign aid in ways that maximise positive revenue-raising incentives and local accountability.116 The overtone of the report was that an effective tax system played a key role in state-building and in developing the economy.117 For that, broader governance improvements were necessary. In its report, the OECD concluded that measures to improve tax governance and to support more integrated administrative structures were indispensable to any long-term strategy of achieving revenue stability and self-sufficiency.118

109  Alicja Brodzka and Sebastiano Garufi, ‘The Era of Exchange of Information and Fiscal Transparency: The Use of Soft Law Instruments and the Enhancement of Good Governance in Tax Matters’ (2012) 52 European Taxation 394; Gemma Martinez Barbara, ‘The Role of Good Governance in the Tax Systems of the European Union’ (2011) 65 Bulletin for International Taxation 270. 110 OECD, Citizen-State Relations: Improving Governance Through Tax Reform (Paris, 2010). 111  Ibid, p 9. 112  Ibid, pp 9–10. 113  Ibid, pp 10–11. 114  Ibid, p 9. 115  Ibid, p 12. 116  Ibid, ch 4 entitled ‘The role of development partners in building tax-governance linkages’, pp 51–58. 117  It was, however, acknowledged in the concluding ch 5 of the report, n 110 above, that further research on the linkage between taxation and state-building was necessary. It was also conceded that in the report there was heavy reliance on case studies from a relatively small number of countries. Furthermore, very few of the suggestions made had been rigorously and specifically tested in practice. 118  Gemma Martinez Barbara, n 109 above, p 270.

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New Themes in Taxation

Similarly, in developing fiscal good governance principles, the UN’s focus is on supporting tax policies for developing countries, removing obstacles to crossborder operations and fighting tax evasion. Following a UN-led international conference on financing for development in 2008, the Doha conference, the Doha Declaration on Financing for Development was adopted by consensus.119 The Doha Declaration recognised the importance of strengthening technical assistance and enhancing international cooperation in addressing international tax matters, including in the area of double taxation. Commitments were made to enhance tax revenues through modernised tax systems, and more efficient tax collection. This would help broaden the tax base and effectively combat tax evasion. The Doha Declaration also reaffirmed the Monterrey Consensus120 and called for a United Nations Conference at the highest level to examine the impact of the world financial and economic crisis on development. The European Union has also had an active involvement in the development of the concept of good governance. At an ECOFIN meeting in 2008, one of the conclusions of the Council was to promote the principles of good governance in the tax area, described as ‘the principles of transparency, exchange of information and fair tax competition, as subscribed to by Member States at Community level’.121 Good governance in the tax area was seen as an essential means for combating cross-border tax fraud and evasion and for strengthening the fight against money laundering, corruption, and the financing of terrorism. This task was taken on by the Commission. A series of initiatives had already been undertaken prior to the ECOFIN resolution,122 which in 2009 culminated in a Communication for the promotion of good governance in tax matters.123 In this Communication, the Commission suggested measures124 to strengthen the ­principle of good governance in the tax area within the European Union and

119 UN, Doha Declaration on Financing for Development: Outcome Document of the Follow-up International Conference on Financing for Development to Review the Implementation of the Monterrey Consensus, 9 December 2008, para 16, pp 8–9. 120 See Monterrey Consensus of the International Conference on Financing for Development (2003). Available on: www.un.org/esa/ffd/monterrey/MonterreyConsensus.pdf. 121  Press Release, 2866th Council Meeting, Economic and Financial Affairs (8850/08 (Presse 113), Brussels, 14 May 2008) p 22. 122  See eg Communications on Preventing and Combating Corporate and Financial Malpractice (COM(2006) 611), on Caribbean countries (COM(2006) 86), on Pacific countries (COM(2006) 248), on Hong Kong and Macao (COM(2006) 648), on Governance and Development (COM(2006) 421) and on EU competitiveness (COM(2006) 567). 123  Communication from the Commission to the Council, the European Parliament and the European Economic and Social Committee, Promoting Good Governance in Tax Matters, 28 April 2009. See Timothy Lyons, ‘Promoting Good Governance in Tax Matters’ [2009] British Tax Review 361; Gemma Martinez Barbara, n 109 above; Alicja Brodzka and Sebastiano Garufi, n 109 above; Wolfang Schön, ‘Tax and Corporate Governance: A legal Approach’ in Wolfgang Schön and others (eds), Tax and Corporate Governance (Berlin/Heidelberg, Springer-Verlag, 2008). 124  Good Governance Communication, n 123 above, pp 9–10.

Good Governance in Tax Matters

25

internationally. It identified existing internal initiatives, as well as proposals to improve the Mutual Assistance Directive125 and the Savings Directive.126 The Commission urged the Council to give the issue of good governance in the tax area appropriate political priority and to include provisions to that effect in general agreements with third countries.127 Member States were also encouraged to establish a more unified approach towards third countries, regardless of whether those countries apply the principles of good governance in the tax area.128 Finally, the Commission reiterated its intention to pursue a constructive dialogue with all stakeholders concerned.129 The European Parliament has also adopted a resolution promoting good governance in the area of taxation. In this resolution, the European Parliament condemned the role played by tax havens in encouraging and profiting from tax avoidance, tax evasion and capital flight and urged Member States to make the fight against these phenomena a priority.130 The resolution also noted the need for an EU policy of good tax governance.131 At a subsequent ECOFIN Council meeting, the Commission was given a mandate to initiate dialogue with Switzerland and Liechtenstein, to extend the Code of Conduct on Business Taxation beyond the European Union for the first time.132 This would facilitate the promotion of the principles of the Code of Conduct in third countries.133 In 2012, in furtherance to the Commission’s plan to strengthen the fight against tax fraud and evasion, the Commission published two recommendations. One dealt with aggressive tax planning134 and the other one with measures intended to encourage third countries to apply minimum standards of good governance in tax matters.135 Arguably, to the Commission these are two sides of the same coin. Member States should tackle aggressive tax planning but at the same time, they should also ensure that they as well as any third countries they interact with,

125 

See proposal COM(2009) 29 of 2 February 2009. See proposal COM(2008) 727 of 13 November 2008. Also see Christiana HJI Panayi, ‘The proposed amendments to the Savings Directive’ (2009) 49 European Taxation 179. 127  Good Governance Communication, n 123 above, p 10. 128  Ibid, p 13. 129  Ibid, p 14. 130  See European Parliament resolution of 10 February 2010 on promoting good governance in tax matters (2009/2174(INI)), para 1. 131  Ibid, para 17. 132  3020th Council meeting Economic and Financial Affairs, Luxembourg, 8 June 2010, PRESSE 162, 10689/10. 133  Ibid, p 20. 134  Communication from the Commission to the European Parliament and the Council, An Action Plan to strengthen the fight against tax fraud and tax evasion, COM(2012) 722. See extensive analysis in Ch 5 of this volume. 135  Communication from the Commission to the Council on concrete ways to reinforce the fight against tax fraud and tax evasion including in relation to third countries, COM(2012) 351. See analysis in Ch 5 of this volume. 126 

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apply principles of good governance. In the Good Governance Recommendation, ­Member States were urged to reinvigorate the work of the Code of Conduct on Business Taxation. In fact, in order to encourage third countries to apply minimum standards of good governance in tax matters, Member States were urged to renegotiate, suspend or terminate tax treaties with third countries that do not respect the principles of the Code of Conduct and to place such countries on national blacklists. As a follow-up, the Commission announced on 23 April 2013 that it would set up a Platform for Tax Good Governance.136 The Platform was set up to monitor Member States’ progress in tackling aggressive tax planning and clamping down on tax havens. Its tasks were, inter alia, to encourage discussion between businesses, civil society and national tax authorities on issues of good governance in tax matters. The term good governance in tax matters was to cover transparency, exchange of information and fair tax competition. The Platform would make suggestions to the Commission on the appropriate means and instruments to achieve progress in these areas. A Call for Application to select the member organisations of the Platform was launched the same day.137 The European Union has exerted considerable influence on third countries to support the dialogue on governance. For example, clauses of commitment to good governance in different policy areas have been included in various European Neighbourhood Policy instruments.138 Also, as far as developing countries are concerned, the Commission provides financial incentives and funding to countries that support and implement governance-related objectives and reforms.139 In addition, the Enlargement Policy strategy of the European Union is intended to address good governance in tax matters at an early stage of the pre-accession process.

136  See decision of 23 April 2013, C(2013) 2236 final and European Commission Press Release dated 23 April 2003, reported in Tax Analysts in Doc 2013-9887. Also see Stephanie Soong Johnston, ‘AntiEvasion Initiative Meant to Create “Peer Pressure” Among EU’ in 2013 WTD 73-2 (24 April 2013). 137  The first appointment of member organisations was made in June 2013. In line with article 4(2) of the Commission Decision of 23 April 2013, C(2013)2236, Members of the Platform are the tax authorities of all Member States and 15 organisations representing business, civil society and tax practitioners. Some of the selected organisations are Tax Justice Network, Christian Aid, Oxfam International, BusinessEurope, the ACCA, the International Chamber of Commerce and the European Association of Tax Law Professors. The Platform meets approximately three times a year. It is chaired by the Director-General of DG Taxations and Customs Union. The work of the Platform on these issues is still very much in progress. See ec.europa.eu/taxation_customs/taxation/gen_info/ good_governance_matters/platform/index_en.htm. 138  Gemma Martinez Barbara, ‘The Role of Good Governance in the Tax Systems of the European Union’ (2011) 65 Bulletin for International Taxation 270. 139  See Gemma Martinez Barbara, ibid, at p 277, who notes that the European Neighbourhood and Partnership Governance Facility provides funding to partner countries that are assessed as having made the most progress in implementing the governance-related objectives of their agreed reform agenda as set out in their Action Plans. The 10th European Development Fund (EDF, 2008–13) also offers additional funding to support a dialogue on governance and reform, including in respect of taxation.

Good Governance in Tax Matters

27

In February 2013, the Commission issued a consultation paper on the proposal for the development of a European Taxpayer’s Code.140 It was proposed that in order to improve tax compliance, the Commission would compile good administrative practices in Member States to develop a taxpayers’ code setting out best practices for enhancing cooperation, trust and confidence between tax administrations and taxpayers, for ensuring greater transparency on the rights and obligations of taxpayers and encouraging a service-oriented approach.141

By improving relations between taxpayers and tax administrations and by enhancing the transparency of tax rules, tax compliance would be encouraged, leading to more effective tax collection. Most of the contributions to the consultation paper were in favour of the development of a European Taxpayer’s Code, as this would ensure equal treatment of all citizens and a higher level of legal certainty, enhance transparency and harmonise the different legal systems.142 However, it had also been expressed that a European Taxpayer’s Code should in no way be binding, as national tax matters are a highly sensitive issue and there would be a danger of going too far, too fast at European level. Furthermore, any attempt to make a code binding would raise subsidiarity concerns. Other concerns expressed were that such a code would jeopardise legal certainty and merge different principles of different jurisdictions. Finally, such a code would not be an appropriate instrument to tackle tax fraud and tax ­evasion.143 A Fiscalis Working Group consisting of national experts was established to discuss and develop a European Taxpayer’s Code, in light of these conclusions. Nothing has been reported at the time of writing. It is obvious that the concept of good governance in taxation is becoming very important not only within the European Union but also internationally. This is also reflected by some of the guidelines and soft law produced lately. Measures promoting good governance in taxation are also seen as part of the polemic against multinationals’ aggressive tax planning or tax avoidance—it is the other side of the coin. The international tax community cannot just police ‘rogue’ taxpayers; it needs to also police and rehabilitate ‘rogue’ states or states with some questionable regimes or rules. Nevertheless, any concrete developments in this area are likely to require political will. There is certainly scope for more coordinated action by EU Member States, so as to support, streamline and complement international action taken in other fora such as the OECD and the UN. Outside of the European Union, instilling and institutionalising principles of good tax governance may not

140  Consultation Paper, A European Taxpayer’s Code (Brussels, 25 February 2013, TAXUD.D.2.002 (2013)) 276169. See Ch 5, section 5.3.1 of this volume. 141  Ibid, p 2. 142 See Summary Report on the outcome of the public consultation from DG TAXUD (Brussels, 12 September 2013 TAXUD.D.2 (Ares 2013) 3252439), p 6. 143  Ibid, p 6.

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be an easy task, as such p ­ rinciples are likely to be seen as interfering with a state’s sovereignty in a much more p ­ olitically sensitive way than any suggested anti-abuse measures targeted against what appears to be stateless income. What is also evident from the above is that the idea that taxes are part of statebuilding is beginning to be engrained. Therefore, taxing powers must be exercised in a certain way by countries. There is also the reverse of that—ie that companies are beginning to be expected to behave in a certain way not only by tax authorities internationally but also by civil society. This is certainly the undertone of the various hearings discussed in section 1.2 above. There seems to be a demand for the political rhetoric to translate to concrete societal benchmarks, which are not necessarily underpinned by existing tax laws. Corporate social responsibility, primarily a management concept whereby companies integrate social and environmental concerns in their business operations and interactions with their stakeholders,144 is beginning to be used in this field. This is examined below.

1.4.  Corporate Social Responsibility and Aggressive Tax Planning As explained above, initiatives on good governance relate to the tax policies of countries. Corporate social responsibility (CSR) in the tax context relates to the conduct of the tax affairs of companies. It is a relatively new concept, or rather a new application of an old concept. It has been argued that paying taxes is a fundamental and easily measured example of a company’s citizenship behaviour. In other words, there is a link between CSR and the payment of taxes, and, as a corollary, CSR and aggressive tax planning or tax avoidance.145 Although literature

144  The literature on CSR is vast. See, inter alios, Archie B Carroll, Kenneth J Lipartito, James E Post and Patricia H Werhane, Corporate Responsibility: The American Experience (Cambridge University Press, 2012); Michael C Jensen, ‘Value Maximization, Stakeholder Theory and the Corporate Objective Function’ (2001) Journal of Applied Corporate Finance 8–21; Ioannis Ioannou, George Serafeim and Robert G Eccles, ‘The Impact of a Corporate Sustainability on Organizational Processes and Performance’ (2014) 60 Management Science 2835–57 etc. 145  See, inter alios, Reuven Avi-Yonah, ‘Corporations, society, and the state: A defense of the corporate tax’ (2004) 90 Virginia Law Review 1193; Reuven Avi-Yonah, ‘Corporate social responsibility and strategic tax behaviour’ and Schön, ‘Tax and Corporate Governance: A legal Approach’ in Wolfgang Schön (ed), Tax and corporate governance (Berlin/Heidelberg, Springer-Verlag, 2008); Reijo Knuutinen, ‘Corporate Social Responsibility, Taxation and Aggressive Tax Planning’ (2014) 1 Nordic Tax Journal 36–75; Mihir Desai and Dhammika Dharmapala, ‘CSR and Taxation: The missing Link’ (Winter 2006) Leading Perspectives (Business for Social Responsibility) 4–5; Grahame R Dowling, ‘The Curious Case of Corporate Tax Avoidance: Is it Socially Irresponsible?’(August 2013) Journal of Business Ethics; Jasmine M Fisher, ‘Fairer Shores: Tax Havens, Tax Avoidance, And Corporate Social Responsibility’ (2014) 94 Boston University Law Review 337; Moran Harari, Ofer Sitbon and Ronit Donyets-Kedar, ‘Aggressive Tax Planning and Corporate Social Responsibility in Israel’ (2013) Accountancy Business and the Public Interest 1; Grant Richardson, Corporate Social Responsibility and Tax Aggressiveness, AAA Conference 6–10 August 2011, Denver, Colorado, USA.

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on mainstream CSR is voluminous, there is not much discussion on this specific angle of tax avoidance, which is distinguishable from tax evasion.146 First, it is useful to describe what CSR entails or purports to entail from a general perspective. There are many definitions of CSR.147 For example, CSR has been defined by a UK Government report as ‘how business takes account of its economic, social and environmental impacts in the way it operates—maximizing the benefits and minimizing the downsides’.148 However, the report adds, ‘we are not talking about altruism—CSR should be good for long-term business success as well as good for wider society’.149 In a report produced by SustainAbility in 2006, corporate responsibility was described as an approach to business that embodies ‘a commitment to economic, social and environmental accountability, open and transparent business principles and practices, ethical behaviour rooted in clearly defined values and active respect for the full range of stakeholders’.150 Earlier definitions also captured the voluntary nature of CSR. For example, Engel argued that CSR refers to the ‘obligations and inclinations, if any, of corporations organised for profit, voluntarily to pursue social ends that conflict with the presumptive shareholder desire to maximize profit’.151 Similarly, in its Green Paper, the European Commission saw CSR as ‘a concept whereby companies

146  Some contributions do not make a distinction between the two concepts in arguing that CSR applies in corporate taxes. The point is also made by Fisher, n 145 above, at p 352 who gives as an example the following articles: John Christensen and Richard Murphy, ‘The Social Irresponsibility of Corporate Tax Avoidance: Taking CSR to the Bottom Line’ (2004) 47 Development 37 and Prem Sikka, ‘Smoke and Mirrors: Corporate Social Responsibility and Tax Avoidance’ (2010) 34 Accounting Forum 153. Also see Christensen and Murphy who state, at p 39, that the ‘scale of tax-avoidance activity has become so enormous that it can fairly be described as a shadow economy operating in the majority of globalized sectors…’. For criticism of Sikka’s paper see John Hasseldine and Gregory Morris, ‘Corporate Social Responsibility and Tax Avoidance: A comment and reflection’ (2013) 37 Accounting Forum 1–14. 147  For an interesting historical overview of CSR, see Harwell Wells, ‘The Cycles of Corporate Social Responsibility: An Historical Retrospective for the Twenty-first Century’ (2002) 51 Kansas Law Review 77. Also see Cynthia A Williams, ‘Corporate Social Responsibility in an Era of Economic Globalization’ (2002) 35 UC Davis Law Review 705; Joe W Pitts, ‘Corporate Social Responsibility: Current Status and Future Evolution’ (2009) 6 Rutgers Journal of Law & Public Policy 334; Aviva Geva, ‘Three Models of Corporate Social Responsibility: Interrelationships between Theory, Research and Practice’ (2008) 113 Business & Society Review 1–41 and William Allen, ‘Our Schizophrenic Conception of the Business Corporation’ (1992) 14 Cardozo Law Review 261. For criticism because of the divergent definitions, see Michael Hopkins, ‘Criticism of the Corporate Social Responsibility Movement’ in R Mullerat (ed), Corporate Social Responsibility: The Corporate Governance of the 21st Century 543, 2nd edn (Kluwer Law International, 2011); Michael Hopkins, Corporate Social Responsibility & International Development (Earthscan, 2007). 148  UK Government, Corporate Social Responsibility: A Government Update, May 2004, p 3. Available on: www.berr.gov.uk/files/file48771.pdf. 149  Ibid. 150  SustainAbility report, entitled Tax Issues—Responsible Business and Tax, p 10. Available on: www. taxjustice.net/cms/upload/pdf/Sustainability_taxing_issues.pdf. 151 David L Engel, ‘An Approach to Corporate Social Responsibility’ (1979) 32 Stanford Law Review 1, 5–6.

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decide voluntarily to contribute to a better society and a cleaner environment’.152 In describing the concept, the Commission Green Paper explained that it is a ‘concept whereby companies integrate social and environmental concerns in their business operations and in their interaction with their stakeholders on a voluntary basis’.153 Furthermore, as explained, being socially responsible meant ‘not only fulfilling legal expectations, but also going beyond compliance and investing “more” into human capital, the environment and the relations with stakeholders’.154 It is noteworthy that in the Green Paper, it was emphasised that CSR should ‘not be seen as a substitute to regulation or legislation concerning social rights or environmental standards, including the development of new appropriate l­ egislation’.155 When such regulations do not exist, ‘efforts should focus on putting the proper regulatory or legislative framework in place in order to define a level playing field on the basis of which socially responsible practices can be ­developed’.156 In this Green Paper, there was no mention of corporate tax responsibility. Passing reference was once made to ‘tax revenues’ as one of the contributions that companies make to their communities.157 In a later discussion document published in 2011, the Commission renewed its commitment to a CSR policy.158 It was emphasised that CSR ‘concerns actions by companies over and above their legal obligations towards society and the ­environment’.159 As the economic crisis and its social consequences ‘have to some extent damaged consumer confidence and levels of trust in business’,160 the businesses have focused public attention on the social and ethical performance of enterprises. By renewing efforts to promote CSR now, the Commission aimed to create conditions favourable to sustainable growth, responsible business behaviour and durable employment generation in the medium and long term. The Commission reviewed its pioneering role in the development of CSR and the establishment of the European Multistakeholder Forum on CSR.161

152 Commission, Green Paper, Promoting a European Framework for Corporate Social Responsibility, COM(2001) 366 final, para 8, p 4. For commentary, see Kristina K Herrmann, ‘Corporate Social Responsibility and Sustainable Development: The European Union Initiative as a Case Study’ (2004) 11 Indiana Journal of Global Legal Studies 205. 153  Ibid, para 20, p 6. This definition is repeated in Commission, A renewed EU strategy 2011–14 for Corporate Social Responsibility, COM(2011) 681 final, Brussels, 25 October 2011, p 3. 154  Ibid, para 21, p 6. 155  Ibid, para 22. 156  Ibid. 157  See para 43: ‘Corporate social responsibility is also about the integration of companies in their local setting, whether this be in Europe or world-wide. Companies contribute to their communities, especially to local communities, by providing jobs, wages and benefits, and tax revenues’. 158  Communication from the Commission to the European Parliament, the Council, the European Economic and Social Committee and the Committee of the Regions, A renewed EU strategy 2011–14 for Corporate Social Responsibility, COM(2011) 681 final, Brussels, 25 October 2011. 159  Ibid, p 3. 160  Ibid, p 4. 161  Ibid, pp 4–6.

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The Commission put forward a new definition of CSR as ‘the responsibility of enterprises for their impacts on society’.162 To meet their CSR duties, the Commission urged enterprises to have in place a process ‘to integrate social, environmental, ethical, human rights and consumer concerns into their business operations and core strategy in close collaboration with their stakeholders’.163 The aim was to maximise the creation of shared value for their owners/shareholders and for their other stakeholders and society at large, as well as identify, prevent and mitigate possible adverse impacts.164 In this report, the Commission referred to the multidimensional nature of CSR. According to the Commission, the concept at least covers human rights, labour and employment practices, and combating bribery and corruption.165 For the first time in its CSR discourse, the Commission promoted the three principles of good tax governance in relations between states: transparency, exchange of information and fair tax competition. Enterprises were encouraged, where appropriate, also to work towards the implementation of these principles.166 It was highlighted that the development of CSR should be led by enterprises themselves, as appropriate to their circumstances, and that public authorities should play a supporting role.167 In the remainder of the report, the Commission set out its agenda on how to promote CSR, as well as suggestions for enterprises, Member States, and other stakeholder groups. As far as taxes were concerned, it was merely stated that ‘the Commission encourages enterprises to disclose information related to the implementation of good tax governance standards’.168 The European Parliament resolution on CSR in 2013 was in the same spirit.169 It was stressed that businesses could not take over public authorities’ responsibility for promoting, implementing and monitoring social and environmental standards.170 The development of CSR ought to be driven primarily through the multi-stakeholder approach. Businesses had an important role and must be able to develop an approach tailored to their own specific situation.171 As for tax planning, the language used in this resolution was much stronger than in the Commission’s Communication—‘a business’s tax policy should be considered part and parcel of CSR and that socially responsible behaviour consequently leaves no room for strategies aimed at evading tax or exploiting tax havens’.172

162 

Ibid, p 6. Ibid, p.6 164  Ibid, p 6. 165  Ibid, p 7. 166  Ibid. 167  Ibid. 168  Ibid, p 11. 169 See European Parliament Resolution of 6 February 2013 on corporate social responsibility: accountable, transparent and responsible business behaviour and sustainable growth (2012/2098(INI)). 170  Ibid, para 1. 171  Ibid, para 56. 172  Ibid, para 7. 163 

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The importance of transparency was stressed, ‘[to] combat tax avoidance and illicit money flows’.173 The European Parliament emphasised the need for any regulatory measures to be drawn up within a robust legal framework and in line with international standards, in order to avoid disparate national interpretations, leading to the emergence of competitive advantages or disadvantages at regional or national level.174 This is a very important point. CSR-driven tax standards, as all types of tax standards, will inevitably impact on a company’s profitability as certain tax planning strategies will no longer be available. If only some countries adopt these standards and others do not, then this will distort the level playing field. In other words, countries that adopt these standards might lose their competitive edge. A similar problem arises with the proposals made in the BEPS project and is discussed in subsequent chapters. This is an issue that ought to be seriously considered especially in the European Union, which is leading the way with its own Action Plan.175 Irrespective of the development of the concept of CSR and the extent to which it actually includes (or should include) tax planning, what is evident from these definitions is the inherent conflict with the idea that a company exists solely to maximise profits for its shareholders, and that corporate social responsibility goes against this primary objective of the company. As Reuven Avi-Yonah claimed, our view of CSR largely depends on our view of the corporation. He explains that historically, three views of the corporation had emerged and rotated in cyclical fashion.176 The first view is the ‘artificial entity’ view whereby the corporation is primarily a creature of the state. The second view is the ‘real entity’ view in that the corporation is an entity separate from both the state and from its shareholders. The third view is the ‘aggregate’ or ‘nexus of contracts’ view, whereby the corporation is merely an aggregate of its individual members or shareholders. As Avi-Yonah explains, each of these three views has different implications for the issue of tax and CSR. Under the first two views—ie the artificial entity view and the real entity view—CSR is encouraged as a means of fulfilling the corporation’s obligations to the state. The state is also justified in using the corporate tax as a regulatory device to steer corporate CSR activity. However, under the ‘aggregate’ or ‘nexus of contracts’ view, CSR is an illegitimate attempt by managers to tax shareholders without their consent and leads to managers being unaccountable to their shareholders. Pursuant to this view, the management’s responsibility is to maximise shareholder profits by minimising corporate taxes as much as possible.

173 

Ibid, para 22. Ibid, para 54. 175  See Ch 5 of this volume. For a discussion on the application of CSR in the EU context, also see Luca Cerioni, ‘Corporate Social Responsibility (CSR): Crucial Issues and a Proposed “Assessment” in the European Union Context’ (2014) 25 European Business Law Review 845–74. 176 Reuven S Avi-Yonah, ‘The Cyclical Transformations of the Corporate Form: A Historical ­Perspective on Corporate Social Responsibility’ (2005) 30 Delaware Journal of Corporate Law 767. 174 

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The state has no business in encouraging corporations to engage in illegitimate CSR through the tax system. Very representative of this approach, Milton Friedman stated in 1970, that ‘there is … only one social responsibility of business—to use its resources and engage in activities designed to increase its profits’.177 Avi-Yonah disagreed with this approach, in that taken to its logical extreme, it is self-defeating. If corporations are not permitted to engage in CSR, then all social responsibility functions devolve to the state. As corporate managers would be required to minimise their tax payments as much as possible, that could mean that the state is left without adequate resources to fulfil its governmental functions, given that, it is argued, the payment of corporate income tax ensures the financing of public goods.178 Therefore, if CSR is not applicable, neither corporations nor the government can fulfil their responsibilities to society and this would not be an acceptable outcome. Other scholars have also argued that a corporation’s tax aggressive policies may have a negative effect on society and may be socially irresponsible.179 Judith Freedman discussed the concept of enlightened shareholder value which has shifted the emphasis from immediate profit maximisation.180 ‘Longer term and sustainable profit maximisation is not only consistent with paying regard to wider stakeholder interests but is actually dependent upon doing so’.181 In an opinion issued on 7 June 2013 by Farrer & Co to Tax Justice Network Ltd,182 it was stated that it was not possible to construe the directors’ statutory duty to promote the success of the company183 as constituting a positive duty to avoid tax. On the contrary, legislation expressly protected directors from criticism in circumstances where they took decisions based on the kind of factors which would militate against tax avoidance (eg change-of-law risk, reputation, brand impact, relationship with HMRC and community impact). The idea of a strictly fiduciary duty to avoid tax was wholly misconceived, according to the authors of the opinion.

177  See Milton Friedman, ‘A Friedman Doctrine—the Social Responsibility of Business Is to Increase Its Profits’, New York Times Magazine, 13 September 1970, at p 32 (citing Milton Friedman, Capitalism and Freedom (University of Chicago Press, 1962) 133). 178  Arne Freise, Simon Link, and Stefan Mayer, ‘Taxation and corporate governance—the state of the art’ in Wolfgang Schön (ed), Tax and Corporate Governance (Berlin/Heidelberg, Springer-Verlag, 2008). 179  See David F Williams, Developing the Concept of Tax Governance (KPMG, 2007) and references therein. Also see Urs Landolf, ‘Tax and Corporate Responsibility’ (2006) 29 International Tax Review 6–9; Joel Slemrod, ‘The economics of corporate tax selfishness’ (2004) 57 National Tax Journal 877–99; Bernd Erle, ‘Tax risk management and board responsibility’ and Wolfgang Schön, ‘Tax and Corporate Governance: A legal Approach’ in Wolfgang Schön and others (eds), Tax and Corporate Governance (Berlin/Heidelberg, Springer-Verlag, 2008). 180  See Judith Freedman, ‘Tax and Corporate Responsibility’, Tax Journal, Issue 695, 2 June 2003, pp 1–4. 181  Ibid, p 2. Also see John M Conley and Cynthia A Williams, ‘Engage, Embed and Embellish: Theory Versus Practice in the Corporate Social Responsibility Movement’ (2005) 31 Journal of Corporation Law 1. 182 See ‘Fiduciary Duties and Tax Avoidance—Opinion’, available on: www.taxjustice.net/cms/ upload/pdf/Farrer_and_Co_Opinion_on_Fiduciary_Duties_and_Tax_Avoidance.pdf. 183  Here, s 172(1) Companies Act 2006.

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Arguably, in this opinion, tax avoidance is too widely defined. What is also somehow dubious is the conclusion that the reasoning in the opinion is ‘applicable to any specific deliberate course of action that, because of tax, yields a more financially advantageous result than another available course of action which is nonetheless reasonable in the circumstances’.184 The authors of the opinion state that their conclusions ‘are therefore equally applicable across the spectrum from unexceptionable tax planning to criminal tax evasion, although of course it goes without saying that there can be no legal duty to engage in the latter’.185 In my view this generalisation is wrong. There should be a better distinction between legitimate tax planning, aggressive tax planning and tax avoidance. Attacking all in the same way, and, even worse, grouping them together with criminal tax evasion cannot help but make readers, especially those with a technical background, sceptical. Moreover, it is one thing to say it is not the directors’ statutory duty to avoid tax, and another thing to say that companies (via their directors) that engage in aggressive tax planning are socially irresponsible. This argument is based on too many generalisations and too many assumptions. Certainly, the intuitive (and political) appeal of the social nature of corporate taxation is undeniable. Nevertheless, there is limited research showing a consistently strong correlation between the CSR activities of a corporation and corporate tax aggressiveness. It is, however, worth considering how the topic has been approached by some economists. In a seminal paper by Desai and Dharmapala,186 the authors found that increases in incentive compensation tended to reduce the level of tax sheltering. The report also found the surprising result that firms that were poorly governed but where managers had high levels of equity incentives engaged in less tax avoidance. Desai and Dharmapala interpreted this result as evidence that tax avoidance and managerial rent extraction were complementary activities. They argued that the level of a firm’s tax avoidance increased with the strength of its corporate governance. Another recent study187 found that risk-taking equity incentives exhibit a positive relationship with the level of tax avoidance. However, in contrast to Desai and Dharmapala, it was found that corporate governance appears to be related to managers’ tax avoidance decisions, but only for high levels of tax avoidance.188

184 

Ibid, para 2. Ibid. 186  Mihir A Desai and Dhammika Dharmapala, ‘Corporate tax avoidance and high powered incentives’ (2006) 79 Journal of Financial Economics 145–79. 187  Chris Armstrong et al, Corporate Governance, Incentives, and Tax Avoidance, (May 2014) Rock Center for Corporate Governance at Stanford University Working Paper No 136, available on: papers. ssrn.com/sol3/papers.cfm?abstract_id=2252682. 188  For other recent studies, see, inter alios, Fariz Huseynov, Bonnie K Klamm, ‘Tax Avoidance, Tax Management and Corporate Social Responsibility’ (2012) 18 Journal of Corporate Finance 804–27; Roman Lanis and Grant Richardson, ‘Corporate Social Responsibility and Tax Aggressiveness: An Empirical Analysis’ (2012) 31 Journal of Accounting and Public Policy 86–108; Moran Harari et al, n 145 above. 185 

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Studies have also found that board composition may influence the level of tax aggressiveness of a corporation. A study by Lanis and Richardson189 showed that outside directors were more responsive to the needs of society and were thus expected to influence the board of directors away from an aggressive tax policy stance. In a similar vein, Robinson et al190 also examined the association between incentives and governance for both general and ‘risky’ tax avoidance—here, in tax havens. They found that the proportion of accounting experts on the board was associated with more general, but less risky tax planning. The level of tax expertise was associated with a lower likelihood of participation in risky tax planning. The reputational concerns from tax avoidance have also been considered in numerous studies.191 Interestingly, in a survey by Graham et al,192 company tax executives were questioned whether the potential for an adverse effect on company reputation significantly constrained incentives to engage in tax planning strategies. In this survey, 69 per cent of the survey respondents, including 72 per cent from publicly traded companies, indicated that reputation concerns were ‘important’ or ‘very important.’ Reputation concerns ranked second only to the concern that a tax strategy might not pass the judicial standard of business purpose/economic substance. It was found that publicly traded companies, larger companies, more profitable companies and companies in the retail industry were significantly more concerned about the adverse reputation consequences of tax planning. The data suggested that a company would adopt tax avoidance schemes when the benefits outweighed the risks of harm to the company’s reputation. In another recent study, it was found that tax risk management systems used by large Australian companies did not systematically identify reputational risk as one of the tax risks that needed to be managed, even though tax aggressiveness could have a great impact on a company’s reputation. A company that had a comprehensive tax risk management system that identified reputational risk would 189  Roman Lanis and Grant Richardson, ‘The effect of board of director composition on corporate tax aggressiveness’ (2011) 30 Journal of Accounting and Public Policy 50–70. Also see a later study by these authors which examines the association between CSR and corporate tax aggressiveness. Based on a sample of 408 publicly listed Australian corporations for the 2008/2009 financial year, it is shown that the higher the level of CSR disclosure of a corporation, the lower the level of corporate tax aggressiveness. See Roman Lanis and Grant Richardson (2012), n 188 above. 190  John R Robinson, Yanfeng Xue and May H Zhang, Tax planning and financial expertise in the audit committee (2012), available on: papers.ssrn.com/sol3/papers.cfm?abstract_id=2146003. Also see Sean T McGuire, Thomas C Omer and Dechun Wang, ‘Tax Planning: Does Tax-Specific ­Industry ­Expertise Make a Difference?’ (2012) 85 The Accounting Review 975–1003; Burak Guner, Ulrike ­Malmendier and Geoffrey Tate, ‘Financial Expertise of Directors’ (2008) 88 Journal of Financial ­Economics 323–54. 191 Joseph Bankman, ‘An academic’s view of the tax shelter battle’ in Henry J Aaron and Joel ­Slemrod  (eds), The Crisis in Tax Administration (Brookings Institution, 2004) pp 9–37; Michelle ­Hanlon and Joel Slemrod, ‘What does tax aggressiveness signal? Evidence from stock price reactions to news about tax shelter involvement’ (2009) 93 Journal of Public Economics 126–41; Carlo Garbarino, Aggressive Tax Strategies and Corporate Tax Governance: An Institutional Approach, SDA Bocconi School of Management (2008). 192  John R Graham et al, Incentives for Tax Planning and Avoidance: Evidence from the Field (MIT Sloan Research Paper No 4990–12, 2013) 26.

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make more informed and potentially less aggressive tax decisions than a company that did not have a comprehensive tax risk management system that recognised reputational risk.193 Apart from the reputational costs, it has also been noted that complex tax planning produces litigation costs.194 It may also damage the trust that tax authorities have in a company and have a negative effect on the good relations between the company and the authorities. Furthermore, aggressive tax strategies might generate uncertainty as to the tax liability of the company and, as a corollary, uncertainty for investors regarding the value of the shares of the company. Such tax planning may also lead collectively to the adoption of complex tax legislation to close the loopholes, generating new complexities and new compliance costs for the business. Other studies have attempted to address the question why some firms engage in tax avoidance enthusiastically while others appear to shun it. This has been described as the under-sheltering puzzle.195 Rather surprisingly, it could not be proved that the reputational costs of tax avoidance led to under-sheltering.196 The above brief review of some of the important literature is certainly not comprehensive. Nevertheless, the variations in the studies seem to suggest that the statement that companies that engage in aggressive tax planning are socially irresponsible is a generalisation. While one may more readily be convinced by arguments that engaging in socially responsible activities produces long-term financial gains in excess of any short-term gains from engaging in socially irresponsible activities,197 it is submitted that as far as taxes are concerned, the arguments are much more complex and nuanced. For example, a local construction firm in a small town is not in the same position to engage in CSR as far as its tax planning is concerned, as a multinational such as Starbucks, Amazon etc. Arguably, its CSR responsibility would be limited to an obligation not to engage in tax evasion. Even among larger companies and MNEs, some are more susceptible to reputational harm than others. Companies whose success depends strongly on their

193  Catriona Lavermicocca and Jenny Buchan, ‘Role of Reputational Risk in Tax Decision Making by Large Companies’ (2015) 13 eJournal of Tax Research 5–50. 194  Moran Harari et al, n 145 above. 195  See Mihir Desai and Dhammika Dharmapala, n 186 above; John Gallemore, Edward L Maydew and Jacob R Thornock, ‘The reputational costs of tax avoidance and the under-sheltering puzzle’ (2013) Contemporary Accounting Research; Carlo Garbarino, n 191 above; Michelle Hanlon and Shane Heitzman, ‘A review of tax research’ (2010) 50 Journal of Accounting and Economics 127–78. 196  Of course, all the studies were subject to caveats. For example in Gallemore et al, n 195 above, the results were confined to shelters that were implemented by firms and later made public. Another point made was that firms self-selected into tax avoidance, so, arguably, firms that engaged in aggressive tax avoidance already had bad reputations. As such, the reputational effect could not be measured. Also, there could be unidentifiable reputational costs that were not considered. 197  See, inter alios, Ramon Mullerat (ed), International Corporate Social Responsibility: The Role of Corporations in the Economic Order of the 21st Century (Kluwer Law International, 2010) 40; Kash Rangan et al, Why Every Company Needs a CSR Strategy and How to Build it (Harvard Business School Working Paper, 2012).

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r­eputation and branding are more likely to eschew a tax avoidance scheme in favour of tax practices that are less likely to attract public scrutiny. However, other companies may not bother. This could be, for example, the case when a company is already unpopular (eg if it belongs in the arms or tobacco industries) or when the product it produces is essential and cannot be substituted (eg some pharmaceuticals). One can easily switch from Starbucks to Costa Coffee or Café Nero, but it may not be so easy to do so with medication for Alzheimer’s or cancer. If a company producing the latter views an (arguably) aggressive tax planning technique such as a corporate inversion as not only acceptable but also necessary to fulfil its fiduciary duties to shareholders, there is little that customers/patients or healthcare providers may do about this, short of a government intervention. It is noteworthy that in the European Commission’s 2011 discussion document, CSR was seen as a concept to be developed by enterprises primarily, as appropriate to their ­circumstances.198 The Commission paper was strongly imbued with the idea of voluntary participation. For taxes, the Commission referred to transparency, exchange of information and fair tax competition as the prerequisites of good tax governance that ought to be followed. Neither tax planning nor aggressive tax planning were mentioned. Moreover, there could be different levels of CSR and different attitudes towards it. For example, a company (or better, its management) in a high tax jurisdiction may be more justified in ‘feeling’ that it does not owe anything to society and that it is acceptable to try and minimise its very high taxes and mitigate the impact of worldwide taxation. By contrast, the management of a company in a jurisdiction which does not have such high taxes may not necessarily ‘feel’ that it owes more to society and that it should refrain from aggressive tax planning. How can CSR proponents dictate the solution? What boundaries can be drawn? Furthermore, what if an MNE has subsidiaries in low and high tax jurisdictions? What should its CSR policy be? Should it be a group CSR policy or more localised?199 What compounds the situation is the fact that the distinction between tax avoidance, aggressive tax planning and legitimate tax planning is not clear. Tax avoidance has the connotation of doing something artificial and unlawful. Aggressive tax planning has softer connotations than tax avoidance as it does not entail any illegality. But it may be unclear when tax planning is legitimate and when not—because it is aggressive. Is the dividing line of legitimacy whether tax planning leads to double non-taxation? If there is no double non-taxation, is it because there is a reduction of taxes? But how great a reduction should be considered improper? These are very difficult questions. As a corollary, one should be wary of characterising a company as being socially irresponsible on the basis of its tax planning. 198  Communication from the Commission to the European Parliament, the Council, the European Economic and Social Committee and the Committee of the Regions, A renewed EU strategy 2011–14 for Corporate Social Responsibility, COM(2011) 681 final, Brussels, 25 October 2011. 199  On this point, also see Luca Cerioni, n 175 above.

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In the author’s view, it is a slippery slope for a country to expect to raise or increase corporate tax revenues as a result of CSR. What is next? Professional social responsibility of accountants, auditors, lawyers and/or anyone else who advises companies on their tax planning? Incidentally, the Public Accounts Committee in its 2015 follow-up report on the role of large accountancy firms may be going down that route, as it suggested a code of conduct for tax advisers.200 In any case, notwithstanding the theoretical limitations and legal challenges of linking CSR with aggressive tax planning, this appears to be a popular (perhaps populist) cause for some, which is likely to continue. Lately, many MNEs voluntarily adopt CSR initiatives and there is a trend towards self-regulation.201 This also seems to be encouraged by influential NGOs.202 While these initiatives are laudable, it may not be easy to translate them in the tax context. Here, as shown above, the application of CSR may be more complicated. Obviously, Google and Amazon are not going to set up training centres for tax officials; and Starbucks will not be making charitable donations every year. The difficulty is in how to constrain these MNEs in choosing their tax planning strategies and, most importantly, what tax planning strategies should be constrained. Is it strategies that make use of tax havens? But which country is officially a tax haven—is it only in the eyes of the OECD and its ever-changing tests and benchmarks? Is it strategies that result in very low effective tax rates? But what effective tax rate is adequately high? What if the use of a certain structure leads to higher effective tax rates but low (or no) taxes on profit distributions? Are corporate inversions contrary to the CSR duties of companies? Why are such companies socially irresponsible for wishing to replicate the tax benefits enjoyed by companies in foreign jurisdictions that have a territorial system of taxation? The international tax system is all about choices. Absent a uniform and harmonised international tax system, why should a company be deemed socially 200 

See section 1.2 above. for example, the CSR report of Walmart which states, inter alia, that it promoted about 190,000 US associates in 2013, ‘51% of our new hires were women and 49% were people of color’; it delivered on its commitment of US$2 billion in cash and in-kind given to fight hunger in America one year ahead of schedule; it hired more than 32,000 US military veterans; it collaborated with the UN Office for Disaster Risk Reduction, etc. See corporate.walmart.com/global-responsibility/ environment-sustainability/global-responsibility-report. Also, following allegations of sweatshops and child labour, Nike, inter alia, helped create the Fair Labor Association, a non-profit group that combined companies, and human rights and labour representatives to establish independent monitoring and a code of conduct, including a minimum age and a 60-hour working week, and encouraged other brands to join. See www.businessinsider.com/how-nike-solved-its-sweatshopproblem-2013-5#ixzz38sUzDj6n. For other company affiliates of the Fair Labor Association, see www. fairlabor.org/affiliates; blog.designedgood.com/unique-examples-of-corporate-social-responsibility/. 202  See, for example, ActionAid’s publication of July 2011, entitled Tax Responsibility—The Business Case for Making Tax a Corporate Responsibility Issue, available on www.actionaid.org.uk/sites/default/ files/doc_lib/tax_responsibility.pdf. Similarly, see the report by SustainAbility, entitled Tax Issues— Responsible Business and Tax, available on: www.taxjustice.net/cms/upload/pdf/Sustainability_ taxing_issues.pdf. Also see Business Ethics Briefing, ‘Tax Avoidance as an Ethical Issue for Business’, Issue 31, April 2013, available on: www.ibe.org.uk/userassets/briefings/ibe_briefing_31_tax_ avoidance_as_an_ethical_issue_for_business.pdf. 201  See,

CSR and Aggressive Tax Planning

39

irresponsible for benefitting from certain choices? If some choices are universally unacceptable, then rules or at least guidance should be put in place by international organisations such as the OECD to abolish them; and countries should duly abolish them. Hopefully, this is what the OECD is or should be doing in the context of its BEPS project; and this is what countries ought to be doing in the post-BEPS world.203 Selective denounciation of some of these choices does little to deter the ‘socially irresponsible’ behaviour of ­multinationals—if at all acknowledged as socially irresponsible. What makes it even more complicated is the fact that one company may be viewed as a major CSR player but may still be targeted as ‘socially irresponsible’ in its tax planning.204 For example, Starbucks has long been considered as a rather ethical company in non-tax circles. The same cannot be said following the recent revelations and denouncement of its tax planning structures. Therefore, there may be different perspectives of CSR depending on the subject-matter (eg taxation, employee rights, environmental protection etc) or even depending on the jurisdiction. For instance, European companies are thought to be more active in the CSR field than US companies.205 In general, there may be different societal expectations from companies, whether in general, or in specific areas. Overall, the author believes that how most companies conduct their tax affairs and engage in strategic tax planning should not be (or become) a function of CSR or any other soft law concept transplanted from another context—at least not primarily. Ideally, there should be clear rules and principles. This should be the starting point.206 In any case, tax avoidance or aggressive tax planning has not up until recently been widely discussed or analysed in the context of mainstream CSR literature. Most notably, in established CSR guidelines issued by international organisations, tax was not mentioned at all,207 though this is now changing.

203 

More on this ch 9. Margaret Hodge, an outspoken critic of tax avoidance and aggressive tax planning, who led the Public Accounts Committee hearings discussed in section 1.2 above, has been criticised for taking advantage of a tax amnesty (the Liechtenstein Disclosure Facility) that she had once criticised herself as being too lenient. Technically, she was just a beneficiary to the tax planning and did not drive the tax planning. See Stephanie Soong Johnston, ‘UK Politician Under Fire for Tax Affairs’ 2015 WTD 83-4 (30 April 2015). 205  See, for example, a comparative study of the US and the EU approach in Laura P Hartman, Robert S Rubin and K Kathy Dhanda, ‘The Communication of Corporate Social Responsibility: United States and European Union Multinational Corporations’ (2007) 74 Journal of Business Ethics 373–89. Also see Dirk Matten and Jeremy Moon, ‘“Implicit” and “Explicit” CSR: A Conceptual Framework for a Comparative Understanding of Corporate Social Responsibility’ (2008) 33 Academy of Management Review 404–24. 206  Also see the point made in Commission Green Paper, n 152 above para 22, that CSR should not be seen as a substitute to regulation or legislation concerning social rights or environmental standards, including the development of new appropriate legislation. 207 See, for example, the ISO 26000 Guidance Standard on Social Responsibility. Section 6.6 on ‘Fair Operating Practices’ is not specific enough to cover taxes, but covers the ethical behaviour of an organisation in its dealings with other organisations, including relationships between organisations 204  Ironically,

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The OECD Guidelines for Multinational Enterprises, last updated in 2011, now includes a chapter on taxation which sets out several recommendations on tax governance and management.208 There is a specific chapter on taxation.209 It is emphasised that corporate citizenship in the area of taxation implies that enterprises should comply with both the letter and the spirit of the tax laws and regulations in all countries in which they operate, co-operate with authorities and make information that was relevant or required by law available to them.210 ­Furthermore, as noted in section 1.5 below, the duty of care of the board of directors in the context of aggressive tax planning is also mentioned for the first time in the recent draft update to the OECD Principles of Corporate Governance.211 Arguably, these changes imply a higher level of socially responsible conduct in relation to tax compliance, compared to previous guidelines. It is only as a result of the recent tax ‘scandals’ discussed earlier on in this chapter that the topic has become more popular. In any case, irrespective of the difficulties of proving empirically how less aggressive tax planning—and how much less—will be to the benefit of the company and its shareholders, other than reputation-wise in some cases, CSR implications are likely to become increasingly entrenched in the whole debate.212 It may, therefore, be useful to attempt to map the contours of a CSR concept more specifically to taxes—arguably, the idea of corporate tax responsibility or how tax should feature in the boardroom agenda. Whilst the author believes CSR is not the solution to the problems faced in the international tax field, it may be used as a (constructive) palliative. Of course, if one were to go down this road, then it would be crucial to align European and global approaches to CSR, to ensure the development of uniform (CSR-derived) standards of transparency in tax matters. Otherwise, some countries would be under greater constraints than others, leading to unintentional tax competition.

and governmental agencies. There is only passing reference to tax in section 6.8 on ‘Active Involvement and Community Development’, which mentions that governments rely on organisations to comply with their tax obligations to generate the revenue to address critical development issues. See also the ILO Tri-partite Declaration of Principles Concerning Multinational Enterprises and Social Policy, 4th edn (International Labour Office, 2006).This focuses on employment issues. Available on: www.ilo.org/ wcmsp5/groups/public/---ed_emp/---emp_ent/---multi/documents/publication/wcms_094386.pdf. Also see the United Nations Guiding Principles on Business and Human Rights (2011) which focus on human rights. on: www.ohchr.org/Documents/Publications/GuidingPrinciplesBusinessHR_EN.pdf 208 OECD Guidelines for Multinational Enterprises (2011). Available on: www.oecd.org/ investment/mne/48004323.pdf. 209  Ibid, chapter XI. 210  Ibid, para 100. 211  OECD Principles of Corporate Governance, Draft for Public Comment—November 2014. See para 104. Available on: www.oecd.org/investment/mne/48004323.pdf. 212  See, for example, Fisher, n 145 above, at p 354, who argues that ‘MNCs should treat tax avoidance as they treat environmentally harmful activities or human rights abuses: as a CSR issue that may necessitate the sacrifice of profits to mitigate financial harm to various other stakeholders’.

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1.5.  Tax in the Boardroom Until recently, tax was not really an item on the boardroom agenda—at least not such an important one. It is only recently that studies were conducted on the topic of tax in the boardroom. Indicatively, in a study conducted by KPMG in 2004, it was emphasised that tax can no longer remain in the isolation to which its technical nature and its perceived independence from the business have traditionally placed it.213 Tax is embedded in the fabric of the capital markets in which wealth is created and companies compete. A company’s policies for tax and its risks need to be as sophisticated, coherent and transparent as its policies in all other areas involving multiple stakeholders, such as suppliers, customers, staff and investors.214

The survey noted that initially taxation was not treated as a normal business risk but this attitude has changed, with companies now less inclined to engage in tax planning activities that might be construed as aggressive. While companies examined more closely the potential downside in adopting a certain tax planning strategy, ‘it [was] often unclear whether management [were] making a fully informed decision or simply reacting to events’.215 It was further noted that in some countries such as Australia, the UK and the US, tax authorities were inclined to see a lack of board-level involvement in setting the tax agenda as tantamount to bad management or in some cases negligence.216 In explaining the corporate role of tax, it was shown that the company, through its management, must decide how it sees tax; ie its tax philosophy. There were two ends of the spectrum. On the one hand, tax was perceived as a social levy that the company had a duty to pay to the community, so it was payable at whatever level was set. On the other hand, tax was perceived as a normal business cost and the company had a duty to its shareholders to reduce it to the lowest level legally possible. The survey noted that the position taken by most senior managers of companies fell somewhere between the two views,217 though there was an inclination to adopt a position closer to ‘the duty to shareholders’ end of the spectrum.218 It was argued that the reputational risk from aggressive tax planning structures could have material consequences and also increase costs.219 213 KPMG, Tax in the Boardroom—A Discussion Paper (2004) p 1. Available on: www.kpmg.com/ ca/en/topics/managing-risk-driving-performance/documents/tax%20in%20the%20boardroom.pdf. At the time, it was reported that although there were signs that tax departments were becoming less isolated, there was scant evidence of a formal or comprehensive integration of tax into the mainstream. See p 3. Also see KPMG, Tax Risk Management in the Financial Sector (KPMG International, 2004). 214 KPMG, Tax in the Boardroom, n 213 above, p 1. 215  Ibid, p 5. 216  Ibid. 217  Ibid, p 6. 218  Ibid, p 7. 219  Ibid, pp 7–8.

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In overseeing the design and monitoring of tax strategies, it was recommended that boards should recognise that the ‘contemporary debates about governance, corporate social responsibility and ethics mean that even legal tax-minimisation activity can generate reputational liabilities that can destroy shareholder value’.220 This might have been exaggerated at the time, but with hindsight it has proved truthful. Overall, it was recognised that company boards were under growing pressure to oversee their tax affairs in ways that reconciled their obligations to shareholders with the expectations of external stakeholders such as governments, pressure groups and very importantly the public. In 2004, the OECD published a set of corporate governance standards and guidelines, intended to assist OECD and non-OECD governments in their efforts to evaluate and improve the legal, institutional and regulatory framework for corporate governance in their countries, and to provide guidance and suggestions for stock exchanges, investors, corporations, and other parties that have a role in the process of developing good corporate governance.221

Corporate governance was only part of the larger economic context in which firms operated and depended on the legal, regulatory and institutional environment. Factors such as ‘business ethics and corporate awareness of the environmental and societal interests of the communities in which a company operates can also have an impact on its reputation and its long-term success’.222 These were the OECD’s Principles of Corporate Governance. The 2011 OECD Guidelines for Multinational Enterprises, mentioned in section 1.4 above, included a chapter on taxation which set out several recommendations on tax governance and management.223 It was noted that an enterprise would comply with the spirit of tax laws if it took reasonable steps to determine the intention of the legislature and interpreted those tax rules consistently with that intention.224 Transactions should not be structured in a way that will have tax results that are inconsistent with the underlying economic consequences of the transaction unless there exists specific legislation designed to give that result. In this case, the enterprise should reasonably believe that the transaction is structured in a way that gives a tax result for the enterprise which is not contrary to the intentions of the legislature.225

Another area of corporate citizenship in taxation was co-operation with tax authorities and provision of the information they require to ensure an effective and equitable application of the tax laws.226 Such co-operation should include 220 

Ibid, p 8. OECD Principles of Corporate Governance (2004), p 11. Available on: www.oecd.org/corporate/ ca/corporategovernanceprinciples/31557724.pdf. 222  Ibid, p 12. 223  OECD Guidelines for Multinational Enterprises (2011), n 208 above. 224  Ibid, para 100. 225  Ibid. 226  Ibid, para 101. 221 

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responding in a timely and complete manner to requests for information made by a competent authority. However, it was emphasised that cooperation was not without limitations. There should be a link between the information that should be provided and its relevance to the enforcement of applicable tax laws.227 In 2014, the OECD published a revised draft text of these guidelines, reflecting recent developments in the corporate sector and capital markets.228 What becomes obvious is that tax is increasingly considered an essential part of corporate governance. There was a reference to aggressive tax planning in reviewing the duty of care of board members.229 In discussing how the board should apply high ethical standards, it was also added that jurisdictions are increasingly demanding that boards oversee the tax planning strategies management is allowed to conduct, thus discouraging practices that do not contribute to the long term interests of the company and its shareholders, and can cause legal and reputational risks.230

In addition to the forms of internal controls and compliance programmes that companies were advised to establish, it was noted that compliance must also relate to other laws and regulations, as well as relevant international agreements, such as those covering taxation.231 The importance of corporate governance tools in deterring non-compliant behaviour has also been emphasised by the OECD in the Final Seoul ­Declaration,232 where it was acknowledged that the policy debate ‘revealed continued concerns about corporate governance and the role of tax advisors and financial and other institutions in relation to noncompliance and the promotion of unacceptable tax minimization arrangements’. Similar issues were raised in an HMRC-sponsored independent study233 which canvassed the views of over 500 chairmen of large UK 227  Ibid. As noted, there was a ‘need to balance the burden on business in complying with applicable tax laws and the need for tax authorities to have the complete, timely and accurate information to enable them to enforce their tax laws’. 228  OECD Principles of Corporate Governance (2014), n 211 above. The final version of the revised Principles is scheduled for completion in 2015. 229  See para 104, addition in italics: ‘The duty of care requires board members to act on a fully informed basis, in good faith, with due diligence and care. In some jurisdictions there is a standard of reference which is the behaviour that a reasonably prudent person would exercise in similar circumstances. In nearly all jurisdictions, the duty of care does not extend to errors of business judgement so long as board members are not grossly negligent and a decision is made with due diligence etc., or to an obligation to pursue aggressive tax avoidance. The principle calls for board members to act on a fully informed basis’. 230  Ibid, para 106. 231  Ibid, para 117. 232 OECD, Final Seoul Declaration (Third Meeting of the OECD Forum on Tax Administration, 14–15 September 2006) p 3. 233 HMRC, Tax on the Boardroom Agenda—The Views of Business (2006). This was an independent study produced through the HMRC Partnership Enhancement Programme. Also see 2006 Review of Links with Large Business (Varney Report, 2006) and the papers that followed it in March 2007, Making a Difference: Delivering the Review of Links with Large Business (Delivery Plan) and HMRC Approach to Compliance Risk Management for Large Business (Risk Management Report). For commentary, see Judith Freedman (ed), Beyond boundaries: Developing approaches to tax avoidance and tax risk management (Oxford University Press, 2008).

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companies. There, it was concluded, inter alia, that better direct communication channels were needed between businesses and HMRC and a cost effective system of reporting. Lack of trust appeared to be a recurrent theme.234 What becomes evident is that even before the whole BEPS project took off, it was becoming increasingly apparent that a purely technical approach to tax planning was ‘unlikely to protect companies from charges of irresponsibility and associated reputational damage’.235 This was irrespective of the theoretical difficulties—legal and economic ones—in linking CSR and tax planning. Nevertheless, with hindsight of the recent developments, it is undeniable that corporate governance and tax are becoming closely interwoven. As accurately depicted in the KPMG study in 2004: Tax has changed dramatically in recent years. Its public profile has become much more conspicuous, it has acquired moral, ethical and social dimensions that have never been discussed before and, for these reasons, the business management issues associated with tax have become more complicated, more subtle, more steeped in risk and much more challenging.236

Certainly, in evaluating tax planning and risk, the variables have increased. Tax is now not only a corporate governance issue but in some cases, a reputational issue as well. Company managers have recognised that their tax strategy must be appropriate from a commercial and legal perspective but also from a reputational one. Otherwise, tax can present a significant risk to shareholder value. It is now widely accepted that the head of tax in a company must be able to communicate effectively at board level with management, with investors, shareholders and external stakeholders, such as tax authorities, customers, the general business community, employees, NGOs, the media etc.237 Furthermore, organisations with a global footprint are under increased pressure to adopt a global tax policy and to ensure compliance from a global perspective. To facilitate compliance especially on a large scale for large corporate taxpayers, in the past decade or so, several countries have established enhanced cooperation regimes subsequently rebranded as cooperative compliance. The importance of enhanced cooperation was highlighted in the OECD’s 2008 study into the role of tax intermediaries.238 In this study, there was an attempt to form the basis for an agreed approach to the management of tax risk by revenue authorities. The OECD report considered the tripartite relationship between revenue bodies, taxpayers and tax advisers (the ‘intermediaries’ for the purposes of the report) in the context of aggressive tax planning, and the impact of this on tax administration. 234 HMRC, Tax

on the Boardroom Agenda, n 233 above, p 18. report, entitled ‘Tax Issues—Responsible Business and Tax’, p 2. Available on: www.taxjustice.net/cms/upload/pdf/Sustainability_taxing_issues.pdf. 236 KPMG, Tax in the Boardroom, n 213, p 1. 237  Tax in the Boardroom—The Implications (Odgers & Berndtson, 2013) p 5. Available on: www. odgersberndtson.co.uk/fileadmin/uploads/united-kingdom/Documents/tax_in_the_boardroom_ board_paper_sept2013.pdf. 238 OECD, Study into the Role of Tax Intermediaries (OECD, 2008). 235 SustainAbility

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It was recommended that revenue bodies establish a tax environment in which trust and cooperation could develop leading to enhanced relationships with large corporate taxpayers and tax advisers, with all parties going beyond their statutory obligations. It was noted that risk management was an essential tool for revenue bodies, assisting with the identification and treatment of risks, and facilitating the allocation of resources. Risk management, however, relied on information, very much dependent on disclosure from taxpayers. To encourage disclosure, revenue bodies had to operate using the following five attributes when dealing with all taxpayers: understanding based on commercial awareness; impartiality; proportionality; openness (disclosure and transparency); and responsiveness.239 It was emphasised that an enhanced relationship would benefit many taxpayers. Taxpayers who behaved transparently and who presented a lower risk were likely to enjoy a cooperative relationship with revenue bodies and therefore lower compliance costs, and increased certainty. Nevertheless, it was recognised that the availability of an enhanced relationship may not deter all large corporate taxpayers from aggressive tax planning. Several countries have established a form of enhanced relationship or cooperative compliance with taxpayers,240 some even before the publication of the report.241

1.6. Conclusion What becomes evident is that as far as tax avoidance and aggressive tax planning are concerned, the debate is multifaceted. There is an attack on tax havens and countries that engage in harmful tax competition (however defined), as well as an attack on MNEs that conduct their tax affairs ‘immorally’ vis-à-vis developed countries and the developing countries. The political rhetoric is buttressed by the development of doctrines of good governance in tax matters and of corporate tax responsibility. Civil society now attaches great weight to the issue of taxation, which could harm the public image of companies that follow aggressive tax

239  Ibid, ch 7. For commentary, see, Judith Freedman, Geoffrey Loomer and John Vella, ‘Corporate Tax Risk and Tax Avoidance: New Approaches’ [2009] British Tax Review 74–116. 240  Inter alia, Australia, Ireland, Italy, the Netherlands, the UK, New Zealand, Spain and the United States have adopted similar regimes. For commentary, see Eelco van der Enden and Katarzyna Bronzewska, ‘International/Australia/Italy/Netherlands/United States—The Concept of Cooperative Compliance’ (2014) 68 Bulletin for International Taxation 567–72; Asmita Singh, ‘Enforcement or Cooperation—An Analysis of the Compliance Psychology of Taxpayers’ (2015) 21 Asia-Pacific Tax Bulletin. For commentary on the French cooperative compliance regime launched in 2013, see Rudolf Reibel, ‘Tax Transparency—How to Make it Work’ (2015) 55 European Taxation 209, 212. 241  For example, in the UK, following the Varney Report, n 233 above, a similar approach had been adopted in the context of HMRC’s links with large business programme. See Annex 4 of 2008 OECD Study on Intermediaries, n 238 above and HMRC reports discussed in n 233 above.

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­ lanning practices. This often leads to negative media coverage and consumer p backslash. Also, advances in technology have meant that the existing tax rules may no longer be appropriate or may need refinement in order to deal with today’s tax strategies. Finally, transfer pricing is a topic which now features heavily in the international tax community. Over relatively recent years most countries have introduced transfer pricing rules and generally those rules have been based on the OECD’s Transfer Pricing Guidelines and on the concept of transactions between connected parties being at an ‘arm’s length price’ within an ‘arm’s length range’. Transfer pricing rules help to ensure that profits fall in the right country and can themselves be seen as anti-avoidance rules. From the brief review of the tax planning practices of MNEs in section 1.2 above, it is obvious that there is an urgent need for the rules to be refined to cope with the current global trading environment. The above, not necessarily in chronological order, are some of the factors that have led to BEPS. In any case, the BEPS project is now a reality and at the time of writing close to completion. It is examined in the next three chapters.

2 The OECD/G20 Base Erosion and Profit Shifting Project: Actions 1–5 It seems that tax avoidance, however defined and whatever it encompasses at any moment of time, is always on the agenda one way or another. Certainly in the context of the Base Erosion and Profit Shifting (BEPS) project, there is renewed momentum. The OECD, at the request of the G20 Finance Ministers in 2012, launched an international action plan to combat international tax planning structures used by multinationals to escape taxes. Arguably, the BEPS project is the culmination of a number of other recent initiatives and reports, generally on aggressive tax planning1 and also on corporate loss utilisation2 and hybrid mismatch arrangements.3 However, it has acquired urgency from the political-level visibility of ‘the failure of cross-border taxation rules to keep up with the realities of modern commerce and finance’.4

1 OECD, Tackling Aggressive Tax Planning through Improved Transparency and Disclosure (2011). Prior to this, there were other reports; eg OECD, Engaging with High Net Worth Individuals on Tax Compliance (2009); OECD, Addressing Tax Risks Involving Bank Losses (2010) etc. 2 OECD, Corporate Loss Utilisation through Aggressive Tax Planning (2011). 3 OECD, Hybrid Mismatch Arrangements: Tax Policy and Compliance Issues (2012). See Andrei ­Cracea, ‘OECD Actions to Counter Tax Evasion and Tax Avoidance (2013): Base Erosion and Profit Shifting and the Proposed Action Plan, Aggressive Tax Planning Based on After-Tax Hedging and Automatic Exchange of Information as the New Standard’ (2013) 53 European Taxation 565–74. It should be noted that shortly after the launch of the BEPS Action Plan, the OECD published a report entitled Aggressive Tax Planning Based on After-Tax Hedging (OECD, 2013). This report describes features of aggressive tax planning based on after-tax hedging and the strategies used to detect and respond to such planning. The report further highlights a number of challenges from a compliance and policy perspective. 4  Hugh J Ault, Wolfgang Schön and Stephen E Shay, ‘Base Erosion and Profit Shifting: A Roadmap for Reform’ (2014) 68 Bulletin for International Taxation 275–79.

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OECD/G20 BEPS Project: Actions 1–5

2.1.  Addressing Base Erosion and Profit Shifting Backed by both G8 and G20 countries,5 the OECD report Addressing Base Erosion and Profit Shifting6 was released on 12 February 2013. BEPS was described in the FAQs of the OECD website7 as tax planning strategies that exploit gaps and mismatches in tax rules to make profits ‘disappear’ for tax purposes or to shift profits to locations where there is little or no real activity but the taxes are low resulting in little or no overall corporate tax being paid.

In this report, it was accepted that the practices used by some multinational enterprises to reduce their tax liabilities had become more aggressive over the past ­decade. The OECD report did not suggest optimal tax rates but was expected to draft an action plan, identifying key pressure areas and providing concrete timelines and methodologies for solutions. The overtone of the report was that international tax standards may not have kept pace with global changes.8 Measures were needed to address the perceived inequity between multinationals that were able to pay very little taxes and domestic enterprises that could not do the same, as well as the discrepancies between the place where the business was conducted and where taxes were paid.9 At a ministerial council meeting in Paris on the 29–30 May 2013, the OECD adopted a declaration on BEPS.10 It reiterated that BEPS ‘constitutes a serious risk to tax revenues, tax sovereignty and the trust in the integrity of tax systems of all countries that may have a negative impact on investment, services and competition, and thus on growth and employment globally’.11 The declaration emphasised the need for governments to work together to develop methods of addressing asymmetries in domestic and international tax laws that can result in double nontaxation or very low effective taxation. There was a pressing need to address BEPS and to work towards a level playing field in this area.12 In July 2013 the OECD launched the BEPS Action Plan, in which it identified specific courses of action to be taken.13 The OECD recognised that fundamental 5  See references to statements of heads of States in Martijn Nouwen, ‘The Gathering Momentum of International and Supranational Action against Aggressive Tax Planning and Harmful Tax Competition: The State of Play of Recent Work of the OECD and the European Union’ (2013) 53 European Taxation 491–96. 6 OECD, Addressing Base Erosion and Profit Shifting (OECD Publishing, 2013). 7  Available on: www.oecd.org/ctp/beps-frequentlyaskedquestions.htm. 8  Nouwen, n 5 above, p 492. 9  Shee Boon Law, ‘Base Erosion and Profit Shifting—An Action Plan for Developing Countries’ (2013) 68 Bulletin for International Taxation 41–46, 41. 10  See OECD, Declaration on Base Erosion and Profit Shifting Adopted on 29 May 2013. Available on: www.oecd.org/mcm/C-MIN%282013%2922-FINAL-ENG.pdf. 11  Ibid, p 2. 12  Ibid, p 2. 13 OECD, Action Plan on Base Erosion and Profit Shifting (OECD Publishing, 2013). Available on:www.oecd.org/ctp/BEPSActionPlan.pdf.

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changes were needed to effectively prevent double non-taxation, but also cases of no or low taxation ‘associated with practices that artificially segregate taxable income from the activities that generate it’.14 A realignment of taxation and relevant substance was needed, as international tax standards may not have kept pace with changing business models and technological developments.15 While the Action Plan was not directly aimed at changing the existing international standards on the allocation of taxing rights on cross-border income, it sought to restore both source and residence taxation where cross-border income would otherwise go untaxed or would be taxed at very low rates.16 The need for consensus and multilateralism was emphasised. ‘[I]f the Action Plan fails to develop effective solutions in a timely manner, some countries may be persuaded to take unilateral action for protecting their tax base, resulting in avoidable uncertainty and unrelieved double taxation’.17 The BEPS Action Plan, which was fully endorsed by the G20, outlined 15 actions across a range of tax areas, including the digital economy, transfer pricing, coherence of corporate income taxation and transparency. Fundamental changes to the international tax architecture and the current source/residence dichotomy were ruled out. The 15 actions were scheduled to be delivered in three phases: September 2014, September 2015 and December 2015. In general, it seems that the BEPS Action Plan is aimed at integrating or reviving several related on-going OECD projects. The technical work is being undertaken by the Committee on Fiscal Affairs (CFA) through a number of its working parties and other subsidiary bodies.18 The BEPS Action Plan was endorsed by the G20 Finance Ministers on 19 July 2013 in Moscow and by the G20 leaders in September 2013, in St Petersburg. To show commitment to this project and to ensure progress would be made, the UK, Germany and France contributed €550,000 to the OECD.19 Since the endorsement of the Action Plan a number of reports have been published on all

14 

Ibid, p 13. Ibid, p 13. 16  Ibid, p 11. 17  Ibid. On this point, see also David D Stewart, ‘Unilateral Changes in Anticipation of OECD BEPS Project Risk Fragmenting Tax Rules’, 2013 WTD 226-2 (22 November 2013). 18  These are Working Parties 1, 2, 6 and 11, as well as the Forum on Harmful Tax Practices and the Task Force on Digital Economy. Working Party 1 (Tax Conventions and Related Questions), in relation to part of action 2, action 6, action 7 and action 14. Working Party 2 (Tax Policy Analysis and Tax Statistics), in relation to action 11. Working Party 6 in relation to part of action 4, actions 8–10 and 13. Working Party 11 (Aggressive Tax Planning), in relation to part of action 2, action 3, part of action 4 and action 12. The Forum on Harmful Tax Practices, in relation to action 5 and the Task Force on Digital Economy in relation action 1. See www.oecd.org/tax/beps-about.htm. 19  HM Treasury, HM Revenue & Customs, Tackling Aggressive Tax Planning in the Global Economy: UK Priorities for the G20-OECD Project for Countering Base Erosion and Profit Shifting (March 2014). Available on: www.gov.uk/government/publications/tackling-aggressive-tax-planning-in-the-globaleconomy-uk-priorities-for-the-g20-oecd-project-for-countering-base-erosion-and-profit-shifting. 15 

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Action items, as well as comments from interested stakeholders.20 The reports are examined in this and the following two chapters. It has been questioned21 whether the BEPS project will be the starting point for the development of new principles of international tax law or whether it will be the final failure of the OECD to gain consensus on topics, notwithstanding the unprecedented level of political support. It is widely acknowledged that BEPS is a political commitment of the OECD and G20 countries, though as has been argued, it is a commitment to the agenda and ‘not a commitment to accept whatever solutions come out of the process’.22 It may prove impossible to reach consensus on solutions to some problems and/or some solutions adopted by the majority might not be implemented by all countries.23 The need for coordination is crucial. It is not just the survival of the international tax regime that is at stake here but also ‘the relevance of the OECD and its dominant members as the key players in the international tax world’.24

2.2. The BEPS Action Plan The Action Plan appears to be broadly concerned with reform in the following three or four categories.25 The first category relates to rules on tax base allocation and, to an extent, the application of the source/residence doctrines to some modern-day transactions. Aligning value creation with taxation appears to be the leitmotif. Topics such as the taxation of the digital economy,26 the avoidance of the permanent establishment (PE) status,27 transfer pricing of intangibles and other high risk transactions28 would appear to fall under this category. The second category relates to anti-abuse rules tackling base erosion and preventing double non-taxation. These would include rules on hybrids,29 controlled

20 A calendar for planned stakeholders’ input was revised and released a number of times (27 ­February 2014, 15 April 2014, etc). 21  Philip Baker, ‘Is there a Cure for BEPS?’ [2013] British Tax Review 605. 22  Ibid. 23  Ibid. 24  Yariv Brauner, ‘BEPS: An Interim Evaluation’ (2014) 6 World Tax Journal 10, 13. 25  The BEPS Action Plan itself groups some of the actions under different headings. For different categorisations, see, for example, Ault, Schön and Shay, n 4 above, who group the action items in the following way: (a) Rules for the digital economy (Action 1); (b) Prevention of double non-taxation (Actions 2, 3, 4, 5, 6); (c) Alignment of economic activity and taxation (Actions 7, 8, 9, 10); (d) Tax Transparency and dispute resolution (Actions 11, 12, 13, 14); (e) Efficient and effective implementation (Action 15). 26  Action 1. 27  Action 7. 28  Actions 8–10. 29  Action 2.

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foreign corporation (CFC) rules,30 thin capitalisation rules,31 the countering of harmful tax practices32 and anti-treaty-shopping rules.33 The third category deals with procedural reforms. One set of suggestions is to devise rules on country-by-country reporting for transfer pricing ­documentation.34 The Action Plan also suggests rules to collect and analyse data and ­counteractions.35 Rules demanding disclosure of aggressive tax planning arrangements36 are also to be developed. Suggestions to make dispute resolution more effective37 and to develop multilateral instruments38 could be viewed as part of the procedural reforms, or as comprising a fourth category on promoting multilateralism. This category could also encompass some of the proposals under the action item on harmful tax practices.39 It would seem that most of the action items, especially those under the first two categories (ie tax base allocation rules and anti-abuse rules), are not really new.40 In some of the BEPS deliverables the OECD refines its previous work but in a few instances it departs from it. Up to the time of writing, important progress had been made in all areas though nothing was finalised. This chapter examines the outputs on Actions 1–5. The next two chapters examine the outputs on the remaining action items.

2.3.  Action 1: Addressing the Tax Challenges of the Digital Economy Action 1 deals with the challenges that the digital economy poses for the application of existing international tax rules and the possible solutions. The work to be undertaken is described as follows. Identify the main difficulties that the digital economy poses for the application of existing international tax rules and develop detailed options to address these difficulties, ­taking a holistic approach and considering both direct and indirect taxation. Issues to be

30 

Action 3. Action 4. 32  Action 5. 33  Action 6. 34  Action 13. 35  Action 11. 36  Action 12. 37  Action 14. 38  Action 15. 39  Action 5. 40  Regarding the overlap with previous initiatives and reports, see, inter alios, Yariv Brauner, ‘What the BEPS?’ (2014) 16 Florida Tax Review 55; Ault, Schön and Shay, n 4 above; Nathan Boidman and Michael N Kandev, ‘BEPS: The OECD Discovers America?’ (2013) 72 Tax Notes International 1017 (16 Dec 2013) etc. 31 

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e­ xamined include, but are not limited to, the ability of a company to have a s­ ignificant digital presence in the economy of another country without being liable to taxation due to the lack of nexus under current international rules, the attribution of value created from the generation of marketable location-relevant data through the use of digital products and services, the characterisation of income derived from new business models, the application of related source rules, and how to ensure the effective collection of VAT/ GST with respect to the cross-border supply of digital goods and services. Such work will require a thorough analysis of the various business models in this sector.41

As has been pointed out, the overall concern in this area is the absence of base creation rather than the existence of base erosion.42 This is not a new area of concern. In the late 1990s, the digital economy, then in its embryonic form referred to as e-commerce, was considered by the OECD leading up to the adoption of the Ottawa Taxation Framework Conditions which guided governments in their approach to e-commerce­.43 The precursor to this was a joint government and business conference in Finland in November 1997.44 In this conference, the OECD expressed its support for an environment in which electronic commerce could develop its full potential. At the Ottawa conference45 held in the following year, a taxation framework was adopted. This was the Ottawa Taxation Framework Conditions, which were also mentioned in the OECD’s March 2014 Discussion Draft on Digital Economy.46 In the Ottawa Taxation Framework Conditions, it was stated that ‘[t]he taxation principles which guide governments in relation to conventional commerce should also guide them in relation to electronic commerce’.47 It was thought that at this stage of development in the technological and commercial environment, existing taxation rules could implement these principles. The broad taxation principles which should apply to electronic commerce were the following: neutrality, efficiency, certainty and simplicity, effectiveness and fairness and lastly, flexibility.48 The challenges faced by revenue authorities on how to implement these principles

41 

BEPS Action Plan, n 13 above, pp 14–15. Boidman and Kandev, n 40 above, p 1019. 43 OECD, Electronic Commerce: Taxation Framework Conditions—A Report by the Committee on Fiscal Affairs, as presented to Ministers at the OECD Ministerial Conference, ‘A Borderless World: Realising the Potential of Electronic Commerce’ on 8 October 1998. Available on: www.oecd.org/tax/ consumption/1923256.pdf. 44  The title of the conference was ‘Dismantling the Barriers to Global Electronic Commerce’. See OECD, Implementation of the Ottawa Taxation Framework Conditions: The 2003 Report, para 5, p 11. 45  The title of the Ottawa OECD Ministerial Conference in 1998 was A Borderless World—Realising the Potential of Electronic Commerce. 46 Public Discussion Draft, BEPS Action 1: Address the Tax Challenges of the Digital Economy, 24 March–14 April 2014 (henceforth, the Digital Economy Discussion Draft). Available on: www.oecd. org/ctp/tax-challenges-digital-economy-discussion-draft-march-2014.pdf. Also see Tax Analysts, 2014 WTD 57-33. 47 OECD, Electronic Commerce: Taxation Framework Conditions, n 43 above, para 4. 48  Ibid, para 9, box 2. 42 

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were ­recognised and rather vague suggestions were made.49 More work was to be done on a ­post-Ottawa agenda and process.50 In January 1999, the OECD Committee on Fiscal Affairs appointed the Technical Advisory Group (TAG) to examine how the current treaty rules on business profits apply in the context of e-commerce and to consider proposals for alternative rules. Following the publication of a number of discussion drafts,51 in its final report in 2004, the TAG concluded that existing concepts were sufficient to ensure the tax-neutral treatment of e-commerce and physical transactions. Furthermore, it was thought that there was no ‘actual evidence that the communications efficiencies of the Internet have caused any significant decrease to the tax revenues of capital importing countries’.52 This view is no longer held though. The rapid evolution of information and communication technologies has led to renewed attempts to address the taxation of the digital economy. As noted in the BEPS Action Plan, the spread of the digital economy poses significant challenges for international taxation. The digital economy is characterised by an unparalleled reliance on intangible assets, the massive use of data (notably personal data), the widespread adoption of multi-sided business models capturing value from externalities generated by free products, and the difficulty of determining the jurisdiction in which value creation occurs. This raises fundamental questions as to how enterprises in the digital economy add value and make their profits, and how the digital economy relates to the concepts of source and residence or the characterisation of income for tax purposes. At the same time, the fact that new ways of doing business may result in a relocation of core business functions and, consequently, a different distribution of taxing rights which may lead to low taxation is not per se an indicator of defects in the existing system. It is important to examine closely how enterprises of the digital economy add value and make their profits in order to determine whether and to what extent it may be necessary to adapt the current rules in order to take into account the specific features of that industry and to prevent BEPS.53

49  See para 11, box 3, for a number of recommendations. Inter alia: (i) Revenue authorities should make use of the available technology and harness commercial developments in administering their tax system to continuously improve taxpayer service. (ii) Revenue authorities should maintain their ability to secure access to reliable and verifiable information in order to identify taxpayers and obtain the information necessary to administer their tax system. (iii) Countries should ensure that appropriate systems are in place to control and collect taxes. (iv) International mechanisms for assistance in the collection of tax should be developed, including proposals to insert language in the OECD Model Tax Convention, etc. 50  For an excellent summary of the post-Ottawa developments in this field, see Digital Economy Discussion Draft, n 46 above. 51  The TAG produced discussion drafts on ‘Attribution of Profit to a Permanent Establishment Involved in Electronic Commerce Transactions’, which was released in February 2001, and ‘Place of Effective Management Concept: Suggestions for Changes to the OECD Model Tax Convention’, released in May 2003. 52 OECD, Are the Current Treaty Rules for Taxing Business Profits Appropriate for E-Commerce? Final Report (2004), para 350, p 72. 53  BEPS Action Plan, n 13 above, p 10.

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On 24 March 2014 the OECD released its first discussion draft on Action 1, the Digital Economy Discussion Draft.54 The Digital Economy Discussion Draft was developed by the Task Force on Digital Economy.55 The Digital Economy Discussion Draft was largely descriptive of the current situation and did not make any specific recommendations. The first half of the Digital Economy Discussion Draft contained a comprehensive examination of the evolution of the digital economy and the creation of new business models,56 without really defining the concept of digital economy. Thereafter, there was a general discussion of the common features of tax planning structures that create opportunities for BEPS with respect to both direct and indirect taxes. Part VI of the report was entitled ‘Tackling BEPS in the Digital Economy’. However, it was very difficult to deduce from the analysis any specific recommendations. Here, overlap with other Action items was identified. Confusingly, in discussing most57 of the overlaps, the Digital Economy Discussion Draft used the terms ‘market jurisdiction’ and ‘market country’ as if they were synonymous with source-based taxation58 and source country59 respectively. This has been criticised for creating a tension between possible new rules of tax nexus for each of the concepts but mainly for market jurisdiction.60 The broader tax challenges were grouped into four categories. The first category looked at the appropriateness of the rules on nexus, due to the limited need for extensive physical presence in order to carry on business.61 The second category considered how to attribute value created from the generation of data through digital products and services, and how to characterise for tax purposes a person or entity’s supply of data in a transaction.62 The third category examined the characterisation of payments made in the context of new business models for the provision of products or the delivery of services, such as ‘cloud’ computing.63 In the fourth category, there was an examination of how to modify the VAT rules to improve the administration of the system.64

54 

Digital Economy Discussion Draft, n 46 above. On the various working groups looking into BEPS issues, see n 18 above. 56  Digital Economy Discussion Draft, n 46 above, parts I–III. 57  In discussing the overlap with the action item on CFCs, the discussion paper uses the term ‘source country’ and not ‘market jurisdiction’. Ibid, paras 167–69. 58  See, for example, ibid, p 48, heading in 2.1 (‘Measures that will restore taxation in the market jurisdiction’) which is immediately followed by the text of paragraph 147: ‘A number of measures of the BEPS Action Plan will in effect restore source taxation, in particular…’. 59  See, for example, p 49, para 150: ‘The treaty definition of permanent establishment may limit the application of domestic law rules applicable to the taxation of the business profits of non-resident companies derived from sources in the market country. The work done with respect to Action 7 aims at preventing the artificial avoidance of the treaty threshold below which the market country may not tax’. 60  Mindy Herzfeld, ‘The BEPS Digital Economy Draft—Struggling for Consensus’, 2014 WTD 96–2 (19 May 2014). Also see Business Europe comments, 19 April 2014. 61  Digital Economy Discussion Draft, n 46 above, pp 56–57. 62  Ibid, pp 57–58. 63  Ibid, pp 58–59. 64  Ibid, pp 59–62. 55 

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As mentioned, the Digital Economy Discussion Draft did not make any c­ oncrete recommendations—rather it made several suggestions in the last part of the report, Part VII. Even here, there was merely a broad overview of these suggestions, with the promise of a more thorough analysis in the final report.65 The first suggestion was to modify the exemptions in paragraph 4 of Article 5 of the OECD Model—ie the preparatory or auxiliary exemptions from the PE status—when such activities of a business constituted core functions.66 The second suggestion was to establish a new nexus based on significant digital presence. When an enterprise engaged in certain ‘fully dematerialised digital activities’ it would have a permanent establishment if it maintained a ‘significant digital presence’ in the economy of another country.67 The third suggestion was to establish a virtual PE.68 The last two suggestions were more general in nature and did not interfere with the current structure and scope of Article 5 of the OECD Model. The creation of a withholding tax on digital transactions was considered: imposing a final withholding tax on certain payments made by residents of a country for digital goods or services provided by a foreign e-commerce provider.69 Lastly, consumption tax options were reviewed, such as an exemption for imports of low-valued goods.70 As expected, the Digital Economy Discussion Draft attracted great interest— and criticism. Many business groups and NGOs made representations.71 NGOs tended to favour radical changes to the current rules, whereas the business sector adopted a more conservative approach, lobbying for limited changes to the existing rules and urging the OECD to hold back in making recommendations until the rest of the BEPS project was completed.72 At the core of the matter lies the disagreement whether the business models arising from the digital economy

65 

Ibid, p 63. Ibid, pp 64–65. This could be done by eliminating paragraph 4 entirely, or eliminating subparagraphs (a) through (d), or making them subject to the overall condition that the character of the activity conducted be preparatory or auxiliary in nature, rather than one of the core activities of the enterprise in question. Ibid, p 65. Also see analysis of Action 7 in Ch 3, section 3.2 of this volume. 67  For suggested guidelines on the interpretation of these terms, see Digital Economy Discussion Draft, n 46 above, pp 64–65. 68  Ibid, para 267, p 66. 69  Ibid, pp 66–67. 70  Ibid, pp 67–68. 71  See comments received on the Digital Economy Discussion Draft, published on the OECD website, available on: www.oecd.org/tax/comments-action-1-tax-challenges-digital-economy.htm. 72  Herzfeld, ‘The BEPS Digital Economy Draft—Struggling for Consensus’, n 60 above. Also see KPMG, Comments on the OECD Discussion Draft on the Tax Challenges of the Digital Economy (14 April 2014) at p 4: ‘We strongly endorse the Task Force’s conclusion stated above and encourage the OECD to develop solutions through other aspects of the BEPS Action Plan to address the tax challenges of the digital economy—challenges manifest more clearly through innovative and modern business models adopted across all sectors’. Reported in Tax Analysts, 2014 WTD 75-15 (14 April 2014). Similarly, see Opinion Statement FC 7/2014 of the CFE on the OECD Discussion Draft: Addressing the tax challenges of the digital economy (BEPS Action 1). The Opinion was prepared by the CFE Fiscal Committee and submitted to the OECD in April 2014. Reported in Tax Analysts, 2014 WTD 76-30 (18 April 2014). 66 

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are so unique as to require new ‘tailor-made’ international tax rules, or not.73 The OECD, through its discussion draft, does not seem to take a position on this issue. The fact that there was nothing in the report supporting the conclusion that the digital economy should be treated differently from other businesses suggests that there was no preference for the development of a special set of rules. Moreover, it was argued that many of the tax challenges mentioned in the Digital Economy Discussion Draft were the result of advances in technology and were either outside the framework of BEPS altogether or fell under other Action items.74 The same lack of consensus on how to tackle the digital economy was also reflected at governmental level. This became evident at the OECD public consultation meeting held on 23 April 2014. Some countries, such as France, favoured the taxation of digital commerce in the country of residence of the customer because the product was transformed when the customer used it. India and China also favoured the modification of the taxable nexus rules in light of the evolution of the digital economy.75 Other countries, most notably the US, argued that digitisation was ubiquitous and that there should be no special rules for particular industries.76 A second version of the report was issued on 16 September 2014, along with the reports on six other deliverables. The Digital Economy Revised Discussion Draft77 largely followed the initial discussion draft and confirmed its conclusions. It revisited the key features of the ‘new’ business models in the digital economy, how these features may exacerbate BEPS risks and how these issues should be addressed.

73  See, for example, the comments submitted by the BEPS Monitoring Group in favour of revisiting the PE definition to address the shift to a digitalised economy. Available on: bepsmonitoringgroup.files. wordpress.com/2014/04/bmg-digital-economy-submission-2014.pdf. Also reported in Tax Analysts, 2014 WTD 75-16 (17 April 2014). For the contrary view, see, for example, a comprehensive letter from the United States Council for International Business to the OECD, dated 11 April 2014, which endorses ‘wholeheartedly the conclusion that there should not be a separate taxation regime for the “digital economy”, however defined’. Reported in Tax Analysts, 2014 WTD 76-29 (11 April 2014). See, furthermore, David D Steward, ‘Silicon Valley Concerned About OECD Digital Economy Draft, Practitioner Says’, 2014 WTD 75-1 (18 April 2014) and ‘OECD Members Divided Over Need for Unique Tax Treatment of Digital Economy’, 2014 WTD 81-2 (28 April 2014). Also see a PwC Tax Policy Bulletin which also raises the point that the different treatment of digital economy transactions might give rise to state aid problems. Reported in Tax Analysts on 16 May 2014, 2014 WTD 96-23. 74  See comments of the Business and Industry Advisory Committee to the OECD and comments of the Chartered Institute of Taxation submitted on 14 April 2014, and reported in Tax Analysts on 18 April 2014, at 2014 WTD 76-28 and 2014 WTD 76-31 respectively. In its comments to the OECD, Deloitte suggested the setting up of a Working Group to continue investigating the broader taxation issues specifically attributable to the digital market, outside the scope of the BEPS project. Reported in Tax Analysts, 2014 WTD 76-27 (18 April 2014). Also see comments of the Digital Economy Group, discussed in Herzfeld, ‘The BEPS Digital Economy Draft—Struggling for Consensus’, n 60 above. 75  Ibid. 76  See Kristen A Parillo, ‘OECD Digital Economy Draft Lays Out Reform Options’, Tax Analysts, 2014 WTD 57-2 (25 March 2014). 77 OECD, Addressing the Tax Challenges of the Digital Economy, OECD Publishing (henceforth, Digital Economy Revised Discussion Draft). Available on: www.keepeek.com/Digital-Asset-Management/ oecd/taxation/addressing-the-tax-challenges-of-the-digital-economy_9789264218789-en#page3.

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The OECD continued to acknowledge that it would be impossible to ring-fence the digital economy for the purposes of creating separate tax rules ‘[b]ecause the digital economy is increasingly becoming the economy itself ’.78 Attempting to isolate the digital economy ‘would inevitably require arbitrary lines to be drawn between what is digital and what is not’.79 Furthermore, as the digital economy is in a continuous state of evolution, ‘possible future developments need to be monitored to evaluate their impact on tax systems’.80 On the basis of the fundamental principles of taxation discussed in a new chapter,81 the options for reform to address the broader tax challenges raised by the digital economy were reviewed in the final chapter. It was obvious that developments on other BEPS items would be intertwined. Similar to the Digital Economy Discussion Draft, the revised discussion draft suggested that the PE exceptions need to be refined to ensure that core activities would not inappropriately benefit. As such, work on Action 7 ought to be expanded to consider whether certain activities that were previously considered preparatory or auxiliary might be significant components of business in the digital economy.82 Several suggestions were made most of which were repeated in the discussion draft on Action 7.83 The Digital Economy Revised Discussion Draft also considered the importance of intangibles, the use of data and the impact on transfer pricing practices. There was a strong suggestion that transfer pricing allocation methodologies for global value chains in this context should be reviewed. In the taxation of these business models, heavy reliance on collection, analysis and monetisation of data should be factored in.84 Similarly to the Digital Economy Discussion Draft it was also suggested that CFC rules should be adapted to the digital economy. Income from digital products and services provided remotely was often not caught by CFC rules. Such income may be particularly mobile due to the importance of intangibles in this context and the relatively few people needed to carry out online sales activities. The Digital Economy Revised Discussion Draft furthermore examined how to deal with tax planning by businesses engaged in VAT-exempt activities.85 The ­suggestion was to focus on administrative procedures to collect business to consumer VAT-type taxes rather than make changes to VAT regimes.86 As regards

78 

Ibid, p 12. Ibid. 80  Ibid. 81  See ch 2, entitled ‘Fundamental Principles of Taxation’. Also see review of prior work on this topic and especially the Ottawa Taxation Framework Conditions, set out in Annex A. 82  See ch 8 and pp 153–54. 83  See section 3.2 in Ch 3 of this volume. 84  Digital Economy Revised Discussion Draft, n 77 above, pp 129–32. Also see pp 116–19. 85  Ibid, pp 133–34. 86  Ibid, pp 135–38. 79 

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cross-border compliance matters, non-OECD countries participating in the BEPS project should be included on equal footing with OECD countries.87 Working Party 9 had already been working on the issue for its international VAT/GST Guidelines. It was also recommended that the OECD work with all BEPS participants to clarify the characterisation under current treaty rules of payments for cloud computing services, including infrastructure-as-a-service, software-as-aservice and platform-as-a-service transactions.88 It was stated that as the recommendations on the other Actions items were to be finalised, the OECD would evaluate how the outcomes affected the broader tax challenges mentioned in the Digital Economy Revised Discussion Draft and would complete an evaluation of the options for addressing them. Overall, a waitand-see approach was recommended for many issues that may be addressed elsewhere in the BEPS project.89 Apart from the OECD’s work on the digital economy, the topic has also been considered within the European Union. This is examined in Chapter five, where the work of the Group on Digital Economy is reviewed.90 Also, as a response to one of the conclusions of the Digital Economy Revised Discussion Draft, further progress on the drafting of the OECD International VAT/GST Guidelines was achieved.91 On 18 December, the OECD published a joint discussion draft dealing with two new elements to be included in these Guidelines, relating to the place of taxation of business-to-consumer supplies of services and intangibles, and provisions to support the application of the Guidelines in practice.92

87 

Ibid, p 152. Ibid, p 159. 89 Kristen A Parillo, Amanda Athanasiou, Margaret Burow, Ajay Gupta and David D Steward, ‘OECD Releases BEPS Reports Ahead of G-20 Meeting’, 2014 WTD 180-1 (17 September 2014). 90  See section 5.5 of this volume. 91  The CFA had already been working on the International VAT/GST Guidelines to address issues of double taxation and unintended non-taxation resulting from inconsistencies in the application of VAT in international trade. The first three chapters of these Guidelines were approved in January 2014 and were endorsed as a global standard at the second meeting of the OECD Global Forum on VAT on 17–18 April 2014 in Tokyo. 92  Discussion Drafts for Public Consultation, International VAT/GST—Guidelines on Place of Taxation for Business-to-Consumer Supplies of Services and Intangibles Provisions—Provisions on Supporting the Guidelines in Practice (18 December 2014–20 February 2015). Available on: www.oecd.org/ctp/ consumption/discussion-draft-oecd-international-vat-gst-guidelines.pdf. The discussion draft of the B2C Guidelines presents a set of common principles for determining the place of taxation for B2C supplies of services and intangibles, in accordance with the destination principle. It also presents the recommended approach for collecting the VAT/GST on these supplies, focusing in particular on supplies by non-resident suppliers. It is recommended that non-resident suppliers should be required to register and remit the VAT/GST in the jurisdiction of taxation and that countries should implement a simplified registration and compliance regime to facilitate c­ ompliance for non-resident suppliers. There is an analysis of the possible key features of such a simplified regime. The draft supporting provisions present approaches for facilitating the proper and consistent 88 

Action 2: Hybrid Mismatch Arrangements

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2.4.  Action 2: Neutralise the Effects of Hybrid Mismatch Arrangements Action 2 under the OECD has called for the development of instruments to neutralise the effects of hybrid mismatch arrangements. Develop model treaty provisions and recommendations regarding the design of domestic rules to neutralise the effect (e.g. double non-taxation, double deduction, long-term deferral) of hybrid instruments and entities. This may include: (i) changes to the OECD Model Tax Convention to ensure that hybrid instruments and entities (as well as dual resident entities) are not used to obtain the benefits of treaties unduly; (ii) domestic law provisions that prevent exemption or non-recognition for payments that are deductible by the payor; (iii) domestic law provisions that deny a deduction for a payment that is not includible in income by the recipient (and is not subject to taxation under controlled foreign company (CFC) or similar rules); (iv) domestic law provisions that deny a deduction for a payment that is also deductible in another jurisdiction; and (v) where necessary, guidance on co-ordination or tie breaker rules if more than one country seeks to apply such rules to a transaction or structure. Special attention should be given to the interaction between possible changes to domestic law and the provisions of the OECD Model Tax Convention. This work will be co-ordinated with the work on interest expense deduction limitations, the work on CFC rules, and the work on treaty shopping.

On 19 March 2014, the OECD released two discussion drafts in connection with Action 2. The first discussion draft (the Domestic Law Discussion Draft) made recommendations on domestic law.93 The second discussion draft (the Treaty Discussion Draft) examined treaty issues and made recommendations to the OECD Model.94 In the Domestic Law Discussion Draft, it was recognised that the problematic nature of hybrid mismatch arrangements had been discussed in a number of previous OECD reports.95 A hybrid mismatch arrangement was described as a profit shifting arrangement that utilised a hybrid element in the tax treatment of an entity or instrument to produce a mismatch in tax outcomes in respect of a payment that was made under that arrangement.96

implementation of the principles of the Guidelines in national legislation, as well as their consistent interpretation by tax administrations. See OECD website: www.oecd.org/tax/consumption/release-ofdiscussion-drafts-of-two-new-elements-of-the-oecd-international-vat-gst-guidelines.htm. 93 OECD, BEPS Action 2: Neutralise the Effects of Hybrid Mismatch Arrangements (Recommendations for Domestic Laws) 19 March 2014–2 May 2014 (henceforth, the Domestic Law Discussion Draft). 94 OECD, BEPS Action 2: Neutralise the Effects of Hybrid Mismatch Arrangements (Treaty Issues) 19 March 2014–2 May 2014 (henceforth, the Treaty Discussion Draft). 95  Domestic Law Draft, paras 1–15, referring to OECD, Addressing Tax Risks Involving Bank Losses (OECD, 2010); OECD, Corporate Loss Utilisation through Aggressive Tax Planning (OECD, 2011); OECD, Hybrid Mismatch Arrangements: Tax Policy and Compliance Issues (OECD, 2012). 96  Domestic Law Discussion Draft, n 93 above, para 17.

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The two principal mismatches identified were payments that are deductible under the rules of the payer and not included in the income of the recipient (deduction/no inclusion outcomes—D/NI) and payments that give rise to duplicate deductions from the same expenditure (double deduction—DD outcome).97 Arrangements were defined to involve payments. Therefore unilateral deductions granted by domestic law which did not involve a payment, such as notional interest deductions for equity capital, were not covered98—something which has attracted criticism.99 The Domestic Law Discussion Draft set out design principles for the proposed domestic rules that should be developed to neutralise the effect of hybrid mismatch arrangements. In particular, it was suggested that the rules should operate to eliminate the mismatch without requiring the jurisdiction applying the rule to establish that it has ‘lost’ tax revenue under the arrangement; they should be comprehensive; they should apply automatically; they should avoid double taxation through rule co-ordination, they should minimise the disruption to existing domestic law; they should be clear and transparent in their operation; they should facilitate coordination with the counterparty jurisdiction while providing the flexibility necessary for the rule to be incorporated into the laws of each jurisdiction; they should be workable for taxpayers and keep compliance costs to a minimum; and they should be easy for tax authorities to administer.100 It seems that according to the design principles, the domestic rules would eliminate the mismatch without a distinction between intended and unintended mismatches and without targeting the tax benefit in the particular jurisdiction where it arises. Therefore, there would be no need for any ‘purpose or intention test’, but merely an analysis of tax outcome. This aspect of the proposals has also been criticised because inadvertent results may arise from applying purely mechanical rules.101 The overall approach adopted in the Domestic Law Discussion Draft was to identify and categorise hybrid mismatch arrangements based on the particular hybrid technique that produced the profit shifting. Recommendations were set out for domestic rules that would neutralise the effect of these arrangements. The specific categories of hybrid mismatch arrangements considered were the

97 

Ibid, para 20. Ibid, paras 21–22. 99  See PwC Tax Policy Bulletin, OECD releases two discussion drafts on hybrid mismatch arrangements (21 March, 2014). Available on: www.pwc.com/en_GX/gx/tax/newsletters/tax-policy-bulletin/ assets/pwc-oecd-releases-two-discussion-drafts-hybrid-mismatch-arrangemen.pdf. 100  Domestic Law Discussion Draft, n 93 above, para 27. 101  See, for example, the PwC Tax Policy Bulletin, dated 21 March 2014. 98 

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following: hybrid financial instruments and transfers,102 hybrid entity ­payments,103 reverse hybrid and imported mismatches.104 The Domestic Law Discussion Draft recommended changes to domestic laws designed to reduce the incidence of hybrid mismatches, and linking rules that specifically target the mismatch in tax outcomes under hybrid mismatch ­arrangements.105 In order to minimise the risk of double taxation, two linking rules were recommended: a primary rule and a secondary or defensive rule. The primary rule would apply whenever a hybrid mismatch arose, and the secondary or defensive rule would only apply in circumstances where the primary rule did not apply in the jurisdiction of the counterparty. ‘The choice of primary and defensive rules is based on ensuring that the hybrid mismatch rules are effective and relatively easy to apply, rather than looking to compensate the jurisdiction that has lost tax revenue under the arrangement’.106 For each category of hybrid arrangements identified above, the Domestic Law Discussion Draft provided detailed descriptions of arrangements and examples, domestic law recommendations to be adopted, technical tax discussions, and the application and scope of the rules.107 The second discussion draft, the Treaty Discussion Draft, specified that it complemented the first discussion draft but also considered the interaction between the recommendations of the two. The Treaty Draft also made recommendations for amendments to the OECD Model, in order to address the following two problems: the use of dual resident entities to obtain the benefits of treaties unduly; and the use of transparent entities to obtain the benefits of treaties unduly.

102  This is where a deductible payment made under a financial instrument is not treated as taxable income under the laws of the payee’s jurisdiction. See Domestic Law Discussion Draft, n 93 above, para 49. Also see fuller description in para 60, where this is described as any financing arrangement that is subject to a different tax characterisation under the laws of two or more jurisdictions such that a payment under that instrument gives rise to a mismatch in tax outcomes. Domestic Law Discussion Draft, para 60. 103  This is where differences in the characterisation of the hybrid payer result in a deductible payment being disregarded or triggering a second deduction in the other jurisdiction: ibid, paras 49 and 163. 104  The Domestic Law Discussion Draft, n 93 above, states, in para 49 that these cover payments made to an intermediary payee that are not taxable on receipt. There are two kinds of arrangements targeted by these rules: (i) arrangements where differences in the characterisation of the intermediary result in the payment being disregarded in both the intermediary jurisdiction and the investor’s jurisdiction (reverse hybrids); (ii) arrangements where the intermediary is party to a separate hybrid mismatch arrangement and the payment is set-off against a deduction arising under that arrangement (imported mismatches). As discussed in paras 50 and 206–7, reverse hybrids are treated as a subset of the broader category of imported mismatch arrangements. Imported mismatch arrangements are hybrid structures created under the laws of two jurisdictions where the effects of the hybrid mismatch are imported into a third jurisdiction. Imported mismatches rely on the absence of effective hybrid mismatch rules in the investor and intermediary jurisdictions in order to generate the mismatch in tax outcomes which can then be ‘imported’ into the payer jurisdiction. 105  Domestic Law Discussion Draft, n 93 above, para 52. 106  Ibid. 107  There is a summary of the recommendations in para 58, ibid.

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As regards the recommendations on dual resident entities, it was suggested that these should be included in the discussion draft on Action 6. They were in fact partially addressed by a proposed change to Article 4(3) of the OECD Model, which would allow the competent authorities of the Contracting States to determine the residence of dual resident taxpayers on a case-by-case basis. However, this proposal would not address all BEPS-related concerns (such as deductible hybrid payments made by dual resident companies)108 and other issues that could arise from dual residence where no bilateral tax treaty was involved.109 Comments were invited on these points. As far as transparent entities were concerned, the Treaty Discussion Draft proposed a change to Article 1(2) of the OECD Model and corresponding additional commentary to provide a rule for fiscally transparent entities.110 Under this rule, income derived by or through an entity or arrangement that was treated as wholly or partly fiscally transparent under the tax laws of either Contracting State should be considered to be income of a resident of a Contracting State, but only to the extent that the income was treated, for purposes of taxation by that State, as the income of a resident of that State. The suggested new Commentary would focus on applying the rule to partnerships and was consistent with the principles of the 1999 OECD report on the Application of the OECD Model Tax Convention to Partnerships. In the third part of the Treaty Discussion Draft, the interaction with the Domestic Law Discussion Draft and its recommendations was considered. Most specifically the recommendations to deny deductions or force income inclusions in the context of hybrid financial instruments and hybrid entity payments were ­examined.111 It was recognised that the deductibility of payments was mainly an issue to be dealt with under domestic law and the only tax treaty provisions that might be relevant were Articles 7 and 24 of the OECD Model.112 In the Treaty Discussion Draft, it was questioned whether the anti-hybrid provisions would be incompatible with Article 7 of the OECD Model where they lead to the imposition of tax on a non-resident without a permanent establishment in the taxing state.113 It was also questioned whether they would be incompatible with Article 24 of the OECD Model. Apart from these issues, it was noted in the Treaty Discussion Draft that there does not seem to be a potential conflict with the OECD Model. These discussion drafts and especially the Domestic Law Discussion Draft, have attracted a lot of criticism. It is obvious that the Domestic Law ­Discussion Draft attempts to neutralise hybrid mismatch arrangements on a unilateral basis. ­Nevertheless, the ultimate test of success would be the extent to which these domestic law proposals are broadly and uniformly adopted. Coordination of the

108 

Treaty Discussion Draft, n 94 above, para 8. Ibid, para 9. 110  Ibid, paras 10–11. 111  Ibid, para 12. 112  Ibid, paras 14–15. 113  Ibid, para 15, citing para 9 of the Domestic Law Discussion Draft, n 93 above. 109 

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treatment of a hybrid arrangement in two or more countries is key to the OECD’s proposals. It has been recommended that domestic General Anti-Abuse Rules (GAARs) should be made inapplicable to hybrid arrangements that are covered by the proposals114 but at the same time, the recommended rules should not interfere with other regulatory regimes at a domestic or multilateral level. In addition, there should also be internal consistency, as far as the BEPS project is concerned. It was emphasised in some of the comments by stakeholders that the OECD should not finalise its work on hybrids in advance of its work on CFCs, interest deductions and harmful tax practices.115 Another issue already mentioned is the absence of any subjective purpose or intention or motive test. It was argued that this might lead to double taxation. As noted by some of the stakeholders, [o]bjective mechanical tests such as those recommended in the proposals may offer certainty, but such tests do not take into account situations that are not abusive but happen to fall within the defined parameters. If the OECD seeks to ensure that global commerce operates without distortion resulting from income tax considerations, then such unintended applications of mechanical tests would be counter-productive.116

It has also been suggested that the OECD should take into account the broader economic impact of the proposals117 and that it may be useful to perform an impact assessment.118 It is likely that there will be an increased incentive for multinationals to document the tax treatment of each cross-border intercompany transaction in two or more jurisdictions, generating compliance costs.119 Much more critically, the BEPS Monitoring Group argued that the OECD should ‘end this pointless and wasteful game’120 and deal with the root of the ­problem and

114  ‘EY Urges OECD to “Act Cautiously” on Hybrid Mismatch Arrangements’, reported in Tax Analysts, 2014 WTD 91-26 (9 May 2014) pp 4–5. 115  See, inter alios, comments of the European Business Initiative on Taxation in ‘International Cooperation Paramount in Hybrid Mismatch Issues, Corporate Tax Group Tells OECD’, 2014 WTD 96-25 (15 May 2014); ‘EY Urges OECD to “Act Cautiously” on Hybrid Mismatch Arrangements’, n 114, ‘Japanese Business Federation Wants OECD to Ensure “Normal Business Activities” in Hybrid Mismatch Draft’, reported in Tax Analysts 2014 WTD 96-28 (15 May 2014) etc. 116  ‘PwC Fears “Disproportionate Consequences” of Hybrid Mismatch Recommendations’, reported in Tax Analysts, 2014 WTD 92-24 (12 May 2014). For an overview of some of the comments, see Amanda Athanasiou, ‘OECD’s Hybrid Mismatch Proposals Too Drastic, Commentators Say’, 2014 WTD 94-1 (15 May 2014); Amanda Athanasiou, ‘Pessimism Marks Hybrid Mismatch Consultation’, 2014 WTD 97-4 (20 May 2014). 117 ‘Deloitte Tells OECD to Take “Broader Economic Impact” of Hybrid Mismatch Draft Into Account’, reported in Tax Analysts, 2014 WTD 92-25 (12 May 2014). 118 ‘U.S. Business Council Suggests OECD Perform Impact Assessment in Hybrid Mismatch Response’, reported in Tax Analysts, 2014 WTD 92-26 (12 May 2014). 119  See Ernst & Young, Global Tax Alert, 7 April 2014. 120  See comments in the submission of the BEPS Monitoring Group on Hybrid Mismatch Arrangements, p 3, available on: bepsmonitoringgroup.files.wordpress.com/2014/05/bmg-hybrid-mismatchessubmission.pdf.

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the strong motivation for BEPS which is created by the separate entity principle. Many of the proposals considered in the BEPS project, including these relating to hybrids, attempt to counteract some base erosion techniques by overriding the separate entity principle, but only in specifically defined circumstances. As such, ‘they can at best hope to provide only temporary palliatives to a system which desperately needs a more fundamental cure’.121 In September 2014, the OECD released its revised discussion draft on this ­deliverable.122 The Hybrids Revised Discussion Draft broadly followed the March discussion document. As such, the principle of automatic application with no motive or purpose test, as well as the hierarchical linking rules were preserved.123 Hybrid payments were broadly defined and could include royalties or even payments for goods but still did not include deemed payments, eg interest deductions. There was clarification of the reverse hybrid and imported mismatch rules, making them consistent with other recommendations. The Hybrids Revised Discussion Draft treated payments deferred for an ‘unreasonable’ amount of time as giving rise to a hybrid mismatch, though there was no guidance as to what was a reasonable or an unreasonable amount of time. The Hybrids Revised Discussion Draft provided that reasonable differences in the timing of the recognition of payments did not constitute a mismatch in tax outcomes.124 However, there was no guidance as to what was a reasonable or an unreasonable difference in the timing of recognition. It was stated in the Hybrids Revised Discussion Draft that further details would be agreed in the Commentary on the circumstances and requirements for ‘establishing permissible differences in the timing of recognition of payments under the hybrid financing instrument rule’.125 Further on it was established that in some circumstances, ‘a timing mismatch will be considered permanent if the taxpayer cannot establish to the satisfaction of a tax authority that a payment will be brought into account within a defined period’.126 A bottom-up approach was favoured for the purposes of scoping the application of the hybrid financial instrument rules.127 The rules were restricted to related parties, structured arrangements or controlled groups. Rules against deductible dividends and double deduction situations were proposed to have unrestricted scope.

121 

Ibid, p 1. OECD/G20 Base Erosion and Profit Shifting Project, Neutralising the Effects of Hybrid Mismatch Arrangements—Action 2: 2014 Deliverable (henceforth, Hybrids Revised Discussion Draft). Available on: www.oecd-ilibrary.org/docserver/download/2314261e.pdf?expires=1422995216&id=id&accname =guest&checksum=26AD343B4D9DE9B0FFCC3564C452ABA3. 123 See commentary in Kristen A Parillo, Amanda Athanasiou, Margaret Burow, Ajay Gupta and David D Steward, ‘OECD Releases BEPS Reports Ahead of G-20 Meeting’, 2014 WTD 180-1, (17 ­September 2014); Reinout de Boer and Otto Marres, ‘BEPS Action 2: Neutralising the Effects of Hybrid Mismatch Arrangements’ (2015) 43 Intertax 14–41. 124  Hybrids Revised Discussion Draft, n 122 above, para 61, p 36 and p 72. 125  Ibid, para 61. 126  Ibid, ch 7, Key Terms, p 72. 127  Ibid, para 119, p 67. 122 

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In the Domestic Law Discussion Draft, the OECD had proposed a 10 per cent ownership threshold for relatedness,128 but in the September 2014 Hybrids Revised Discussion Draft, the threshold was raised to 25 per cent. Two persons were related if one person held, directly or indirectly, 25 per cent or more of the voting rights or the value of any equity interests in another. In addition, two persons in the same control group were related if they fulfilled certain conditions. Also, instruments or arrangements between two persons may fall within the scope of the hybrid instrument rules if the persons were acting together, under certain conditions.129 There were no substantive changes to the treaty recommendations of the Treaty Discussion Draft. As far as the OECD Model was concerned, the Hybrids Revised Discussion Draft repeated recommendations regarding dual resident entities130 and transparent entities.131 There was a suggestion to include in the OECD Model a new provision in Article 1 and changes to the Commentary to ensure that income of fiscally transparent entities was treated in accordance with the principles of the OECD’s Partnership Report 1999.132 The last part of the Hybrids Revised Discussion Draft examined potential treaty issues that could arise from the recommended domestic law changes and made various proposals. Some issues are still unresolved. The Hybrids Revised Discussion Draft does not address whether or under what circumstances income included under CFC regimes is to be treated as included in ordinary income for the purposes of these proposals. Moreover, the Hybrids Revised Discussion Draft notes that there are some specific areas where further refinements in the recommended domestic law rules may be needed; for example in the treatment of hybrid regulatory capital that is issued intra-group, for certain capital market transactions (such as onmarket stock lending and repos), in the treatment of imported hybrid mismatches and the application of the imported hybrid mismatch rule.133 It is anticipated that the output on Action 2 will be finalised in September 2015. The report is likely to be in the form of commentary and transitional rules. The proposals of the revised discussion draft were again criticised by the BEPS Monitoring Group for being still rather limited and not dealing with the underlying problem of the separate entity approach and interest deductibility.134 For example, they did not deal with Belgium’s notional interest deduction regime

128 

Domestic Law Discussion Draft, n 93 above, para 128. definitions for ‘structured arrangements’, ‘related persons’, ‘control group’ and ‘acting together’ in ch 6. The Hybrids Revised Discussion Draft, n 122 above, at p 70 provides a potential exception for collective investment vehicles under common management, to ensure that such vehicles managed by the same manager would not be treated as acting together for the purposes of the legislation. 130  Hybrids Revised Discussion Draft, n 122 above, ch 8. 131  Ibid, ch 9. 132 OECD, The Application of the OECD Model Tax Convention to Partnerships, Issues in International Taxation, No 6 (OECD Publishing, 1999). 133  Hybrids Revised Discussion Draft, n 122 above, para 7. 134  BEPS Monitoring Group, OECD BEPS Scorecard, pp 5–6. Available on: bepsmonitoringgroup. files.wordpress.com/2014/10/oecd-beps-scorecard.pdf. 129 See

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which provided an allowance for corporate equity—this was to be dealt with (if at all) as a ‘harmful tax practice’. What was needed, according to the Group, was a more comprehensive and coherent approach which would enable each country to limit deductions by treating a multinational’s debt on a consolidated basis, and to apportion it to entities in each country by an appropriate criterion such as EBITDA. This proposal, while notable, is unlikely to be adopted, since it requires a level of consensus that clearly does not exist for the time being. The OECD’s deliberate attempts to address the problem of hybrids through a series of unilateral domestic rules rather than a supra-national instrument have also been criticised.135 As a result of the proposals, domestic tax laws are likely to become much more contingent and structurally dependent on the policies and practices of other governments, thus, to an extent, surrendering some of their tax sovereignty. It has been claimed that so far, the deliverables in Action 2 and the design principles therein are ‘agnostic as to who should be collecting tax from situations involving inconsistent government choices’.136 Overall, there could be a significant departure from the BEPS mantra of taxing income where it is earned.

2.5.  Action 3: Strengthen CFC Rules Under Action 3 of the BEPS Action Plan, the OECD is to: Develop recommendations regarding the design of controlled foreign company rules. This work will be co-ordinated with other work as necessary.

On 3 April 2015, the OECD published the discussion draft on strengthening CFC rules.137 It was emphasised that this was not a consensus document. The CFC Discussion Draft considered all the constituent elements of CFC rules and put them into categories of ‘building blocks’ that were necessary for effective CFC rules.138 These building blocks would allow countries without CFC rules to implement recommended rules directly and countries with existing CFC rules to modify their rules to align them more with the recommendations. The majority of these building blocks included recommendations. One building block—that on the definition of a CFC—did not yet include any recommendations but there was a discussion of the possible options. Specific questions were identified for which input was required in order to advance the work on CFC rules. 135  See analysis by Graeme S Cooper, ‘Some Thoughts on the OECD’s Recommendations on Hybrid Mismatches’ (2015) 69 Bulletin for International Taxation 334–49. 136  Ibid. 137 OECD, Public Discussion Draft, BEPS Action 3: Strengthening CFC Rules (henceforth, the CFC Discussion Draft). Available on: www.oecd.org/ctp/aggressive/discussion-draft-beps-action3-strengthening-CFC-rules.pdf. 138 The building blocks considered were the following: (1) definition of a CFC; (2) threshold requirements; (3) definition of control; (4) definition of CFC income; (5) rules for computing income; (6) rules for attributing income; and (7) rules to prevent or eliminate double taxation.

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The recommendations discussed were designed to combat BEPS. However, it was recognised that some countries design their CFC rules to achieve wider policy objectives. Jurisdictions could choose to adopt CFC rules that applied more broadly than the recommendations as long as these were consistent with other international legal obligations. Such wider aims were not within the scope of Action 3.139 The work was to be completed by September 2015, and interested parties were invited to send comments by 1 May 2015. The first chapter of the CFC Discussion Draft briefly addressed the policy considerations. There were fundamental policy considerations that needed to be considered when designing CFC rules such as how to strike a balance between the need to tax foreign income and the need to maintain competitiveness,140 how to limit administrative and compliance burdens while ensuring that CFC rules were effective, and the avoidance of double taxation. The CFC Discussion Draft also considered the role of CFC rules, the scope of base stripping prevented by CFC rules, and the interaction between transfer pricing rules and CFC rules. The obligations for Member States of the European Union were also considered. It was acknowledged that whilst recommendations developed under Action 3 needed to be broad enough to be effective in combatting BEPS, they also had to be adaptable where necessary, to enable Member States to comply with EU law.141 The CFC Discussion Draft referred to the Cadbury Schweppes case142 and the wholly artificial arrangements test, as the litmus test.143 It was also argued that on the basis of the Thin Cap GLO case,144 a CFC rule in a Member State that targeted income earned by a CFC that was not itself wholly artificial may nevertheless be justified so long as the transaction giving rise to the income was at least partly artificial. Reference was also made to the SGI145 and Oy AA146 cases as supporting the argument that a CFC regime may not be limited to wholly artificial arrangements, if the regime explicitly ensured a balanced allocation of taxing power. This position is considered in greater detail and criticised in Chapter six of this volume. It was also noted that under EU law, a CFC rule would only be found inconsistent with the freedom of establishment if the rule itself discriminated against non-residents. Therefore, if a CFC rule treated domestic subsidiaries the same as cross-border subsidiaries, there would be no discrimination. Of course, CFC regimes tend to apply to non-resident subsidiaries. The CFC Discussion Draft acknowledged the concern that non-EU-based multinational groups could be put at a competitive disadvantage compared to groups within the EU if the latter were subject to less vigorous CFC rules under EU law. 139 

Ibid, para 4. Ibid, para 10. Ibid, para 11. 142  Case C-196/04 Cadbury Schweppes plc and Cadbury Schweppes Overseas Ltd v Commissioners of Inland Revenue [2006] ECR I-7995. 143  CFC Discussion Draft, n 137 above, para 14. 144  Case C-524/04 Test Claimants in Thin Cap Group Litigation Order [2007] ECR I-2107. 145  Case C-311/08 Société de Gestion Industrielle (SGI) v Belgian State [2010] ECR I-0487. 146  Case C-231/05 Oy AA [2007] ECR I-6373. 140  141 

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The following chapters of the CFC Discussion Draft set out the building blocks. Chapter 2 looked at how to define a CFC but no specific suggestion was made. Rather, it was recommended to broadly define a CFC so that in addition to including corporate entities, CFC rules would also apply to partnerships, trusts, and PEs when those entities were either owned by CFCs or treated in the parent jurisdiction as taxable entities separate from their owners.147 It was further recommended to include a modified hybrid mismatch rule that would prevent entities from circumventing CFC rules by being treated differently in different jurisdictions.148 Threshold requirements were considered in chapter 3. It was recommended to include a low-tax threshold where the tax rate calculation was based on the effective tax rate. The low-tax threshold should also use a tax rate that was meaningfully lower than the tax rate in the country applying the CFC rules.149 The definition of control was examined in chapter 4. Two different determinations were recommended: (i) of the type of control that was required; and (ii) of the level of that control. The recommendation for control was that CFC rules should at least apply both a legal and an economic control test so that satisfaction of either test resulted in control. Countries might also include de facto tests where they achieved the same effect. Secondly, a CFC should be treated as controlled where residents held, at a minimum, more than 50 per cent control, although countries that wanted to achieve broader policy goals or prevent circumvention of CFC rules might set their control threshold at a lower level. This level of control could be established through the aggregated interest of related parties or unrelated resident parties, or the aggregated interest of any taxpayers that were found to be acting in concert. Additionally, CFC rules should apply where there was either direct or indirect control.150 The building block of defining CFC income was considered in chapter 5 of the CFC Discussion Draft but there were no recommendations. The chapter discussed several possible options that jurisdictions could implement in order to accurately attribute income that raised BEPS concerns. First, general features that would likely be included in effective CFC rules were outlined, including a form-based analysis and several different versions of a substance analysis. Then there was a discussion of how CFC rules should attribute the categories of income that raise the most challenges for existing rules. These categories of income included dividends, interest and other financing income, insurance income, sales and services income, royalties and other IP income. Two possible approaches were considered that could accurately attribute these categories of income, whether implemented separately or in combination with each other. There was also a discussion of whether CFC rules should take a transactional or entity approach to attributing income.

147 

CFC Discussion Draft, n 137 above, para 30. Ibid, para 31. 149  Ibid, para 43. 150  Ibid, para 65. 148 

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Comments were invited about the form of recommendations for the building block on the definition of CFC income. Chapter 6 of the CFC Discussion Draft examined rules for computing income. It was recommended that computing the income of a CFC required two different determinations: first, which jurisdiction’s rules should apply; and secondly, whether any specific rules for computing CFC income were necessary. Regarding the first determination, the recommendation was to use the rules of the parent jurisdiction to calculate a CFC’s income. Regarding the second determination, the recommendation was for jurisdictions to have a specific rule limiting the offset of CFC losses so that they can only be used against the profits of the same CFC or against the profits of other CFCs in the same jurisdiction.151 The rules for attributing income were reviewed in chapter 7. The following issues were addressed.152 First, how to determine which taxpayers should have income attributed to them. Here, it was recommended that the attribution threshold should be tied to the minimum control threshold when possible, although countries could choose to use different attribution and control thresholds depending on the policy considerations underlying CFC rules. Secondly, how to determine how much income should be attributed. Here, it was recommended that the amount of income to be attributed to each shareholder or controlling person should be calculated by reference to both their proportion of ownership and their actual period of ownership or influence. Other issues considered were how to determine when the income should be included in the returns of the taxpayers and how the income should be treated. Here, it was recommended that jurisdictions could determine these issues so that CFC rules operated in a way that was coherent with existing domestic law. As for the tax rate that should apply to the income, it was recommended to apply the tax rate of the parent jurisdiction. Finally, chapter 8 considered rules to prevent or eliminate double taxation. It was noted that jurisdictions were primarily153 concerned with at least three situations where double taxation might arise: first, situations where the attributed CFC income was also subject to foreign corporate taxes; secondly, situations where CFC rules in more than one jurisdiction applied to the same CFC income; and thirdly, situations where a CFC actually distributed dividends out of income that had already been attributed to its resident shareholders under the CFC rules, or a resident shareholder disposed of the shares in the CFC.154 In addressing the first two situations, it was recommended to allow a credit for foreign taxes actually paid, including CFC taxes assessed on intermediate companies. As for the third

151 

Ibid, para 131. Ibid, paras 142–43. 153  It was stated that double taxation concerns could arise in other situations, for instance where there had been a transfer pricing adjustment between two jurisdictions and a CFC charge arose in a third jurisdiction. 154  Ibid, para 154. 152 

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situation, it was recommended to exempt dividends and gains on disposition of CFC shares from taxation if the income of the CFC had previously been subject to CFC taxation, but the precise treatment of such dividends and gains could be left to individual jurisdictions so that provisions were coherent with domestic law.155 In the end, there were three annexes with tables outlining how existing CFC rules currently address several of the issues dealt with in the CFC Discussion Draft, including how countries’ de minimis and low-tax thresholds work, and how they define attributable income from insurance. It has been argued that the principal motivator of the CFC Discussion Draft, but also to some extent the entire BEPS project, is the US check-the-box regime.156 The acknowledgement of the limitations under which EU Member States operate also suggests that the CFC Discussion Draft is really addressed to the US. As noted by Mitchell Kane, [h]ybridity regarding payments, residence and entity characterization has taken a prominent place in the analysis of CFC rules, due, in no small part, to the effects of US law on hybridity, especially an elective rule on entity characterization, a highly formalistic rule on corporate residence, a highly non-formalistic rule on the debt-equity distinction and the impressive creativity of the US tax bar.157

Certainly, the lack of consensus suggests fundamental disagreements and a deep political split among OECD countries as to how strict the CFC rules should be. The lack of consensus on the CFC rules can also be attributed in part to countries’ self-interest and a misconception that transfer pricing rules can do the job.158 Furthermore, countries may choose not to have CFC rules so as to attract companies and capital. The most likely outcome of Action 3 of the BEPS project will be a menu of approaches, or suggestions of best practice, or both. This could give a competitive advantage to companies in countries with more relaxed regimes and as a corollary could generate more tax competition which could exacerbate rather than mitigate base erosion and profit shifting. There have also been criticisms in that, notwithstanding the substantial overlap with the other BEPS actions, the lack of consensus among countries in the CFC Discussion Draft raises the question of what role CFC rules should play in the BEPS project altogether and whether CFC rules might in fact be unnecessary in addressing base erosion and profit shifting.159 The BEPS Monitoring Group argued that post-BEPS CFC rules must be set at a high standard and be coordinated because 155 

Ibid, para 155. comments, in Amanda Athanasiou, ‘OECD’s CFC Rule Draft Likely to Spur Controversy’, 2015 WTD 65-5 (6 April 2015). See also, Amanda Athanasiou, ‘Lack of Consensus on CFC Rules Likely Here to Stay’ (2015) 78 Tax Notes International 207, 20 April 2015. 157  Mitchell Kane, ‘The Role of Controlled Foreign Company Legislation in the OECD Base Erosion and Profit Shifting Project’ (2014) 68 Bulletin for International Taxation 321–26, 326. 158  Amanda Athanasiou, ‘Competitive Interests Preventing Consensus on CFCs, Stack Says’ 2015 WTD 96-3 (19 May 2015). 159  See comments of the Tax Executive Institute on the CFC Discussion Draft, in ‘TEI Criticizes OECD’s Strengthening CFC Rules Discussion Draft’, 2015 WTD 85-19 (30 April 2015). 156  See

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‘a weak standard which is left to states to implement would be counter-productive, as it would encourage source states to reduce their tax rates, and hence worsen the race to the bottom in corporate tax’.160 Strong CFC rules could give the BEPS project a better chance of success and a better chance of ensuring that MNEs are taxed where economic activities take place and value is created. Weak rules would mean failure. The adoption of a full inclusion approach was recommended by the BEPS Monitoring Group, under which the home country would tax all CFC income, with a credit for foreign taxes paid.161 An alternative approach was a substance test based on the proportion of profit to employees, determined by payroll costs. It would apply if the effective tax rate in the CFC’s country of residence was below 95 per cent of that of the home country. The preferred response was to adopt a more explicitly unitary approach to MNEs, ‘for example by systematizing and regularizing the profit split method with defined concrete allocation factors and weightings for all commonly used business models’.162 By apportioning profits according to appropriate measures of real economic activity, this would leave countries free to set their corporate tax rates, balancing encouragement of investment in real activities with optimising tax revenues.163 Whilst the expectation for an international unitary approach to be applied to MNEs is currently unrealistic, in the European Union, the Common Consolidated Corporate Tax Base (CCCTB)164 proposal does contain CFC rules in a unitary context. However, these CFC rules would only apply to subsidiaries resident in third countries. To the Commission, there could only be CFCs established in third countries—there could never be non-CCCTB CFCs within the European Union. In any case, in a CCCTB discussion draft on the proposed anti-abuse rules for the purposes of the CCCTB,165 the Commission, referring to its earlier Communication on anti-abuse measures,166 commented that ‘if CFC rules were to be introduced in the CCCTB they should be in line with the recent ECJ rulings’.167 This meant that [t]o comply with the ECJ law either CFC rules are only to be applied in relation with third countries or CFC rules are also to be applied within the EU but, in this case, the rules should be targeted at wholly artificial arrangements only.168 160  BEPS Monitoring Group, ‘Comments on BEPS Action 3: Strengthening the Rules on Controlled Foreign Corporations (CFCs)’, available on: bepsmonitoringgroup.files.wordpress.com/2015/05/ap3controlled-foreign-corporations.pdf. 161  Ibid, page 4, para 6. 162  Ibid, page 4, para 3. 163  Ibid. 164  Brussels, COM(2011) 121/4, 2011/0058 (CNS); SEC(2011) 316 final. See discussion also in sections 5.2.2 and 8.1 of Chs 5 and 8 of this volume respectively. 165  CCCTB/WP065\doc\en: ‘CCCTB: Anti-Abuse rules’ (14–15 April 2008). See discussion in part 6, Christiana HJI Panayi, The Common Consolidated Corporate Tax Base and the UK (Institute for Fiscal Studies, 2011). 166  Commission Communication on Anti-Abuse Measures, COM(2007) 785. See discussion in section 5.2.1 of this volume. 167  CCCTB/WP065\doc\en, n 165 above, para 29. 168  Ibid.

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Perhaps a post-BEPS proposal on the CCCTB, which seems to be likely ­following recent Commission announcements in the context of the Tax Transparency ­Package,169 would now not set the threshold for CFC rules so high.

2.6.  Action 4: Limit Base Erosion via Interest Payments and Other Financial Payments Action 4 mandates the OECD to: Develop recommendations regarding best practices in the design of rules to prevent base erosion through the use of interest expense, for example through the use of related-party and third-party debt to achieve excessive interest deductions or to finance the production of exempt or deferred income, and other financial payments that are economically equivalent to interest payments. The work will evaluate the effectiveness of different types of limitations. In connection with and in support of the foregoing work, transfer pricing guidance will also be developed regarding the pricing of related party financial transactions, including financial and performance guarantees, derivatives (including internal derivatives used in intra-bank dealings), and captive and other insurance arrangements. The work will be co-ordinated with the work on hybrids and CFC rules.

On 18 December 2014 the OECD released its discussion draft on interest deductions and other financial payments.170 The primary concern appeared to be that multinational groups may be able to claim total interest deductions that significantly exceed their actual third-party interest expense. As explained in the Interest Expense Discussion Draft, such deductible payments can give rise to double nontaxation in both inbound and outbound investment scenarios. From an inbound perspective, concerns focus on excess interest deductions reducing taxable profits in operating companies even in cases where the group as a whole has little or no external debt. From an outbound perspective a company may use debt finance to produce tax exempt or deferred income, thereby claiming a deduction for interest expense while the related income is brought into tax later or not at all. Similar concerns are raised by payments under financial instruments such as guarantees and derivatives.171

The Interest Expense Discussion Draft reiterated the OECD’s intention to develop recommendations for a best practice approach or approaches to address concerns

169 

See analysis in Ch 5, section 5.4 of this volume. Action 4: Interest Deductions and Other Financial Payments (henceforth, the Interest Expense Discussion Draft). Available on: www.oecd.org/ctp/aggressive/discussion-draft-action-4-­ interest-deductions.pdf. For commentary, see Amanda Athanasiou and Lee A Sheppard, ‘BEPS Action 4 Draft Outlines Options for Interest Expense Deductions’, 2014 WTD 244-1 (19 December 2014); Emilio Cencerrado Millan and Maria Teresa Soler Roch, ‘Limit Base Erosion via Interest Deduction and Others’ (2015) 43 Intertax 58–71; Jan Vleggeert, ‘Public Discussion Draft on Interest Deductions Proposes Worldwide Interest Allocation Rules’ (2015) 69 Bulletin for International Taxation 297–305. 171  Interest Expense Discussion Draft, n 170, p 2. 170 OECD, BEPS

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about BEPS through interest expense. There was a review of existing approaches used by countries to address this problem and a discussion of a series of issues that were relevant to any approach chosen. It was noted that a rule must apply not only to interest but also to payments that were economically equivalent to interest, as well as other expenses incurred in connection with the raising of finance.172 There was a non-exhaustive list of examples of types of payment that should be covered by such a rule,173 but it was left to each country to determine how this should be reflected within its domestic law.174 In deciding whether a payment is economically equivalent to interest, the focus should be on its economic substance rather than its legal form. It was suggested that an interest deductibility rule should apply to companies and other entities in three different scenarios: first, when they formed part of a corporate group; secondly, when they were under common control, but were not part of a corporate group (eg when a fund, individual or trust exercised the common control); and thirdly, when the parties were (otherwise) related, using a 25 per cent common ownership test, or in the case of a structured arrangement.175 It was questioned whether a rule should operate by reference to the level of interest expense in an entity or the level of debt. It was also questioned whether a rule should focus on an entity’s gross position (ie only its interest expense or debt liabilities) or its net position (ie also taking into account interest income or debt assets).176 Factors in favour of each method were considered. There was also a discussion on whether there should be a de minimis threshold, in order to reduce the level of compliance burden on entities and the administrative burden on tax authorities. Certain entities may pose a sufficiently low risk that excluding them from a rule would be appropriate. The Interest Expense Discussion Draft considered two ways to set a threshold below which entities would not be expected to apply the rule: based on an entity’s size (a size threshold) or its level of net interest expense (a monetary threshold). It was not proposed that a threshold would be required as part of a best practice recommendation—it was up to countries to decide so.177 Where a threshold was introduced, it should be set at an appropriate level, taking into account the economic and interest rate environment in the country. In addition, it was preferable that the threshold should apply to the total level of net interest expense in the local group, to avoid groups fragmenting into multiple entities each applying a separate threshold.178

172 

Ibid, Part IV. For example, profit participating loans, imputed interest on convertible or zero-coupon bonds, foreign exchange gains and losses connected with the raising of finance, guarantee fees with respect to financing arrangements and loan arrangement or similar fees. Ibid, para 35. 174  Ibid. 175  Ibid, Part V. This scoping rule is similar to that used in the Hybrids Revised Discussion Draft, n 122 above, released by the OECD in September 2014. 176  Ibid, Part VI. 177  Ibid, para 57. 178  Ibid. 173 

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The Interest Expense Discussion Draft examined various methods of ­limiting taxpayers’ excessive interest expense deductions. The methods included general interest limitation rules which set an overall limit on the amount of interest expense in an entity, by linking interest deductibility to the position of a group or to fixed ratios, as well as targeted interest limitation rules which address specific base erosion and profit shifting risks. The Interest Expense Discussion Draft focused primarily on two approaches: first, a group-wide rule, which would limit a company’s net interest deductions to a proportion of the group’s actual net thirdparty interest expense; and secondly, a fixed-ratio rule, which would apply irrespective of the level of debt of a group and which would limit a company’s interest deductions to an amount determined by applying a fixed benchmark ratio to an entity’s earnings, assets or equity. Certain combinations of these two approaches and the use of more targeted approaches were also discussed. Other approaches were rejected, although it was acknowledged that some rules, such as targeted anti-abuse rules, might be helpful in defined circumstances. For example, a fixed debt-to-equity ratio test was not to be included because of the perceived manipulability and efficacy concerns. Also, the arm’s length test was not recommended as the sole general rule, as it would be ineffective and/or burdensome to apply and enforce. The imposition of withholding taxes on interest payments was also rejected as a solution in part because the EU’s Interest and Royalty Directive would make it very difficult for Member States to impose withholding taxes on interest payments made within the European Union. It was noted that each of these provisions could play a useful role within an overall approach. Under the group-wide approach, the aim was to align individual entities’ interest expenses with the overall group’s interest expenses.179 This would prevent the group from claiming relief for interest expense in excess of its actual interest costs, and could reduce the risk of profit shifting when taxable income was separated from economic activity, according to the draft. There would be allocation of a group’s net third-party interest expense between group entities in accordance with their economic activity, measured by earnings or asset values. This could operate by either allocating to each entity a portion of the group’s net third-party interest expense or limiting each entity’s interest expense to a portion of the group’s net third-party interest expense. There was also a group ratio rule, which would compare the relevant financial ratio of an entity—its net interest to earnings or net interest to asset values—with the equivalent ratio of the entity’s worldwide group to establish a limit on the net interest expense the entity would be allowed to deduct. Under the fixed-ratio approach, an entity would be entitled to deduct net interest expenses up to a specified proportion of its earnings, assets or equity. The Interest Expense Discussion Draft noted a perception that even the lower 25 per cent and 30 per cent ratios currently used by other countries might be too high to address BEPS concerns. This approach was more rigid and did not account for the

179 

Ibid, Part VIII.

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fact that different sectors require different amounts of leverage. However, it was thought to be administratively less cumbersome. The Interest Expense Discussion Draft described another two approaches that combined elements of the above approaches,180 so as to reduce administrative and compliance costs and offer certainty to companies. Each of these combined approaches included a general rule and then a carve-out from the general rule. ‘Approach 1’ was a general group-wide interest allocation rule with a carve-out for entities meeting a low fixed-ratio test, to help alleviate the compliance costs in lower-risk situations. ‘Approach 2’ was a fixed-ratio rule with a carve-out for entities that might permit them to deduct additional interest expense when the group’s overall ratio exceeded the standard fixed ratio. Targeted rules may be needed to address specific situations, such as for interest paid to connected or related parties, stapled stock, interest accrued on excessive debt push-downs and interest used to fund or acquire tax-exempt or tax-deferred income-yielding assets.181 The Interest Expense Discussion Draft did not recommend any specific targeted rules but opened up the topic for further discussion. The special issues presented by banking and insurance companies, as well as groups in other sectors were recognised—it was recommended that there should be separate rules for these.182 The Interest Expense Discussion Draft acknowledged the interaction with the other BEPS action items, especially Actions 2, 3 and 4, but focused on the need for coordination rather than ranking.183 In general, although the Interest Expense Discussion Draft did not adopt a specific approach, if seen in the context of other Action items, especially Actions 8–10, there is, arguably, a subtle shift away from separate entity accounting and a move towards a more unitary approach, with less respect for contracts. It has been criticised that BEPS represents a slippery slope towards formulary apportionment.184 Written comments by industry and business representatives had denounced the OECD’s groupwide approach and its rejection of the arm’s length test. Also, at the public consultation on 17 February 2015, it was argued that the proposed groupwide allocation would engender complexity and difficulties for both taxpayers and tax administrators. The proposal was also problematic, due to the temporal volatility in earnings, the unique circumstances of individual constituent entities, and the proposal’s perverse incentive for increasing group indebtedness.185 180 

Ibid, Part X. Ibid, Part XI. 182  Ibid, Part XIII. 183  Ibid, Part XIV. 184  David D Steward, ‘BEPS Presents Slippery Slope Toward Formulary Apportionment’, 2015 WTD 29-1 (12 February 2015). For an endorsement of the OECD’s suggestions, see Chloe Burnett, ‘Interest Deductions and Multinational Enterprises: Goldilocks and the Brave New World’ (2015) 69 Bulletin for International Taxation 326. 185 Ajay Gupta, ‘BEPS Action 4: Keeping Formulary Apportionment at Bay’, 2015 WTD 45-3 (9 March 2015). Also see review of comments by Amanda Athanasiou and David D Stewart in ‘OECD Action 4 Draft Consultation Focuses on Fixed Ratios’, 2015 WTD 32-1 (18 February 2015). 181 

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The ­leverage and interest ratios between entities may vary depending on the nature of their business, their stage in the business cycle, their size, the market in which they operate etc.186 Furthermore, due to the differences in tax and accounting in different countries, applying the test might be a complex and cumbersome exercise. Moreover, given that the discussion draft provides a series of options of best practices rather than definite proposals, the inconsistent implementation of a group-wide rule could lead to double taxation. As countries will have some discretion, they may implement different versions of the rule. ‘All this would elevate the compliance burden and related costs to an unprecedented level’.187 A groupwide approach would also likely incentivise groups to increase third-party funding, which could create further economic distortions. There was overwhelming preference for a fixed-ratio test, though it has also been argued that a combined approach with a fixed-ratio rule as the general rule and group-wide approach as the exception might be more sensible than all. It has been reported that the OECD may be retracting its tentative steps towards adopting an apportionment regime for interest expense, going back to approaches based on separate entity accounting.188 The renunciation of the arm’s length standard as a solution and the proposals based on group-wide tests were bound to raise problems. That an MNE should be treated as an integrated firm for deductibility of interest purposes would surely have been perceived by business interests as going beyond just disavowing arm’s length tests to opening the door to some sort of formulary apportionment.189

Endorsing the group-wide tests in an unequivocal way would have represented ‘an unabashed embrace of unitary taxation’.190

2.7.  Action 5: Counter Harmful Tax Practices More Effectively, Taking into Account Transparency and Substance Action 5 of the BEPS Action Plan commits the Forum on Harmful Tax Practices (FHTP) to: Revamp the work on harmful tax practices with a priority on improving transparency, including compulsory spontaneous exchange on rulings related to preferential regimes, 186  Oliver R Hoor and Keith O’Donnell, ‘BEPS Action 4: When Theory Meets Practice’ (2015) 78 Tax Notes International 643 (18 May 2015). 187  Ibid. 188  Gupta, ‘BEPS Action 4: Keeping Formulary Apportionment at Bay’, n 185 above. 189  Ibid. 190  Ibid.

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and on requiring substantial activity for any preferential regime. It will take a holistic approach to evaluate preferential tax regimes in the BEPS context. It will engage with non-OECD members on the basis of the existing framework and consider revisions or additions to the existing framework.

Whilst the bulk of the work under the BEPS Action Plan is directed at the position and actions of taxpayers, this Action item—and arguably also Actions 14 and 15—focus on the actions of countries. Under Action 5, the FHTP was to deliver on three outputs: first, the finalisation of the review of member country preferential regimes; secondly, a strategy to expand participation to non-OECD member countries; and thirdly, consideration of revisions or additions to the existing framework. The OECD deliverable on Action 5 was released for the first time in September 2014.191 The Harmful Tax Practices Discussion Draft outlined the progress made on the delivery of these outputs and discussed progress on the first output at length. Almost half of the discussion draft was devoted to the OECD’s previous work on harmful tax practices—the 1998 Harmful Tax Competition Report192 and its aftermath. The work under Action 5 was seen as an extension of this. The FHTP was now asked to ‘revamp’ its work on harmful tax practices, with a priority and renewed focus on requiring substantial activity for any preferential regime and on improving transparency through compulsory spontaneous exchange of rulings related to preferential regimes. Emphasis was placed on elaborating a methodology to define a substantial activity requirement in the context of intangible property.193 This is understandable given that the taxation of intangible property is at the heart of the BEPS project.194 The OECD recognised that there has been a shift by countries from creating ringfenced tax regimes towards introducing more broadly-based corporate tax reductions for particular types of income, such as financial activities or intangibles.195 In defining substantial activity, the Harmful Tax Practices Discussion Draft focused primarily on the nexus approach.196 This looked at whether an

191 OECD, Countering Harmful Tax Practices More Effectively, Taking into Account Transparency and Substance, OECD/G20 Base Erosion and Profit Shifting Project (OECD Publishing, 2014) (henceforth, Harmful Tax Practices Discussion Draft). Available on: www.oecd-ilibrary.org/docserver/ download/2314271e.pdf?expires=1422733878&id=id&accname=guest&checksum=DFD58772A6E26 FAA92CFD6974A8A8B51. 192 OECD, Harmful Tax Competition: An Emerging Global Issue (OECD Publishing, 1998). See Ch 1 of this volume. 193  Harmful Tax Practices Discussion Draft, n 191 above, p 28. 194  Ibid, p 28. 195  Ibid. 196  Other approaches considered were the value creation approach and the transfer pricing approach. The value creation approach required taxpayers to undertake a set number of significant development activities. The transfer pricing approach would allow a regime to provide benefits to all the income generated by the IP if the taxpayer had located a set level of important functions in the jurisdiction providing the regime, if the taxpayer was the legal owner of the assets giving rise to the tax benefits and used the assets giving rise to the tax benefits, and if the taxpayer bore the economic risks of the assets giving rise to the tax benefits: ibid, pp 28–29. The third approach, the nexus approach, was preferred.

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i­ntellectual property (IP) regime made its benefits conditional on the extent of research and development (R&D) activities of taxpayers receiving benefits. Under this approach, expenditures act as a proxy for substantial activities.197 The nexus approach sought to build on the basic principle underlying R&D credits and similar ‘front-end’ tax regimes that apply to expenditures incurred in the creation of IP. It extended this basic principle to ‘back-end’ tax regimes that apply to the income earned after the creation and exploitation of the IP. Therefore, the initially proposed nexus approach would allow countries to extend their jurisdiction beyond IP regimes that only provide benefits directly to the expenditures incurred to create the IP, permitting jurisdictions to provide benefits to the income arising out of that IP—so long as there is a direct nexus between the income receiving benefits and the expenditures contributing to that income. The nexus approach applied a proportionate analysis to income, under which the proportion of income that may benefit from an IP regime was the same proportion as that between qualifying R&D expenditures and overall R&D expenditures.198 Calculations under the formula would be treated as a rebuttable presumption.199 The purpose of this approach was to grant benefits only to income that arises from IP where the actual R&D activity was undertaken by the taxpayer itself. This goal was achieved by defining ‘qualifying expenditures’ in a way that prevented mere capital contribution or expenditures for substantial R&D activity by parties other than the taxpayer from qualifying the subsequent income for benefits under an IP regime. The various concepts were analysed extensively in the discussion draft. Taxpayers wanting to benefit from an IP regime must track expenditures, IP assets, and income to ensure that the income receiving benefits did in fact arise from the expenditures that qualified for those benefits. Each jurisdiction had to establish procedures for tracking and tracing based on consistent criteria capable of objective measurement.200 There was some criticism of the approach used by the OECD in delineating substantial activity, in that it had ‘a tenuous link to a complex reality’.201 Expenses that may in some cases produce a significant return may sometimes result in no meaningful assets. Having one standard for all intangible-based businesses was

197 

Ibid, p 29. Ibid. For complex business models with multiple strands of income and expenditure, a more complicated formula was recommended: 198 

Qualifying expenditures incurred to develop IP asset Overall expenditures incurred to develop IP asset 199 

× Overall income from IP asset = Income receiving tax benefits

Harmful Tax Practices Discussion Draft, n 191 above, p 30. Ibid, p 34. 201  Mindy Herzfeld, ‘Defining Harmful Patent Boxes’, 2014 WTD 202-2 (20 October 2014). 200 

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unlikely to be effective. Also, the test may be difficult to apply. While it may be easier to link a tax credit to an expense, it may be more difficult to link an income item to an asset generated by a previously incurred expense.202 The framework arguably offered a formulaic view that was unlikely to recognise the complexities of tracing expenses to income-generating assets. There was also criticism that through this formula, ‘the OECD gives its blessing to a global tax system that allows countries with large pools of skilled labour to provide tax incentives’.203 This was likely to favour OECD member countries but not developing countries that tend to lack the labour pools to generate research expenses. It was also lamented that this approach would leave little room for IP management entities set up in small open economies to coordinate R&D activities of MNEs conducted in other jurisdictions.204 The BEPS Monitoring Group was very much against the basic premise of the substantial nexus approach—the linkage with expenses.205 The Group argued that tax allowances were an adequate reward for R&D. ‘The argument that companies deserve even greater contributions from the taxpayer if an investment in R&D generates exceptional income seems hard to justify’.206 Innovating companies already make exceptional profits, especially as a result of patent protection which is a state grant of monopoly. To grant on top of this a low tax rate, especially on income which could reduce the tax base resulting from economic activities (including marketing and sales) taking place in other countries, is a direct encouragement for firms to devise BEPS strategies.207

The Harmful Tax Practices Discussion Draft also set out a framework for compulsory spontaneous exchange of taxpayer-specific rulings related to preferential regimes.208 The framework did not extend to general rulings, ie rulings that apply to types of taxpayers or that may be given in relation to a defined set of circumstances or activities. A ruling must be specific to an individual taxpayer and that taxpayer must be entitled to rely on it. The suggested framework was to apply

202  Ibid. By way of example, Herzfeld referred to the complexities of the much simpler US research credit. She argued that the proposed substantial nexus regime multiplied the problems. Also see Gary Guenther, Research Tax Credit: Current Law and Policy Issues for the 113th Congress (Congressional Research Service, 3 October 2014). Available on: nationalaglawcenter.org/wp-content/uploads/assets/ crs/RL31181.pdf. 203  Ibid. 204  Ajay Gupta, ‘Modifying the Modified Nexus Approach—Behind Closed Doors’, 2015 WTD 60-1 (30 March 2015). 205  See BEPS Monitoring Group, OECD BEPS Scorecard, n 134 above. 206  Ibid, p 8. 207  Ibid. 208  Harmful Tax Practices Discussion Draft, n 191 above, ch 4. The term ‘compulsory’ was understood to introduce an obligation to spontaneously exchange information whenever the relevant conditions were met. The term ‘spontaneous exchange of information’ referred to a situation in which one country was aware of information that could be of relevance to another country, but the information had not been requested by the second country. Ibid, p 36.

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to member country preferential regimes and at a later stage associate countries’ ­preferential regimes. There were four key design questions:209 (1) When does the obligation to spontaneously exchange information on rulings arise? (2) Who must information be exchanged with? (3) What information must be exchanged? (4) What is the legal basis for the spontaneous information exchange? Some of the other issues which were also considered in this framework were, inter alia, the time limits for compulsory spontaneous information exchange, the relevance of reciprocity, protection of confidentiality of the information exchanged and the implementation of the framework.210 In assessing whether the obligation to spontaneously exchange information on rulings arises, a number of filters were recommended. These would ensure that the framework was targeted and that tax authorities’ discretion was reduced. The first three filters limited the obligation to rulings related to (i) preferential regimes that (ii) are within the scope of work of the FHTP and that (iii) meet the no or low effective tax rate factor. If a ruling passed all of these three filters, there were additional filters.211 Under the filter approach, only a ruling that passed through all of the filters would be subject to compulsory spontaneous information exchange.212 The obligation to spontaneously exchange would arise for rulings related to any preferential regime. There was no prerequisite for the ruling to have been reviewed or to have been found to be potentially or actually harmful within the meaning of the 1998 OECD Harmful Tax Competition Report.213 It was stated in the Harmful Tax Practices Discussion Draft that countries with preferential regimes that had not yet been reviewed by the FHTP would need to self-assess whether the first three filters (and the other filters provided in the discussion draft) were satisfied. Regimes that had been reviewed by the FHTP and that were found to meet the first three filters would be added to a compilation to be occasionally updated by the FHTP. The Harmful Tax Practices Discussion Draft also presented the status of the review of member country regimes and the progress made on the review of preferential regimes of associate countries. In a table showing the status of the review for 30 preferential regimes, 15 of these were IP regimes. Nine of the regimes were found to be ‘not harmful’, but the remaining regimes, all being IP regimes, were still

209 

Ibid, pp 38–39. Ibid, p 39. 211  For a comprehensive analysis of the filters, see pp 40–44 of the Harmful Tax Practices Discussion Draft, n 191 above. Also see the flowchart in Annex A which explained how these filters were intended to work. 212  Ibid, p 39. 213  See n 192 above. 210 

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under review.214 Henceforth, all preferential regimes would need to be ­considered in light of the elaborated transparency factor. Going forward, it was stated that the FHTP would complete the work under the first output of Action 5 and commence work on the second output by engaging with other non-OECD member countries. The deadline for the delivery of the second output was September 2015. The review of preferential regimes of associate countries would also continue. It was noted at an earlier juncture that any member and associate country can request at any time a review of any existing preferential tax regime.215 It was emphasised that the goal was to achieve a level playing field and to avoid the risk of the work on harmful tax practices displacing regimes from OECD member and associate countries to other countries, giving them an unwarranted competitive advantage and limiting the effectiveness of the whole exercise.216 The revamping of the OECD’s work on harmful tax practices was never going to be a straight-forward task—like most of the deliverables under the BEPS Action Plan. While the overarching focus of the Action Plan is on aligning taxation with value creation and the substance of transactions, determining the location of substantial activity in the context of Action 5 was inevitably going to be a subjective exercise—and one to generate a lot of disagreement. However, the proposals on the remaining aspects of Action 5 are more likely to go forward and be considered a success. Especially as regards the proposal for compulsory spontaneous exchange of rulings, there is already a legal basis for this in tax treaties which can be used.217 It also fits in with the latest global trends for greater automatic exchange of information. The European Commission has made similar but more wide-ranging proposals to allow for automatic exchange of all tax rulings, not just those relating to preferential regimes. The Commission proposals in the context of its Tax Transparency Package are considered in Chapter five of this volume.218 On 11 November 2014, Germany and the UK announced a proposal to ­modify the OECD’s nexus approach,219 which would also curb the UK patent box regime.220 This was subsequently endorsed by all OECD and G20 countries.

214 

Harmful Tax Practices Discussion Draft, n 191 above, pp 58–59. Ibid, p 56. 216  Ibid, pp 63–64. 217  Art 26 of the OECD Model. 218  See section 5.4. 219 See Germany–UK Joint Statement, available on: www.gov.uk/government/uploads/system/ uploads/attachment_data/file/373135/GERMANY_UK_STATEMENT.pdf. 220  Under the UK regime, companies could apply a lower rate of corporation tax (10%) to profits earned after 1 April 2013 from their patented inventions. A company could benefit from the patent box if it owned or exclusively licensed-in patents granted by the UK Intellectual Property Office, the European Patent Office and several EEA countries (namely, Austria, Bulgaria, Czech Republic, Denmark, Estonia, Finland, Germany, Hungary, Poland, Portugal, Romania, Slovakia and Sweden). See HMRC guidance available on: www.gov.uk/corporation-tax-the-patent-box. Therefore, benefits were given even if the qualifying IP was developed outside of the UK. This was very much resented by Germany, as a number of patents obtained in the UK by German-based companies had significantly increased since 215 

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The agreed modified nexus approach221 maintains the underlying principle of the nexus approach proposed in the September 2014 Harmful Tax Practices Discussion Draft but makes some important amendments, following the UK-Germany proposal. Pursuant to the modified nexus approach, a 30 per cent uplift would be allowed to increase the value of the eligible R&D expenditure proxy for outsourcing or acquisition costs. The 30 per cent uplift to the qualifying expenditures would reflect expenditures for R&D activities outsourced to related parties and IP acquisition costs.222 Broadly, the revised formula would allow the IP box company, when calculating benefits due under the preferential regime, to take into account related party outsource expenditure (and any IP acquisition costs), subject to a cap on actual expenditure. This provision was introduced to reduce the negative impact of an IP box company choosing to outsource R&D activities to group companies.223 Existing regimes would be closed to new entrants (for both products and patents) by June 2016. Countries with IP regimes that are inconsistent with the modified nexus approach would be expected to take steps to amend those regimes and the process to do this should commence in 2015. In addition, there would be no new entrants to such IP regimes after 30 June 2016. There would be a long grandfathering period, under which benefits could continue to be claimed until June 2021. The FHTP would work to reach agreement by June 2015 on a practical and proportionate tracking and tracing approach that can be implemented by companies and tax authorities. It would also work on developing practical methodologies that companies and tax authorities could adopt. The OECD stated that it would develop more detailed guidance on how businesses can track expenditure and income to ensure that the nexus approach was being correctly applied. It would also consider safeguards to prevent taxpayers from inappropriately using the transitional period to get tax benefits under existing IP regimes. More guidance would also be developed on what would be regarded as a qualifying IP asset. In an accompanying explanatory paper,224 the OECD committed to completing the work on this guidance by 30 June 2015.

the UK patent box was introduced in 2011. See Mindy Herzfeld, ‘Political Developments in BEPS and the EU’ (2014) 76 Tax Notes International 653, 24 November 2014. For an overview, see Fabian Mang, ‘The (In)Compatibility of IP Box Regimes with EU Law, the Code of Conduct and the BEPS Initiatives’ (2015) 55 European Taxation 78–87. 221 See Explanatory Paper—Agreement on Modified Nexus Approach for IP Regimes, available on: www1.oecd.org/ctp/explanatory-paper-beps-action-5-agreement-on-modified-nexus-approach-forip-regimes.pdf. For the full report, see Action 5: Agreement on Modified Nexus Approach for IP Regimes (OECD 2015), available on: www.oecd.org/ctp/beps-action-5-agreement-on-modified-nexusapproach-for-ip-regimes.pdf. 222  Gupta, ‘Modifying the Modified Nexus Approach—Behind Closed Doors’, n 204 above. 223  See Jonathan Bridges, ‘The Q&A: The UK/German proposal for preferential IP regimes’, Tax Journal, Issue 1240, p 8 (21 November 2014). 224 See Explanatory Paper—Agreement on Modified Nexus Approach for IP Regimes, n 221 above.

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A final formulation for implementing the agreed modified nexus approach would be included in the 2015 deliverable on Action 5. In a joint statement released on 10 March 2015 by the Federation of German Industries and the Confederation of Dutch Industry and Employers, the modified nexus approach was criticised for being too restrictive.225 Limiting the tax benefits for outsourced R&D may be problematic, as due to the ‘increasingly work-sharing environment it is nearly impossible to provide only local R&D’.226 The modified nexus approach was also criticised for limiting the benefits of IP regimes to patents and other functionally equivalent IP assets that are legally protected and subject to approval and registration processes. As trademarks and other marketing-related IP assets could not qualify for benefits, this approach would lead to a discrimination of industry sectors, where certain inventions might not be patentable, or are not patented due to commercial considerations (eg trade secrets). It might also discriminate against small and medium-sized enterprises, for which registering a patent often entails a high administrative and/or financial burden.227 It was recommended that ‘where a taxpayer can demonstrate that [it] has borne the expenses of developing the IP, the fruits of such IP should be allowed to benefit from the IP box regime’.228 Also, there should be some flexibility in the documentation requirements to accommodate IP which was developed out of experience or by chance, where it was difficult to trace the costs retrospectively. It was argued that the final recommendations ought to be effective in stimulating R&D and minimising the administrative burdens but at the same time they should provide a level playing field for all taxpayers, regardless of size or sector. Other stakeholders made similar comments vis-à-vis the revised draft guidance. It was argued that the nexus approach should be flexible on the definition of qualifying IP assets to include unpatented IP. Limiting benefits to one type of IP asset would create distortions in the type of IP developed and fail to account for the value and expense associated with unpatented IP. It was noted that a significant amount of R&D expenses were devoted to developing unpatented IP assets such as know-how. Stakeholders also recommended that the OECD should broaden the scope of qualifying R&D expenditures, and procedures for tracking and tracing of expenditures.229 Regarding qualifying R&D expenditure, as described above, there was a rebuttable presumption in the September 2014 discussion draft that the amount of IP income that qualifies for IP regime benefits should be proportionate to the ratio of qualifying IP expenditures to overall IP expenditures. This should remain a rebuttable presumption, to ensure there were no unfair and inconsistent results

225 

The joint statement is available in Tax Analysts, 2015 WTD 48-16 (10 March 2015). Ibid, p 1. 227  Ibid, p 2. 228  Ibid. 229  See Margaret Burow, ‘Stakeholders Seek Flexibility in OECD IP Nexus Approach’, 2015 WTD 48-2 (12 March 2015). 226 

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‘particularly­when the element of IP essential to bring the product to the ­market constitutes only a small portion of overall IP expenditures in a multinational group’.230 Regarding the obligation to track and trace IP income and expenditures asset by asset to receive IP benefits, this was criticised as it did not reflect the way businesses develop their IP. Stakeholders noted that IP innovations tended to be interconnected and so were the processes to develop them. Pooling of expenditures was essential. Whilst most of the industry representatives were in favour of expanding the scope of the modified nexus approach, by contrast, in its comments, the BEPS Monitoring Group was very critical. Repeating some of its earlier criticisms, the Group argued that the patent box was unnecessary and undesirable, as encouragement for R&D could already be easily provided through investment allowances.231 It was thought that the OECD approach would simply legitimise ‘innovation box’ regimes and supply a legal mechanism for profit shifting. It would be particularly damaging to developing countries, which may be used as manufacturing platforms, but their tax base would be drained by this mechanism. The BEPS Monitoring Group argued that a better approach would be an extension of the profit split method. The use of such a method, applied with concrete and easily determinable objective allocation keys, would be much easier to administer and less intrusive both for countries and enterprises. It would also leave countries free to decide their own tax rates, as well as investment allowances. The BEPS Monitoring Group also criticised the secrecy around the work that had already been undertaken by the FHTP in reviewing member country regimes. Although this was in an attempt to insulate the FHPT’s work from business pressures, it also hindered the public debate. It was essential to have a widespread public debate about the legitimacy and validity of tax regimes which could be regarded as harmful. The Group recommended that these reviews should be conducted as openly and transparently as other aspects of the BEPS project.232 To an extent, any nexus approach which focuses on economic presence to justify income in a country poses the risk of worsening any adverse economic effects of tax competition, as it creates an incentive for taxpayers to move people and activities from high-tax to low-tax jurisdictions. This could be harmful as well. Although the issue was raised even before the revision of the nexus approach,233 unfortunately, it has not been addressed in the discussion documents. Whether or not the modified nexus approach will reconfigure the parameters of the tax competition debate in such a way as to be deemed to create more rather than less tax-induced relocations and economic distortions remains to be seen. The remaining BEPS deliverables are examined in the next two chapters. 230 

Ibid.

231 BEPS

Monitoring Group, Response to Action 5: Harmful Tax Practices: Agreement on the ­Modified  Nexus Approach. Available on: bepsmonitoringgroup.files.wordpress.com/2015/02/ap5-htpsmodified-substance.pdf. 232  Ibid, p 3. 233  Amanda Athanasiou, ‘The Cost of BEPS’, 2015 WTD 9-1 (14 January 2015).

3 Tax Treaty Abuse, Permanent Establishments and Transfer Pricing Rules: Actions 6–10 In the previous chapter, the launch of the BEPS Action Plan was considered. Then Action items 1 to 5 were reviewed in greater detail. The focus of this chapter is on Action items 6 to 10. The deliverables on these Action items have produced some of the most contentious proposals of the BEPS project as a whole.

3.1.  Action 6: Prevent Treaty Abuse Action 6 of the Action Plan mandates as follows: Develop model treaty provisions and recommendations regarding the design of domestic rules to prevent the granting of treaty benefits in inappropriate circumstances. Work will also be done to clarify that tax treaties are not intended to be used to generate double non-taxation and to identify the tax policy considerations that, in general, countries should consider before deciding to enter into a tax treaty with another country. The work will be co-ordinated with the work on hybrids.

The first discussion draft, which set out the main parameters of the proposals, was published in March 2014 (henceforth, the Treaty Abuse Discussion Draft).1 There was a second discussion draft in September 2014 (henceforth, the Treaty Abuse Revised Discussion Draft)2 and a follow-up report in November 2014 (henceforth, the Treaty Abuse Follow-Up Report).3 A second revised discussion draft was issued in May 2015. The Treaty Abuse Discussion Draft was composed of three sections. The first section examined the development of model treaty provisions and r­ ecommendations 1 OECD, BEPS Action 6: Preventing the Granting of Treaty Benefits in Inappropriate Circumstances­— 14 March–9 April 2014. Available on: www.oecd.org/ctp/treaties/treaty-abuse-discussion-draftmarch-2014.pdf. 2  OECD/G20 Base Erosion and Profit Shifting Project, Preventing the Granting of Treaty Benefits in Inappropriate Circumstances—Action 6: 2014 Deliverable (OECD, 2014). Available on: www.oecdilibrary.org/docserver/download/2314281e.pdf?expires=1433339357&id=id&accname=guest&checks um=B5EBBB1C513F73A6C49C3D79ECAC8E12. 3 OECD, Follow Up Work on BEPS Action 6: Preventing Treaty Abuse. Available on: www.oecd.org/ ctp/treaties/discussion-draft-action-6-follow-up-prevent-treaty-abuse.pdf.

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regarding the design of domestic rules to prevent the granting of treaty benefits in inappropriate circumstances. In the second section, the need to clarify that tax treaties were not intended to be used to generate double non-taxation was assessed. The third section sought to identify the tax policy considerations that, in general, countries should consider before deciding to enter into a tax treaty with another country. The overall recommendations were summed up in paragraph 9 of the Treaty Abuse Discussion Draft. Very importantly, it was recommended ‘to include in the title and preamble of tax treaties a clear statement that the Contracting States, when entering into a treaty, wish to prevent tax avoidance and, in particular, intend to avoid creating opportunities for treaty shopping’.4 Also, the Treaty Abuse Discussion Draft proposed the inclusion of an anti-abuse rule based on the Limitationon-Benefits (LOB) provision found in most US tax treaties, as well as the inclusion of a more general anti-abuse rule designed to address other forms of treaty abuse, not covered by the LOB. This ‘would provide a more general way to address treaty avoidance cases, including treaty shopping situations that would not be covered by [the suggested LOB]’.5 Other recommendations would also assist in preventing treaty shopping.6 The first section contained some of the most important recommendations. As far as the LOB provision was concerned, the Treaty Abuse Discussion Draft set out the suggested wording, much of which resembled versions of the LOB article used in US treaties.7 The title of this anti-abuse proposal was Entitlement to benefits— Article X. Where it diverged from the US LOB provisions was in the final paragraph, paragraph 6, which introduced a general anti-abuse rule (GAAR), based on a main purpose test, discussed below. A detailed Commentary was to explain the main features of the LOB.8 The possibility of inclusion of a ‘derivative benefits’ clause was indicated, with its merits and demerits.9 Comments were invited.10 From paragraphs 18 onwards, the Treaty Abuse Discussion Draft analysed the suggested main purpose test. This test read as follows:11 Notwithstanding the other provisions of this Convention, a benefit under this Convention shall not be granted in respect of an item of income if it is reasonable to conclude, having regard to all relevant facts and circumstances, that obtaining that benefit was one of the main purposes of any arrangement or transaction that resulted directly or indirectly in that benefit, unless it is established that granting that benefit in these circumstances would be in accordance with the object and purpose of the relevant provisions of this Convention.

4 

Treaty Abuse Discussion Draft, n 1 above, para 9, p 4. Ibid, para 10. 6  Ibid, para 10. 7  Ibid, para 11. 8  Ibid, para 12. 9  Ibid, paras 13–16. 10  Ibid, para 17. 11  Ibid, para 18, on p 10. 5 

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Again, the new main purpose test would be supplemented by a detailed Commentary which would include examples. Comments were invited on what should be covered by the Commentary12 but a few explanatory points were included. The main purpose test was meant to supplement the LOB. As such, when a benefit was denied under the LOB it would not be subject to analysis there. C ­ onversely, a benefit allowed under the LOB could be denied under the main p ­ urpose test.13 In determining whether the main purpose test applied, ‘it is important to undertake an objective analysis of the aims and objects of all persons involved in putting that arrangement or transaction in place or being a party to it’.14 This would be a question of fact.15 All the evidence would be weighted to determine whether it was reasonable to conclude that an arrangement or transaction was undertaken or arranged for such purpose.16 Obtaining the benefit under the tax treaty need not be the sole or dominant purpose of a particular arrangement or transaction.17 ‘It is sufficient that at least one of the main purposes was to obtain the benefit’.18 The Treaty Abuse Discussion Draft also reviewed specific situations when a person seeks to circumvent treaty limitations.19 While a general anti-abuse rule may be helpful in addressing such situations, it was suggested that ‘targeted specific anti-abuse rules would provide greater certainty for both taxpayers and tax administrators’.20 Some of these specific situations were discussed. For example, it was proposed that the reduced rates of withholding tax under Article 10 of the OECD Model applicable to non-portfolio dividends be restricted to shareholdings that are owned throughout a period of months. Comments were sought on what the number of months should be.21 Furthermore, the Treaty Abuse Discussion Draft proposed the abolition of the ‘place of effective management’ tie-breaker clause for determining the treaty residence of persons other than individuals. This would be replaced by a requirement that the competent authorities of the two countries endeavour to determine residence, by reference to a number of factors such as the place of effective management, the place of incorporation/ constitution etc.22 There were also suggestions to counter triangular situations involving a third country permanent establishment (PE).23

12 

Ibid, para 19. Ibid, paras 22–23. 14  Ibid, para 29. 15  Ibid. 16  Ibid, para 30. 17  Ibid, para 31. 18  Ibid. 19  Ibid, para 34. 20  Ibid. 21  Ibid, paras 41–43. 22  Ibid, paras 50–53. 23  Ibid, paras 54–56. A new treaty clause was proposed to restrict relief from withholding taxes on payments attributable to a third country PE of a treaty resident. This would apply if the profits of the PE were subject to a combined aggregate effective tax rate in the PE and residence countries which was less than 60% of the general rate of company tax applicable in the residence country: ibid, para 56. 13 

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Furthermore, the Treaty Abuse Discussion Draft addressed cases where a p ­ erson tried to abuse the provisions of domestic tax law using treaty benefits. Here, it was argued, the threat to the national tax base was not caused by the tax treaties but it may have been facilitated by them.24 There was a list of avoidance strategies that were thought to fall into this category (eg thin capitalisation, transfer pricing, arbitrage etc). Many of these strategies were to be addressed through other items of the BEPS Action Plan.25 It was also reiterated that tax treaties did not prevent the application of specific domestic law provisions that would hinder such transactions.26 In order to prevent interpretations intended to circumvent the application of a country’s domestic anti-abuse rules, a ‘savings clause’, often used by the USA should be adopted.27 This clause would confirm the country’s right to tax its residents without regard to the provisions of any tax treaty, other than those provisions that were clearly intended to apply to residents.28 In the second section, which sought to clarify that tax treaties are not intended to be used to generate double non-taxation, the Treaty Abuse Discussion Draft made several recommendations. It was suggested that the ‘title’ of the OECD Model should be amended to state clearly that the prevention of tax evasion and avoidance is a purpose of tax treaties.29 This should also be reflected in a preamble which ‘provides expressly that States that enter into a tax treaty intend to eliminate double taxation without creating opportunities for tax evasion and avoidance’, including a specific reference that treaty shopping arrangements are an example of tax avoidance that should not result from tax treaties.30 The OECD believed that a clear statement of the intention of the signatories that appeared in the preamble would be relevant to the interpretation and application of the treaty.31 The last section addressed the third part of the mandate—ie to identify the tax policy considerations that, in general, countries should consider before deciding to enter into a tax treaty with another country. Here, the Treaty Abuse Discussion Draft proposed additional paragraphs to the introduction of the OECD Model. The policy considerations set out in these new paragraphs would help countries explain their decisions not to enter into tax treaties with low-tax or no-tax jurisdictions but they would also be relevant in deciding whether a country should modify, replace or terminate an existing treaty. It was recognised that there were many other non-tax factors that may also be relevant and states had a sovereign right to decide whether to do so.32

24 

Ibid, para 57 et seq. Ibid, para 58. Ibid, para 59. 27  Ibid, para 69. 28  Ibid. 29  Ibid, para 75. 30  Ibid, para 75. 31  Ibid, para 76. 32  See paras 79–81. The suggested wording is set out in para 81. 25  26 

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In the proposed addition to the Commentary, a number of considerations were raised. The primary tax policy concern would be ‘the existence of risks of ­double taxation resulting from the interaction of the tax systems of the two States involved’.33 Where a state levied no or low taxes, other states should consider whether there were risks of double taxation justifying a tax treaty. States should also consider whether there were elements of another state’s tax system (eg ringfenced tax advantages) that could increase the risk of non-taxation.34 Another tax policy consideration set out was the risk of excessive taxation that may result from high withholding taxes in the source state.35 In considering whether to enter into a tax treaty, various features of tax treaties that encourage and foster economic ties between countries (eg non-discrimination, greater taxpayer certainty, mutual agreement procedures, arbitration etc)36 as well as the effective implementation of administrative assistance provisions should be considered.37 In general, this discussion draft called for a significant rewrite of both the OECD Model Tax Convention and its Commentary. One of the main recommendations, the main purpose test, proved to be very controversial.38 The main purpose test was criticised for not striking the right balance in providing legitimate businesses with treaty protection while preventing treaty shopping.39 It undermined the clarity and predictability principles that were intended by the inclusion of the LOB.40 The US also voiced its disagreement with the new test, due to its subjective connotations.41 It was not just the main purpose test that had attracted criticism. Many stakeholders identified the need for more guidance in various places—for instance, in obtaining discretionary benefits under the suggested LOB.42 Pursuant to this provision, the competent authorities of a Contracting State could allow a resident of another Contracting State not otherwise entitled to benefits to obtain them if the competent authority found no principal purpose of tax avoidance. The OECD

33  See suggested para 15.2 of the Introduction to the OECD Model, set out in para 81 of the Treaty Abuse Discussion Draft. 34  Ibid. 35  Ibid, suggested para 15.4. 36  Ibid, suggested para 15.5. 37  Ibid, suggested para 15.6. It was conceded that administrative assistance could be achieved through more targeted agreements such as the conclusion of a Tax Information Exchange Agreement or participation in the Multilateral Convention on Mutual Administrative Assistance in Tax Matters. Therefore, absent of any actual risk of double taxation, these administrative provisions would not be a sufficient basis for entering into a tax treaty. 38  For a review of the comments submitted to the OECD, see Amanda Athanasiou, ‘Stakeholders Weigh In on OECD’s Treaty Abuse Discussion Draft’, Tax Analysts, 2014 WTD 73-1 (16 April 2014). 39  See comments made by Deloitte Tax LLP, reported in Tax Analysts, 2014 WTD, 71-22 (9 April 2014). Also see comments made by the National Foreign Trade Council, reported in Tax Analysts, 2014 WTD 71-25 (9 April 2014). 40  See comments from the Organisation for International Investment (OFII) reported in Tax Analysts, 2014 WTD 71-26 (9 April 2014). 41  See Amanda Athanasiou, ‘Doubling Down on Treaty Shopping’, 2014 WTD 72–3 (15 April 2014). 42  See suggested para 4 of Article X.

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was urged to develop guidance on this point.43 Furthermore, in order to address ­possible abuse and undue pressure on tax authorities, the BEPS Monitoring Group recommended that ‘tax authorities publish a yearly overview of all persons/entities involved in transactions qualifying under this article (not necessarily the items of income or amounts).44 Most of these concerns were met in the Treaty Abuse Follow-Up Report in November 2014. Some criticised the proposal to broaden the purpose of treaties by the inclusion of various references to the prevention of tax avoidance and evasion in the title of treaties, as well as the addition of references to the tax policy considerations of Contracting States. Some States might be encouraged to the view that ‘even after the application of the various anti-avoidance tests there remains a further residual anti-abuse principle based on this new wording’.45 At a more general level, it was thought that the Treaty Abuse Discussion Draft went too far and had the potential of eroding international trade and investment, and interfering with the proper functioning of tax treaties.46 It was suggested that the uncertainty of some of the proposed rules could be mitigated by provisions allowing proper administrative processes and procedures—not just administrative clarity.47 Albeit more radically, the BEPS Monitoring Group criticised the Treaty Abuse Discussion Draft for the absence of a domestic anti-avoidance rule that would allow source-country tax authorities to disallow treaty benefits unilaterally, quickly and at low cost.48 Others have not been so critical of the OECD’s proposals. For example, Michael Lang has argued that these proposals reflect current trends, especially within

43  Amanda Athanasiou, ‘Stakeholders Weigh In on OECD’s Treaty Abuse Discussion Draft’, n 38 above. Also see comments made by David Rosenbloom, reported by David D Stewart and Kristen A Parillo, ‘OECD’s LOB Approach Needs Refinement, Practitioners Say’ (2014) 74 Tax Notes International 111 (14 April 2014). Also see Kristen A Parillo and Lee A Sheppard, ‘OECD Panel Explores BEPS Treaty Abuse’, 2014 WTD 106-3 (3 June 2014). The US dislike of a ‘main purpose’ test was also evident from the US Senate’s refusal to approve the ratification of negotiated treaties that contained such a test, making the ratification conditional on the deletion of the main purpose test. See Michael Lang, ‘BEPS Action 6: Introducing an Antiabuse Rule in Tax Treaties’ (2014) 74 Tax Notes International 655, 664, 19 May 2014. Citing Kristen A Parillo, ‘Italy-US Tax Treaty Enters Into Force’, 2009 WTD, 241-2 (18 December 2009). 44  See BEPS Monitoring Group, Preventing the Granting of Treaty Benefits in Inappropriate Circumstances. Available on: bepsmonitoringgroup.files.wordpress.com/2014/04/bmg-treaty-abuse-­ submission.pdf, pp 3–4. The BEPS Monitoring Group also commented that because the wording of the whole LOB provision is complex and difficult to understand, it should be simplified as much as is possible, ‘and in any case properly explained in the Commentary; for example, explanations should be given, with examples, of what constitutes “active conduct of trade or business” and “income derived from … that trade or business”, particularly to clarify that it does not cover income from unrelated business’: ibid, p 3. 45  See PwC, ‘OECD releases discussion draft on the use of treaty benefits in inappropriate circumstances’, p 4 (17 March 2014). Available on: www.pwc.com/en_US/us/tax-services/publications/ insights/assets/pwc-oecd-releases-discussion-draft-use-treaty-benefits.pdf. 46  See PwC’s comments on Action 6, reported in Tax Analysts, 2014 WTD 7-23 (11 April 2014) and Ernst & Young’s comments, reported in Tax Analysts 2014 WTD 71-24 (11 April 2014). 47  Amanda Athanasiou, ‘Stakeholders Weigh In on OECD’s Treaty Abuse Discussion Draft’, n 38 above. Also see comments of BEPS Monitoring Group, n 44 above, p 6. 48  BEPS Monitoring Group, n 44 above, p 6.

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the European Union, where many countries have recently introduced general anti-avoidance rules.49 In fact, as explained in Chapter five, in its Action Plan to Strengthen the Fight against Tax Fraud and Tax Evasion, the European Commission has explicitly recommended the adoption of GAARs by Member States. Such clauses also feature in draft directives which have been recently proposed, such as the C ­ ommon Consolidated Corporate Tax Base proposal50 and the Financial Transaction Tax proposal51 as well as in amendments of existing directives such as that of the Parent-Subsidiary Directive.52 As Lang notes, not only do these proposals vary in detail but in fact little international consensus exists on how these rules must be designed and whether they are useful at all.53 He argues that the criticism contained in the statements submitted to the OECD is directed against the design of the rule, unilaterally geared towards the interests of tax administrations, but not against such a rule altogether.54 The Treaty Abuse Revised Discussion Draft,55 published in September 2014, offered a more nuanced approach to treaty abuse. It was recognised that countries have developed different tax treaty policies to reflect their constitutional or other legal capabilities and administrative capacities.56 Because of this, a number of alternatives were set out aimed at reaching a common goal that was ‘to ensure that States incorporate in their treaties sufficient safeguards to prevent treaty abuse, in particular as regards treaty shopping’.57 For that reason, the Treaty Abuse Revised Discussion Draft recommended a minimum level of protection that should be implemented. The need for further refinements in the objective tests was recognised, particularly in view of constitutional or EU law restrictions that prevent some states from adopting the exact wording of the model provisions recommended in the discussion draft.58 Overall, the model provisions and related Commentary suggested were to be considered as drafts subject to improvement before their final versions were released in September 2015. A distinction was made between two types of cases: where a person tries to ­circumvent limitations provided by the treaty itself; and where a person tries to circumvent the provisions of domestic tax law using treaty benefits. 49 

Michael Lang, ‘BEPS Action 6: Introducing an Antiabuse Rule in Tax Treaties’, n 43 above, p 655. for a Council Directive on a Common Consolidated Corporate Tax Base (CCCTB) COM(2011) 121/4, at 48. For further analysis, see Christiana HJI Panayi, European Union Corporate Tax Law (Cambridge University Press, 2013), ch 3. 51  Proposal for a Council Directive implementing enhanced cooperation in the area of financial transaction tax COM(2013) 71, at 30. See Ch 8 of this volume. 52  See section 5.3.2 in Ch 5 of this volume. 53  Michael Lang, ‘BEPS Action 6: Introducing an Antiabuse Rule in Tax Treaties’, n 43 above, p 656. 54  Ibid, p 663. 55  OECD/G20 Base Erosion and Profit Shifting Project, Preventing the Granting of Treaty Benefits in Inappropriate Circumstances—Action 6: 2014 Deliverable (OECD). For commentary, see Kristen A Parillo, ‘BEPS Action 6 (Treaty Abuse): US Gets Its Way’, 2014 WTD 180-3 (17 September 2014). 56  Treaty Abuse Revised Discussion Draft, n 55 above, para 6. 57  Ibid. 58  See Executive Summary, p 11 and para 13, ibid. For an analysis of the compatibility of the proposals, see Ch 6, section 6.6 of this volume. 50  Proposal

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The Treaty Abuse Revised Discussion Draft recommended a three-step approach to be used to address treaty shopping arrangements, as a minimum standard of protection through a flexible approach. First, similarly to the Discussion Draft it was recommended that treaties include in their title and preamble a clear statement of a common intention that the Contracting States, when entering into a treaty, intend to avoid creating opportunities for non-taxation or reduced taxation through tax evasion or avoidance, including through treaty shopping arrangements. Secondly, again similarly to the Discussion Draft, it was recommended to include in tax treaties a specific anti-abuse rule based on the US LOB provisions. Thirdly, to address other forms of treaty abuse not covered by the LOB, it was recommended to add to tax treaties a more general anti-abuse rule based on the principal purposes of transactions or arrangements (principal purposes test or PPT rule).59 Effectively, the following variations were suggested; first, LOB plus PPT; or, secondly, PPT alone; or, thirdly, LOB plus a restricted PPT rule applicable to conduit financing arrangements, or domestic anti-abuse rules or judicial doctrines that would achieve a similar result. The ‘new’ PPT is in fact identical to the previous main purpose test of the Treaty Abuse Discussion Draft, other than the obvious substitution of ‘main purposes’ with ‘principal purposes’.60 It was argued that the PPT rule incorporated principles already recognised in the Commentary on Article 1 of the OECD Model.61 The PPT rule was accompanied by Commentary and examples that illustrated the application of the rule.62 It was recognised that the combination of the proposed LOB and PPT rules had strengths and weaknesses and might not be appropriate for all countries.63 For instance, the LOB tests were based on objective criteria that provided more certainty than the PPT, which required a case-by-case analysis based on what could reasonably be considered to be one of the principal purposes of transactions or arrangements. It was also stipulated that these rules may require adaptations, for example, to take account of constitutional or EU law restrictions.64 In addition, the revised LOB included a ‘derivative benefits’ provision that allowed certain entities owned by residents of other Contracting States to obtain

59  See paras 11–16 of Treaty Abuse Revised Discussion Draft, n 55 above. For commentary, see Luc De Broe and Joris Luts, ‘BEPS Action 6: Tax Treaty Abuse’ (2015) 43 Intertax 122–46; Jack Bernstein, ‘BEPS Action 6—Trying to Curtail Treaty Shopping’ (2014) 76 Tax Notes International 1035 (15 Dec 2014). 60  The PPT reads as follows: ‘Notwithstanding the other provisions of this Convention, a benefit under this Convention shall not be granted in respect of an item of income or capital if it is reasonable to conclude, having regard to all relevant facts and circumstances, that obtaining that benefit was one of the principal purposes of any arrangement or transaction that resulted directly or indirectly in that benefit, unless it is established that granting that benefit in these circumstances would be in accordance with the object and purpose of the relevant provisions of this Convention’. See Executive Summary, p 12. Also see Luc de Broe and Joris Luts, n 59 above, pp 131–34. 61  Treaty Abuse Revised Discussion Draft, n 55 above, p 12. Also see para 17. 62  Ibid, pp 66–74. 63  See para 12. 64  Ibid, para 13.

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treaty benefits that these residents would have obtained if they had invested directly.65 ­Furthermore, following stakeholder comments, a one-year minimum shareholding period for reduced withholding taxes was adopted. Overall, the Treaty Abuse Revised Discussion Draft watered down the ­anti-treaty shopping proposals of the initial discussion draft, making them more flexible. It gave countries a choice between the PPT and the LOB rule, supplemented by a domestic anti-abuse rule. The Treaty Abuse Revised Discussion Draft ­recommended the inclusion of both the LOB rule and the general anti-abuse rule. Neither the US Treasury nor businesses wanted the open-ended treaty abuse clauses suggested in the previous Treaty Abuse Discussion Draft,66 so this was considered a significant improvement. The Treaty Abuse Revised Discussion Draft also included recommendations to deal with a number of other situations such as the splitting up of contracts,67 the hiring out of labour cases,68 transactions intended to avoid dividend characterisation,69 certain dividend transfer situations (usufruct and similar transactions),70 transactions designed to circumvent the application of Article 13(4) of the OECD Model,71 the tie-breaker rule for determining the treaty residence of dual-resident persons other than individuals;72 and anti-abuse rules for PEs situated in third states.73 Further work was needed with respect to the precise contents of the provisions and the implementation of the minimum standard, as well as with respect to the policy considerations relevant to treaty entitlement of collective investment vehicles (CIVs) and non-CIV funds.74 The Treaty Abuse Revised Discussion Draft also addressed cases where persons try to abuse domestic tax law using treaty benefits, such as through thin capitalisation, dual residence strategies, transfer pricing, arbitrage transactions and transactions that abuse double tax relief mechanisms. It was recognised that tax treaty anti-abuse rules were not sufficient to address these strategies. These must be addressed through domestic rules, also in light of the other Action items. ‘The main objective … is to ensure that treaties do not prevent the application of specific domestic law provisions that would prevent these transactions’.75 Additional guidance to the OECD Commentary was suggested to clarify that the i­ ncorporation of

65 

See para 4 of the LOB clause, set out in para 16 of the Treaty Abuse Revised Discussion Draft. Kristen A Parillo, ‘BEPS Action 6 (Treaty Abuse): US Gets Its Way’, Tax Analysts, 2014 WTD 180-3 (17 September 2014). 67  Treaty Abuse Revised Discussion Draft, n 55 above, paras 20–21. 68  Ibid, para 22. 69  Ibid, paras 23–24. 70  Ibid, paras 25–31. 71  Ibid, paras 32–35. 72  Ibid, paras 36–39. 73  Ibid, paras 40–43. 74  The proposed LOB rule includes a place-holder allowing for the Contracting States to negotiate a provision specific to resident CIVs and non-CIV funds. 75  See para 45 and the examples given of when this might occur. 66 

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the PPT principle would not affect domestic anti-abuse rules and the interaction between treaties and domestic anti-abuse rules.76 Similarly to the initial discussion draft, the Treaty Abuse Revised Discussion Draft recommended adding a US-style ‘savings clause’ to the OECD Model.77 There was also reference to departure or exit taxes. The Treaty Abuse Revised Discussion Draft clarified that tax treaties do not prevent such taxes, ‘[t]o the extent that the liability to such a tax arises when a person is still a resident of the State that applies the tax and does not extend to income accruing after the cessation of residence’.78 However, the application of these taxes could lead to double taxation. A possible approach to resolving this would be for the competent authorities of the two states involved to agree, through the mutual agreement procedure, that each state should provide relief as regards the residence-based tax that was levied by the other state on the part of the income that accrued while the person was a resident of that other state, except to the extent that the new state of residence would have had source taxation rights at the time that income was taxed.79 In addressing the second part of this Action item’s mandate—ie that it must be clarified that tax treaties are not intended to be used to generate double nontaxation­—the Treaty Abuse Revised Discussion Draft sets out the same recommendations as in the Treaty Abuse Discussion Draft. In addressing the third part of the mandate—ie to identify the tax policy considerations that, in general, countries should consider before deciding to enter into a tax treaty with another country­—again, the same recommendations were made as in the previous ­discussion draft. On 21 November 2014, the OECD released its follow-up report on Action 6.80 Issues to be addressed included the LOB and the PPT test, treaty entitlement of collective investment vehicles and non-CIVs and other technical issues. Inter alia, suggestions were sought on the guidance that could be included in the Commentary on the discretionary relief provision of the LOB, on the derivative benefits clause, as well as alternative LOB provisions that might be needed to accommodate EU Member States. As criticised, in the Treaty Abuse Follow-Up Discussion Draft, there was essentially no new guidance on the important issues that remain to be resolved. Rather the discussion draft was simply a solicitation of comments on the various open issues.81 As far as the discretionary relief provision of the LOB or the PPT tests was concerned, it was recommended that it be restricted and/or applied with

76 

Ibid, para 49, with the suggested commentary. Ibid, paras 51–53. Ibid, para 55. 79  Ibid, para 57. 80 OECD, Follow Up Work on BEPS Action 6: Preventing Treaty Abuse. For commentary, see Luc De Broe and Joris Luts, ‘BEPS Action 6: Tax Treaty Abuse’ (2015) 43 Intertax 122–46. 81 See ICC comments, available on: www.iccwbo.org/Advocacy-Codes-and-Rules/Document-­ centre/2015/ICC-comments-on-the-OECD-Discussion-Draft-Follow-up-Work-on-BEPS-Action6-Preventing-Treaty-Abuse-%282015%29-21474824286/. 77  78 

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­maximum transparency.82 The exercise of discretionary relief could also have state aid repercussions.83 The BEPS Monitoring Group has criticised the Treaty Abuse Revised Discussion Draft,84 as well as the follow-up report.85 Although there were advantages and disadvantages to both proposed measures (LOB and PPT), the Group argued that the failure to agree on a single effective measure was problematic. The targeted LOB provision was detailed and complex but offered possibilities for circumvention, while the PPT was more flexible but also more discretionary and as such likely to be arbitrary and potentially more prone to abuse. The BEPS Monitoring Group argued that a ‘belt and braces’ approach seems the only solution, combined with a minimum standard as proposed. OECD and G20 countries were urged to comply with their commitment to adopt suitable provisions promptly, and complement these with spontaneous exchange of information by the state of residence. Closer coordination with developing countries was essential.86 The BEPS Monitoring Group also claimed that the suggested statement in the preamble was too weak, as such statements were rarely used to counter what may seem to be a rational literal interpretation of a substantive treaty provision. Tax treaties should begin with an article which clearly states that their purpose is to ensure that persons and companies are taxed where their economic activities take place and value is created. One or more suitable anti-abuse clauses can be helpful, but, as argued, it was unrealistic to expect them to carry too much weight, especially if the substantive provisions were ineffective. In its submission on the Treaty Abuse Follow-Up Report, the BEPS Monitoring Group emphasised, inter alia, that effective implementation was crucial to put pressure on key states with extensive treaty networks to accept inclusion of anti-abuse provisions in their treaties. Some countries were used as global treatyshopping platforms. If these countries did not cooperate to implement Action 6, it would be severely undermined. Treaty abuse could only be effectively addressed if all relevant countries cooperated. A political commitment through the G20 was necessary. A report by KPMG Ireland raised another important general concern from the perspective of small countries. The proposals under Action 6 appear to be heavily biased against small countries and will potentially damage legitimate economic

82  See BEPS Monitoring Group, Follow-Up Work On BEPS Action 6: Preventing Treaty Abuse, available on: bepsmonitoringgroup.files.wordpress.com/2015/01/bmg-ap-6-submission-treaty-abuse-2015. pdf. 83  See analysis in Chs 6 and 7 of this volume. 84  BEPS Monitoring Group, OECD BEPS Scorecard, pp 9–10. Available on: bepsmonitoringgroup. files.wordpress.com/2014/10/oecd-beps-scorecard.pdf. 85  BEPS Monitoring Group, Follow-Up Work On BEPS Action 6: Preventing Treaty Abuse, n 82 above. 86  It was suggested that if a non-G20 developing country had a strong preference for a specific provision, this choice should be decisive in determining the type of provision in its treaties with OECD and G20 partners. Expecting developing countries to have to apply a range of different anti-abuse measures would unnecessarily strain their administrative capacity.

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activity in those countries.87 To an extent, the Action 6 proposals are partly aimed at denying treaty benefits where one of the main purposes of being located in a particular country is access to tax treaties. ‘Clearly, there will always be stronger non tax commercial reasons for locating in a large economy with a large domestic market’.88 It could lead to circumstances where treaty access may be denied to businesses operating in small countries without causing any similar difficulties for businesses operating in large countries.89 At the public consultation in Paris on 22 January 2015, several representatives of US MNEs had argued that the working group should refrain from resolving the complex issues that drafting the text of a model LOB would require and simply provide a general statement of principles on how an LOB could satisfy the OECD’s minimum standard.90 This suggestion was followed-up in the latest OECD revised discussion draft (the Treaty Abuse Second Revised Discussion Draft)91 published on 22 May 2015. In the Treaty Abuse Second Revised Discussion Draft, there was a new proposal for an alternative simplified LOB rule that would be supplemented by guidance in the model Commentary, instead of a fully drafted provision. Several other proposals were made, including new proposals for treaty rules intended to address concerns related to special tax regimes and to changes to domestic law made after the conclusion of a treaty. It was agreed that this approach was consistent with the minimum standard described in the Treaty Abuse Revised Discussion Draft, which may be satisfied by the inclusion of any form of LOB combined with the PPT. The original LOB was considered more appropriate for countries that would prefer to meet the minimum standard through the combination of an LOB rule and a mechanism dealing with conduit arrangements. It was important to ensure that the non-application of the simplified LOB in a given case should not be interpreted in any way as suggesting that the PPT would not be applicable to that case either. In incorporating the simplified LOB into the OECD Model, this could be done by describing the main features of the LOB in the Model and presenting the alternative formulations 87  See KPMG Ireland report, December 2014, Action 6: Preventing the Granting of Treaty Benefits in Inappropriate Circumstances, Fairness for Small Countries. Reported in Tax Analysts, 2014 WTD 238-20 (10 December 2014). 88  Ibid, p 2. 89  Ibid. A suggestion made in this report is that for the purposes of the LOB active business test, business support activities should suffice even where those activities are provided for the benefit of related group parties and where there are no or limited sales of the relevant group products/services in the small country concerned. It was also suggested that if there is a dispute on the interpretation or application of a tax treaty, there should be a right of appeal to an independent international tribunal staffed by respected, qualified and independent jurists. See pp 7–8. Also see analysis in Ch 6, section 6.6 of this volume. 90  Kristen A Parillo, ‘OECD Proposes “Skeletal” LOB Article in Treaty Abuse Draft’, 2015 WTD 100-4 (26 May 2015). 91 OECD, Revised Discussion Draft—BEPS Action 6: Prevent Treaty Abuse (henceforth, Treaty Abuse Second Revised Discussion Draft) available on: www.oecd.org/tax/treaties/revised-discussiondraft-beps-action-6-prevent-treaty-abuse.pdf.

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of each paragraph in the Commentary.92 As stated in a footnote to the proposed LOB,93 the drafting of such an article in bilateral treaties would depend on countries’ preferences for implementing the minimum standard.94 The rest of the discussion draft outlined proposals to address the particular LOB and PPT issues identified in the follow-up report, such as the application of the LOB and treaty entitlement to collective investment vehicles or other funds.95 Further commentary on the discretionary relief provision of the LOB rule was also provided. More guidance was given regarding the factors that should be taken into account by a competent authority considering a request for ­discretionary relief.96 In the amended Commentary,97 there is, inter alia, a stipulation that the availability of clear non-tax business reasons should also be taken into account by the competent authority of the state from which benefits are sought. Also treaty benefits may be extended where the allowance of benefits would not otherwise be contrary to the purposes of the Convention. It was also added that in the case of a resident subsidiary company with a parent in a third state, whilst the fact that the relevant withholding rate provided in the Convention is not lower than the corresponding withholding rate in the tax treaty between the State of source and the third State would be a relevant factor, that fact would not, in itself, be sufficient to establish that the conditions for granting the discretionary relief are met.98

There is emphasis on substantial relationship with the state. The competent authority that receives a request for relief should process that request expeditiously. As far as the LOB rule was concerned, it was noted that it may need to be adapted to reflect certain EU law requirements. The author has argued99 that in the current state of the case law, a derivative benefits test is not required for EU law purposes. The comment was (anonymously) acknowledged in the Treaty Abuse Second Revised Discussion Draft but in any case, proposals were made to amend the Commentary to address specific EU issues related to the publicly-listed entity and pension fund exceptions of the LOB rule.100

92  The Annex in p 42 et seq included an example illustrating how that approach would work in the case of the publicly-listed entity provision. 93  See Annex, p 42. 94  As noted, countries would have three options. ‘This could be done either through the adoption of paragraph 7 only, through the adoption of the detailed version of paragraphs 1 to 6 that is described in the Commentary on Article [X] together with the implementation of an anti-conduit mechanism as described in paragraph [x] of that Commentary, or through the adoption of paragraph 7 together with any variation of paragraphs 1 to 6 described in the Commentary on Article [X]’. Treaty Abuse Second Revised Discussion Draft, n 91 above. 95  Ibid, pp 7–10. 96  Ibid, para 31. 97  Ibid, para 32 on proposed changes to para 63. 98  Ibid. 99  See Ch 6, section 6.6 of this volume. Also see ch 5 in Christiana HJI Panayi, Double Taxation, Tax Treaties, Treaty Shopping and the European Community (Kluwer, 2007). 100  Treaty Abuse Second Revised Discussion Draft, n 91 above, paras 36–40.

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Following the previous discussion drafts, the OECD had been asked to ensure that the inclusion of a derivative benefits provision would not raise BEPS concerns and that it would contribute to the work on other parts of the Action Plan. During the discussion of issues, the US delegate made two proposals that would deal with special tax regimes and would make a tax treaty responsive to certain future changes in a country’s domestic tax laws. It was argued that these proposals could address some of the objections to the addition of a derivative benefits provision in the LOB rule. These proposals have been incorporated in the Treaty Abuse Second Revised Discussion Draft for the first time.101 Recommendations were also made regarding ‘dual-listed company arrangements’, timing issues related to the various provisions of the LOB rule and the ‘active business’ provision, the latter again influenced by a previous proposal of the US delegate.102 The second part to this discussion draft dealt with issues related to the PPT rule. It dealt with issues such as how the PPT rule applies where benefits are obtained under different treaties;103 the suggestion in the Commentary that countries should consider establishing some form of administrative process ensuring that the PPT is only applied after approval at a senior level;104 the possibility of discretionary relief provisions;105 the drafting of the alternative ‘conduit-PPT rule’106 etc. Four more examples were added in the Commentary on the PPT rule.107 The remainder of this discussion draft focused on miscellaneous issues. For example, it was suggested that in the Commentary on the new tie-breaker provision, it should be clarified that the fact that a dual-resident entity would not be entitled to treaty reliefs under the new provision will not prevent the person from being considered a resident of each Contracting State for the purposes of the provisions of the Convention that do not provide reliefs to that entity. It was also agreed that the competent authorities should be encouraged to address as quickly as possible requests made under the new provision.108 There were also proposals relating to the design and drafting of the rule applicable to PEs located in third states.109 As regards the previously proposed Commentary on the interaction between tax treaties and domestic anti-abuse rules, this was to be further discussed due to the potential for domestic law anti-abuse provisions to override tax treaties. 101  Ibid, para 53 containing proposal 1 regarding new treaty provisions on ‘special tax regimes’ and proposal 2 regarding a new general treaty rule intended to make a tax treaty responsive to certain future changes in a country’s domestic tax laws. 102  The proposal was to change paragraph 3 of the LOB rule in order to prevent a resident from aggregating activities of a connected person enjoying a special tax regime and in order to provide that the resident and any connected persons must be in the same or a similar line of business before their activities may be aggregated: ibid, para 72. 103  Ibid, paras 73–75. 104  Ibid, paras 76–79. 105  Ibid, paras 87–90. 106  Ibid, paras 91–95. 107  Ibid, paras 96–98. 108  Ibid, paras 99–102. 109  Ibid, paras 103–107.

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The final report on Action 6 is likely to be produced after a June 2015 meeting with the working group.

3.2.  Action 7: Prevent the Artificial Avoidance of PE Status As regards the action on preventing the artificial avoidance of PE status, the Action Plan set out the following: Develop changes to the definition of PE to prevent the artificial avoidance of PE status in relation to BEPS, including through the use of commissionaire arrangements and the specific activity exemptions. Work on these issues will also address related profit attribution issues.110

On 31 October 2014, the OECD released its first discussion draft on the topic (the PE Discussion Draft)111 with the preliminary results of the work carried on by the Focus Group on the Artificial Avoidance of PE Status. There were no major surprises in this discussion draft and some of the proposals/discussions were foreshadowed in the discussions over Action 1.112 Proposals for changes to the PE definition in the OECD Model were suggested in order to prevent abuse of the PE threshold through commissionaire arrangements and the specific activity exemptions.113 Some of the suggestions have the potential to significantly widen the d ­ efinition of PE, as well as leave room for uncertainty and potentially conflicting tax claims. As far as commissionaire arrangements were concerned, changes to paragraphs 5 and/or 6 of Article 5 were suggested to address the problem. A commissionaire arrangement was loosely defined as an arrangement though which a person sells products in a given state in its own name but on behalf of a foreign enterprise that is the owner of these products.114 As a matter of policy, where the activities that an intermediary exercises in a country are intended to result in the regular conclusion of contracts to be performed by a foreign enterprise, that enterprise should be considered to have a sufficient taxable nexus in that country unless the intermediary is performing these activities in the course of an independent business.115

110 

Action Plan, pp 19–20. Discussion Draft, BEPS Action 7: Preventing Artificial Avoidance of PE Status (OECD, 2014). Available on: www.oecd.org/tax/treaties/action-7-pe-status-public-discussion-draft.pdf. 112  See analysis in Ch 2, section 2.3 of this volume. 113  For an excellent review, see Arthur Pleijsier, ‘The Agency Permanent Establishment in BEPS Action 7: Treaty Abuse or Business Abuse?’ (2015) 43 Intertax 147–54. 114  PE Discussion Draft, n 111 above, para 6, p 10. 115  Ibid, para 10, p 11. 111  Public

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Otherwise, there would be a shift of profits out of the country where the sales take place without a substantive change in the functions performed in that country. Four alternative options were set out in the PE Discussion Draft.116 Although the alternative options had some variations in the wording of suggested paragraphs 5 and 6, they also had some common elements. For example, all alternatives would have the effect of finding a PE when the commissionaire or other agent had substantial input in contract negotiation so that ratification by the principal would be a certainty. Furthermore, all options would clarify that a person cannot be an independent agent when it acts exclusively or almost exclusively on behalf of one enterprise or associated enterprises.117 As regards amending the specific activity exemption of the PE provision, this was anticipated following the OECD’s earlier reports in addressing the tax challenges of the digital economy. There were concerns because under Article 5(4) of the OECD Model, a PE was deemed not to exist where a place of business was used solely for activities listed in that paragraph. It was proposed to modify this provision to make it clear that all the activities listed therein are subject to the condition that the activity be preparatory or auxiliary.118 Alternatively, more targeted changes were suggested, such as deleting the word ‘delivery’ in subparagraphs (a) and (b) of paragraph 4 so that the use of facilities for delivery and the maintenance of merchandise for delivery would not fall under the exceptions.119 Another proposal made was as regards the exception for purchasing goods or merchandise or collecting information, in paragraph 4 of Article 5. Here, it was suggested either to delete the exception for purchasing or to delete paragraph 4 altogether.120

116 

The options which are set out in pages 11–14 are the following: ‘Option A: Add a reference to contracts for the provision of property or services by the enterprise; replace “conclude contracts” by “engages with specific persons in a way that results in the conclusion of contracts”; strengthen the requirement of “independence”. Option B: Add a reference to contracts for the provision of property or services by the enterprise; replace “conclude contracts” by “concludes contracts, or negotiates the material elements of contracts”; strengthen the requirement of “independence”. Option C: Replace “contracts in the name of the enterprise” by “contracts which, by virtue of the legal relationship between that person and the enterprise, are on the account and risk of the enterprise”; replace “conclude contracts” by “engages with specific persons in a way that results in the conclusion of contracts”; strengthen the requirement of “independence”. Option D: Replace the phrase “contracts in the name of the enterprise” by “contracts which, by virtue of the legal relationship between that person and the enterprise, are on the account and risk of the enterprise”; replace “conclude contracts” by “concludes contracts, or negotiates the material elements of contracts”; strengthen the requirement of “independence”’. 117  See Kristen A Parillo and Lee A Sheppard, ‘OECD lays out option on preventing artificial avoidance of PE status’, 2014 WTD 212-1 (3 November 2014). 118  Option E was to amend Article 5(4) so that all its subparagraphs were subject to a ‘preparatory or auxiliary’ condition. See suggested wording in pp 15–16, para 15. 119  See Option F and paras 16–20. It is notable that the word ‘delivery’ is absent from the corresponding provisions of the United Nations Model Double Taxation Convention between Developed and Developing Countries. Although this suggestion was originally focused on electronic trading, it could have much wider application. 120  PE Discussion Draft, n 111 above, paras 21–28 and Options G and H.

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The PE Discussion Draft also attempted to address concerns on the a­ pplication of paragraph 4 where activities were fragmented between related parties.121 It was noted that the OECD Model Commentary already addressed this point by ­clarifying that a (single) enterprise ‘cannot fragment a cohesive operating business into several small operations in order to argue that each is merely engaged in preparatory or auxiliary activity’.122 The PE Discussion Draft sought to go beyond this, given the ease with which subsidiaries may be established.123 A rule was suggested to take account not only of the activities carried on by the same enterprise at different places but also of activities carried on by associated enterprises at different places or at the same place. Two alternative versions of this rule were suggested.124 In order to address the splitting up of contracts to circumvent the restrictions imposed by paragraph 3, it was suggested that there should be an automatic rule to take account of any activities performed by associated enterprises or that this could be caught under the general anti-abuse rule (the principal purpose test) proposed as a result of the work undertaken on Action 6.125 Overall, BEPS concerns around the PE rules could not be addressed successfully without coordination between the work on PE status and the work on other aspects of the Action Plan, especially Actions 4, 8 and 9.126 The question of attribution of profits was a key consideration in determining which changes should be made to the definition of PE. Certainly a potential expansion of the definition of PE would have an impact on the application of the authorised OECD approach. This may prove to be challenging, especially when there is fragmentation of ­activities and/ or splitting up of contracts.127 The PE Discussion Draft did not propose changes to the OECD Model Commentary. It is uncertain whether the Commentary would be refined in a future model update or whether the changes are to be introduced through the ­multilateral instrument proposed under Action 15.

121 

Ibid, p 19 and paras 29–31. See para 27.1 OECD Model Commentary. 123  PE Discussion Draft, n 111 above, para 31, p 19. 124  Under Option I, the anti-fragmentation rule would be extended to cases where complementary business activities were carried on by associated enterprises, at the same location, or by the same enterprise or by associated enterprises at different locations. For the rule to apply, a group of associated enterprises must have at least one fixed place of business that satisfied the PE threshold and the activities concerned must be complementary functions that were part of a cohesive business operation. Option J was similar except that it would apply where none of the places to which it referred constituted a PE but the combination of the activities at the same place or at different places went beyond what was preparatory or auxiliary. PE Discussion Draft, n 111 above, pp 20–21. 125  Ibid, Options K and L in paras 32–34. 126  Ibid, paras 43–45. The same point was made in the example of insurance activities used to artificially avoid the PE status. The PE Discussion Draft proposed two alternative approaches to deal with BEPS concerns. However, it was emphasised that insurance and re-insurance raised difficult issues as regards the question of where profits that represent the remuneration of risk should be taxed. The work had to be coordinated with the work in Actions 4 and 9 of the Action Plan: ibid, paras 35–42. 127  Parillo and Sheppard (2014), n 117 above. 122 

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The PE Discussion Draft and its options have been widely criticised for their subjectivity and for creating additional sources of controversy.128 For example, it would be difficult to reconcile the continued exemption for storage with the removal of the exemption for delivery. If the option to remove the exemption for the delivery of goods is adopted, the OECD Model Commentary will need to make clear when storage/display ends and when delivery (which would create a PE) starts, in order to bring certainty.129 It was also argued that it was unreasonable to conclude that delivery in a jurisdiction connotes a substantial economic activity, such as manufacturing.130 Similar arguments were made as regards the suggested changes to Article 5(6) of the OECD Model. In fact, it has been reported that the United States might take the unprecedented step of entering a reservation on the change to Article 5(6), something it has never done in the past.131 As regards the anti-fragmentation options, it is thought that these may lead to a material increase in uncertainty and subjectivity. How would a ‘cohesive ­operating business’ be interpreted and would these options enable source countries to pierce or ignore the separate legal personality of substantive legal entities? It has also been argued that the splitting rules need to be qualified, to prevent the ­situation whereby a range of different activities within a single multinational group might be aggregated, in the absence of any abuse.132 An overall criticism of business groups was that MNE transactions were being implicated as abusive simply because they took place among related members.133 It appeared that the OECD had ‘failed to understand and properly take into account the commercial drivers for many c­ ommon cross-border structures’.134 The PE Discussion Draft has also been criticised for going beyond the scope of the BEPS project. It has been argued that the proposals do not seem primarily focused on addressing questions of artificial avoidance of PEs but rather just attempt to lower the PE threshold. This is an arbitrary (and inefficient) way of addressing the identified problems. Some of the changes suggested affect routine 128  See Pleijsier (2015), n 113 above; Mindy Herzfeld, ‘The Upcoming Clash over PE Rules’, 2015 WTD 12-1 (20 January 2015). Also see proceedings at the public consultation meeting held on 22 ­January 2015, reported in Ajay Gupta, ‘Business Groups Resist Lower PE Thresholds During OECD Consultation’, 2015 WTD 15-2 (23 January 2015). 129  See PwC, ‘Release of BEPS Discussion Draft: Preventing the Artificial Avoidance of PE Status’, dated 3 November 2014. Available on: www.oecd.org/ctp/treaties/action-7-pe-status-public-­ discussion-draft.pdf. Also published in Tax Analysts on 8 January 2015 (2015 WTD 6-17). 130  Gupta, ‘Business Groups Resist Lower PE Thresholds During OECD Consultation’¸ n 128 above. Also see comments made by Paul Morton of the Reed Elsevier Group to the effect that, the ability to transact business across several jurisdictions via the internet, with relatively little or no local activity, could result in options E through H posing severe practical difficulties in non-abusive cases: ibid. 131  See Lee Sheppard, ‘Stack’s BEPS update’, 2015 WTD 75-1 (20 April 2015). 132  See the example given in p 4 of the PwC commentary to Action 7, n 129 above, of specialist technicians visiting a site to conduct feasibility studies in advance of a local subsidiary acting as contractor. It was noted that this (referring to Option K) could be a particular challenge for an MNE group that was diversified and decentralised, as they may be unaware of all the activities of the MNE group. There was similar criticism of Option L. 133  Herzfeld, ‘The Upcoming Clash over PE Rules’, n 128 above. 134  Ibid.

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business structures for which BEPS has not been and should not be a concern.135 The vague changes suggested in the PE Discussion Draft are likely to lead to a substantial increase in disputes and a significant reduction in cross-border investment and economic growth.136 As commented, ‘it looks like the mission of the Focus Group [on the Artificial Avoidance of PE Status] is to prevent normal business instead of fighting treaty abuse’.137 It was suggested that there should be a transitional period or grandfathering provision for the implementation of a new PE definition in Article 5. The transitional period should be a minimum of three years, preferably longer.138 Another omission is that in the PE Discussion Draft there was no significant discussion on the related PE profit attribution issues. Failure on the part of the OECD to analyse the specific profit attribution implications of each of the various options for amending the PE definition would inevitably lead to unrealistic expectations by governments as to the revenue potentially to be derived from those changes.139 ‘That will in turn lead to ill-considered decisions about whether to make those changes and ultimately to a long period of costly disputes’.140 It has been rightly noted that the question of attribution of profits to a PE can be just as contentious and uncertain as the preliminary question of whether a PE exists. There could be many practical difficulties. For example, many countries would readily accept an attribution of profits to a PE within their jurisdiction as a result of such an analysis, but would be reluctant to accept a share of attributed losses to the same PE under the same analysis.141 This issue was not addressed and it was uncertain whether there would be an official update of the Authorised OECD Approach. Follow-up work on this point was promised in the Revised PE Discussion Draft, analysed below. The BEPS Monitoring Group, although supporting the shift to source country rights, criticised the proposals for being minimalist and only dealing with a few ­specific types of abuse.142 Contrary to what most commentators thought, the Group argued that the proposed rules did not go far enough in ­addressing fundamental problems in this area.143 The Group advocated for a more ­ambitious approach to

135  See comments from the Business and Industry Advisory Committee to the OECD, reported by Herzfeld, ‘The Upcoming Clash over PE Rules’, n 128 above. 136  See TEI Comments—BEPS Action 7, dated 23 December 2014, p 18. 137  Pleijsier (2015), n 113 above, p 149. 138  See TEI Comments—BEPS Action 7, n 136 above, p 17. 139  See comments of the International Alliance for Principled Taxation reported by Herzfeld, ‘The Upcoming Clash over PE Rules’, n 128 above. 140  Ibid. 141  See TEI Comments—BEPS Action 7, n 136 above, p 17. 142 See BEPS Monitoring Group, Comments on BEPS Action 7: Preventing Artificial Avoidance of PE Status, para 2. Available on: bepsmonitoringgroup.files.wordpress.com/2015/01/bmg-ap-7submission-pe.pdf. 143  The Trade Union Advisory Committee to the OECD (TUAC) held similar views. See Herzfeld, ‘The Upcoming Clash over PE Rules’, n 128 above.

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be adopted, which would entail a reconsideration of not only ­paragraphs 4 to 6 of Article 5 but also paragraph 7.144 The Group suggested a revision of Article 5(7) of the OECD Model, so that a controlled entity of an integrated MNE would constitute a PE of the controlling MNE. The Group suggested the reversal of the presumption that the fact that two companies are under c­ ommon control should not of itself create a taxable presence for the multinational as a whole. It also suggested that to align income from sales with expenses, greater use should be made of the profit split method in transfer pricing, or the apportionment approach which is still allowed for a PE in most treaties, especially with developing countries. Another criticism levelled against the proposals was that the current OECD Model provisions made no distinction between small businesses working through unaffiliated entities in foreign jurisdictions and a globally integrated MNE. As such, the existing rules allowed MNEs to hide behind small businesses.145 It has been argued that the PE Discussion Draft seems to ‘reflect a reaction to the unwillingness or inability of residence countries to actually impose their tax on multinationals’.146 While it is unlikely that it will lead to a shift to the UN Model approach as hoped by some interest groups, the proposals are certainly going to be controversial for those refusing to move away from the traditional standards and uncertain for those who wish to see true reform of the international tax system. On 15 May 2015 the OECD published a revised discussion draft on Action 7 (henceforth, the PE Revised Discussion Draft).147 This new discussion draft reflected the proposals that resulted from the previous discussion draft. As regards the proposed changes to the wording of paragraphs 5 and 6 of Article 5 of the OECD Model to address commissionnaire structures and similar arrangements, it was concluded that Option B was preferable.148 There was general support for the changes proposed to the independent agent exception of Article 5(6). It was agreed, however, that the concept of ‘associated enterprises’ used in Article 5(6) should be replaced by a narrower concept and that Article 5(6) should not automatically exclude an unrelated agent acting exclusively for one enterprise. ­Additional Commentary guidance on these changes would be provided.149 Regarding the ­transfer

144  See BEPS Monitoring Group, Comments on BEPS Action 7: Preventing Artificial Avoidance of PE Status, n 142 above, para 5 et seq. 145  See comments made in the public consultation by Sol Picciotto on behalf of the BEPS ­Monitoring Group, reported by Gupta, ‘Business Groups Resist Lower PE Thresholds During OECD Consultation’, n 128 above. He called for Article 5(7) of the OECD Model to be reconsidered, as per the Group’s submissions. The expansion of Article 5(5) and 5(6) envisaged by all four options could then be seen as reinforcing that presumption. 146  Parillo and Sheppard (2014), n 117 above. 147  OECD, ‘Revised Discussion Draft, BEPS Action 7: Preventing the Artificial Avoidance of PE Status, 15 May 2015—12 June 2015’. Available on: www.oecd.org/tax/treaties/revised-discussion-draft-bepsaction-7-pe-status.pdf. 148  See options set out in n 116 above. 149  PE Revised Discussion Draft, n 147 above, paras 9–23 and the suggested changes to paras 5–6 of Article 5 as well as the corresponding changes to the OECD Model Commentary.

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of risks between related parties through low-risk distributor arrangements, ­Article 5(5) of the OECD Model was not to address these. Rather, these concerns would be best addressed through the work on Action 9 (Risks and Capital). As regards changes to the specific activity exemptions in Article 5(4) of the OECD Model, it was concluded that Option E was preferable and that Article 5(4) should be modified so that each of the exceptions included in that paragraph would be restricted to activities that are otherwise of a ‘preparatory or auxiliary’ character. Additional Commentary guidance would be given regarding the meaning of the phrase ‘preparatory or auxiliary’.150 As regards the anti-fragmentation rule, Option J was preferred, which would apply whenever the relevant business activities exceeded the threshold of preparatory or auxiliary, regardless of whether any of the enterprises had a PE.151 As regards the splitting-up of contracts, it was useful to add an example in the OECD Model Commentary on the PPT rule (as proposed under Option L) which would deal appropriately with the splitting-up of contracts issue. It was also agreed that a more automatic rule based on Option K but with some changes should be included in the OECD Model Commentary as a provision to be used where countries, unable to address that issue through domestic anti-abuse rules, would not include the PPT in a treaty or would want expressly to address concerns related to the splitting-up of contracts.152 The PE Discussion Draft included two options (Options M and N) aimed at situations where foreign insurance companies do large-scale business in a state without having a PE in that state. In the PE Revised Discussion Draft it was noted that no specific rule was necessary and the general rules under paragraphs 5 and 6 of Article 5 should apply.153 As mentioned, it had been acknowledged in the initial discussion draft that, although the existing rules on Article 7 of the OECD Model would be appropriate for determining the profits of any additional PE arising under the suggested options, more guidance was needed on how these rules would apply, taking also into account the results of work in other Action items. In the PE Revised Discussion Draft, it was decided that follow-up work on the attribution of profits would be carried on after September 2015 with a view to providing the necessary guidance before the end of 2016, which is the deadline for the negotiation of the multilateral instrument that would implement the results of the work on Action 7.154 The remainder of this chapter reviews the deliverables on Actions 8 to 10 which deal with transfer pricing rules—a very important part of the BEPS Action Plan. Broadly, the aim of these deliverables is to develop rules to assure that transfer pricing outcomes are in line with value creation. Through Actions 8 to 10, the OECD

150 

Ibid, paras 24–32, with the suggested changes to the OECD Model and Commentary. Ibid, paras 33–41 with the suggested changes to the OECD Model and Commentary. Ibid, paras 42–47, with the suggested changes to the Commentary. 153  Ibid, paras 48–52. 154  Ibid, paras 53–37. 151  152 

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attempts to tackle ‘high-risk’ transactions. It is mainly in these areas that MNEs have been able to use contractual arrangements which facilitated base erosion and profit shifting, often leading to what has been described as ‘stateless income’.155

3.3.  Action 8: Intangibles Action 8 reads as follows: Develop rules to prevent BEPS by moving intangibles among group members. This will involve: (i) adopting a broad and clearly delineated definition of intangibles; (ii) ­ensuring that profits associated with the transfer and use of intangibles are appropriately allocated in accordance with (rather than divorced from) value creation; (iii) developing transfer pricing rules or special measures for transfers of hard-to-value intangibles; and (iv) updating the guidance on cost contribution arrangements.

Intangibles are at the heart of the BEPS project. The topic has long been considered as one of the most challenging subjects of transfer pricing. The OECD wants to define the concept of intangibles broadly, with the aim of discouraging transfers to tax havens, while continuing to recognise self-serving contracts between multinational affiliates. The overall aim is to allocate returns to where value is created.156 The mantra used in the BEPS project is that taxable profits (and in this specific item, taxable intangible returns) should correspond to value creation. But how is this to be done given the perceived difficulties of evaluating intangibles?157 As noted, ‘[t]he identification of a correct transfer price for intangibles depends on the assumption that there is an intrinsic market value of a given intercompany transaction and this highlights one of the logical weaknesses of the transfer ­pricing approach’.158 Given the difficulties in evaluating intangibles, one can appreciate how hard it is to design rules that correctly allocate intangible related returns. One suggestion is to use proxies to risk-taking, but this would require ‘rethinking current methods and perhaps accepting innovations’.159 There have been suggestions for

155  Edward D Kleinbard, ‘Stateless Income’ (2011) 11 Florida Tax Review 699. See discussion in Ch 1 of this volume. Also see Georg Kofler, ‘The BEPS Action Plan and Transfer Pricing: The Arm’s Length Standard Under Pressure?’ [2013] British Tax Review 646. 156  Lee A Sheppard, ‘Twilight of the International Consensus: How Multinationals squandered their tax Privileges’ (2014) 44 Washington University Journal of Law & Policy 61, 77. 157  See Yariv Brauner, ‘Value in the Eye of the Beholder: The Valuation of Intangibles for Transfer Pricing Purposes’ (2008) 28 Virginia Tax Review 79, 161–62. In this excellent article, Brauner explains how the transfer pricing rules produce a range of acceptable prices and how such range is available only to MNEs and more so to intangible-extensive MNEs to minimise their effective taxation unrelated to other tax planning. 158 Carlo Garbarino and Mario D’Avossa, ‘The OECD Intangibles Project and the Concept of “Intangible Related Return”’ (2015) 55 European Taxation 12–15, 12. 159  Yariv Brauner, ‘What the BEPS?’ (2014) 16 Florida Tax Review 55, 101.

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partial reform so that the arm’s length principle is replaced by formulary methods in areas such as intangibles, but this has remained an academic exercise.160 Agreement would still be needed on when the arm’s length principle applies and when it does not apply—this is likely to prove difficult. Have the BEPS deliverables in this area advanced the discussion? While BEPS negotiators are in agreement that MNEs should not be able to shift valuable intangibles to tax havens, there is still no agreement on the tools to prevent this practice, nor on the locus of value creation and which affected country could tax it.161

3.3.1.  Transfer Pricing Aspects of Intangibles An initial discussion draft on intangibles was produced in 2012,162 which was considered to be too vague.163 A revised discussion draft (henceforth, the Intangibles Revised Discussion Draft) was released on 30 July 2013,164 shortly after the announcement of the BEPS Action Plan. Some important points arose from this draft. The Intangibles Revised Discussion Draft advocated for rules aligning taxable intangible returns with value creation, inter alia, based on the concept of important functions. Contractual relationships between related parties would continue to serve as a starting point but the location of material functions related to intangible assets was considered crucial. The focus was on value-creating functions, rather than the bearing of risk through contractual arrangements, or the implications of legal rights on remuneration. It was stated that funding and risk-taking were integrally related—a funding party often bears the risk of loss of funds.165 ‘Nonetheless, they can and should be analysed separately because there is no standard set of risks assumed in the

160  Partial reform is not impossible. See arguments by Reuven S Avi-Yonah and Ilan Benshalom, ‘Formulary­Apportionment—Myths and Prospects: Promoting Better International Tax Policies by Utilizing the Misunderstood and Under-Theorized Formulary Alternative’ (2011) 3 World Tax ­Journal 371–98; Reuven S Avi-Yonah, ‘Between Formulary Apportionment and the OECD Guidelines: A Proposal for Reconciliation’ (2010) 2 World Tax Journal 4–18; Reuven S Avi-Yonah and Kimberley A Clausing, ‘Reforming Corporate Taxation in a Global Economy: A Proposal to Adopt Formulary Apportionment’ in Path to Prosperity: Hamilton Project Ideas on Income Security, Education and Taxes (Brookings Institution Press, 2008) p 319; Susan C Morse, ‘Revisiting Global Formulary Apportionment’ (2010) 29 Virginia Tax Review 593; Julie Roin, ‘Can the Income Tax Be Saved? The Promises and Pitfalls of Adopting Worldwide Formulary Apportionment’ (2008) 61 Tax Law Review 169. Also see more recent contribution by Mitchell A Kane, ‘Transfer Pricing, Integration and Synergy Intangibles: A Consensus Approach to the Arm’s Length Standard’ (2014) 6 World Tax Journal 282–314. 161  See Amanda Athanasiou and Lee Sheppard, ‘OECD’s Discussion Draft on Transfer Pricing Goes Beyond Arm’s Length’ (2015) 77 Tax Notes International 44 (5 January 2015). 162 OECD, Revision of the Special Considerations for Intangibles in Chapter VI of the OECD Transfer Pricing Guidelines and Related Provisions (2012). Available on: www.oecd.org/tax/transfer-pricing/ 50526258.pdf. 163  Martin Zetter, ‘The OECD’s Action Plan on Base Erosion and Profit Shifting’, Tax Journal, Issue 1181, p 20 (9 August 2013). 164 OECD, Revised Discussion Draft on the Transfer Pricing Aspects of Intangibles (30 July 2013). Available on: www.oecd.org/ctp/transfer-pricing/revised-discussion-draft-intangibles.pdf. 165  Ibid, para 83.

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funding of intangible development, enhancement, maintenance, or protection’.166 Rather, the risks assumed would vary, based, for example, on contractual terms and the conduct and solvency of group members. The risks must be determined considering all the facts and circumstances of the relationship among such group members. Rules would be developed for risk and capital allocation to match returns with activities rather than contractual arrangements. It was stated that bearing a funding risk without the assumption of any further risk and without any control over the use of the contributed funds or the conduct of the funded activity, generally would entitle the funder to a risk-adjusted rate of anticipated return on its capital invested, but not more.167 According to the discussion draft, the key questions in each case would be the following: (i) what is the financial risk assumed by the funding entity? (ii) does it have the financial capacity to bear the risk? (iii) how and by whom is that financial risk controlled? (iv) what are the financing options realistically available to the parties? and (v) what is the anticipated arm’s length compensation for assuming the financial risk in question? As summed up later on in the Intangibles Revised Discussion Draft, the legal owner of an intangible would be entitled to all returns attributable to the intangible only if: in substance, it performed and controlled all of the important functions related to the development, enhancement, maintenance and protection of the intangibles; it controlled other functions outsourced to independent enterprises or associated enterprises and compensated those functions on an arm’s length basis; it provided all assets necessary to the development, enhancement, maintenance, and protection of the intangibles; and bore and controlled all of the risks and costs related to the development, enhancement, maintenance and protection of the intangible.168 To the extent that one or more members of the MNE group other than the legal owner performed functions, used or contributed assets, or assumed risks or costs related to the development, enhancement, maintenance, and protection of the intangible, returns attributable to the intangible must accrue to such other members through arm’s length compensation reflecting their anticipated contribution to the intangible value. This may, depending on the facts and circumstances, constitute all or a substantial part of the return attributable to the intangible.169 The implications of this were that an intangible could generate a return much higher than a normal return on the capital invested in creating the intangible. As such, a group company other than the legal owner of the intangible, which had p ­ erformed the value-creating functions, could be rewarded by a share of the return from the intangible asset, rather than a cost-plus fee. As criticised, there may be difficulties in the application of this test. For ­example, when an intangible is completely designed and perfected in one country but is 166 

Ibid. Ibid, para 84. 168  Ibid, para 89. 169  Ibid, para 90. 167 

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solely exploited in a second country, then it may be difficult to ascertain where value is created and how the two jurisdictions should split the value creation. It may also be difficult to ascertain where value is created, when the value exists for the MNE group but is not controlled by a single member of the group.170 The implementation of the rules has no chance of success without enhanced collaboration in assessment and enforcement.171 Another criticism is that the OECD lumps together all intangibles despite some very significant differences between them.172 Some of these differences may lead to different patterns of value creation. It is noteworthy that in some circumstances where it was not possible to identify reliable comparable uncontrolled transactions, it was suggested in the Intangibles Revised Discussion Draft that a transactional profit split method could be utilised to determine the arm’s length conditions for a transfer of intangibles or rights to intangibles.173 Some examples of situations were given.174 Very importantly, the Intangibles Revised Discussion Draft opens the door to treating transactions structured in a given way as if they were different transactions for transfer pricing purposes. It has been criticised that the Intangibles Revised Discussion Draft creates confusion and will generate uncertainty for both taxpayers and tax authorities. Apart from the widespread re-characterisation of transactions involving intangibles, it may also lead to re-characterisation for withholding tax purposes, notwithstanding the fact that the Intangibles Revised D ­ iscussion Draft is not intended to have relevance for other tax purposes. Following the Intangibles Revised Discussion Draft, guidelines were published on this topic in a report published in September 2014 (henceforth, the Intangibles Second Revised Discussion Draft).175 The Intangibles Second Revised Discussion Draft proposed the deletion and reinstatement of the whole of Chapter VI of the OECD Transfer Pricing Guidelines to be entitled ‘Special Considerations for Intangible Property’. Parts of the new text were not finalised on the basis that they were interlinked with other material to be released in 2015. These were the guidelines on ownership of intangibles, on intangibles whose valuation was uncertain at the time of the transaction, the use of unspecified methods and the use of profit split methods.

170 KPMG, OECD Invitation to Comment on the ‘Revised Discussion Draft on Transfer Pricing Aspects of Intangibles’. 171  Brauner (2014), n 159 above. 172  Intangibles Revised Discussion Draft, n 164 above, paras 100–101. 173  Ibid, para 166. 174  For example, with the sale of full rights in intangibles (para 167) or with transfers of partially developed intangibles (para 168) or where limited rights in fully developed intangibles are transferred in a licence or similar transaction, and reliable comparable uncontrolled transactions cannot be identified, a transactional profit split method could often be utilised to evaluate the respective contributions of the parties to earning combined income (para 170). 175 OECD, Guidance on Transfer Pricing Aspects of Intangibles (2014). Available on: www.oecdilibrary.org/docserver/download/2314291e.pdf?expires=1422449883&id=id&accname=guest&checks um=8E117AD9FC4D4A195249EE598C02B286. For commentary, see Jens Wittendorff, ‘More Black Smoke From the OECD’s Chimney—Third Draft on Intangibles’ (2015) 77 Tax Notes International 167, 12 January 2015.

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Overall, the new guidelines broadly followed the suggestions in the Intangibles Revised Discussion Draft. There was similar discussion on location savings, assembled workforce, and group synergies. There were additional examples in the annex, taking the total number of examples to 33. The guidance on intangibles included the definition of intangibles from the Intangibles Revised Discussion Draft and similar discussions on ownership of intangibles, use or transfer of intangibles and valuation issues. Some of the stakeholders’ concerns were addressed. For example, the definition of marketing intangibles was further refined,176 as it was thought to be confusing in the previous version. Also, in a section on the ownership of intangibles and transactions involving the development, enhancement, maintenance, protection and exploitation of intangibles, a paragraph was added which explained the challenges of exploiting intangibles according to the principles of the OECD Transfer Pricing Guidelines.177 Some of the identified challenges related to collaborative value creation; ie how a valuable intangible may be developed in an iterative process. The Intangibles Second Revised Discussion Draft failed to develop any robust theory on how to deal with these.178 Another issue where there was a lot of disagreement but which was eventually left unaddressed was that of location savings and location rents.179 In the Intangibles Second Revised Discussion Draft, location savings were excluded from the definition of intangibles. It was indicated that where reliable local market

176  Ibid, para 6.16, p 32. It is ‘[a]n intangible (within the meaning of paragraph 6.6) that relates to marketing activities, aids in the commercial exploitation of a product or service, and/or has an important promotional value for the product concerned. Depending on the context, marketing intangibles may include, for example, trademarks, trade names, customer lists, customer relationships, and proprietary market and customer data that is used or aids in marketing and selling goods or services to customers’. Cf definition in para 50 of the Intangibles Revised Discussion Draft, n 164 above. 177  Intangibles Second Revised Discussion Draft, n 175 above, para 6.32. There may be lack of comparability of the intangible related transactions between related and independent enterprises; lack of comparability between the intangibles in question; the ownership and/or use of different intangibles by different associated enterprises within the MNE group; the difficulty of isolating the impact of any particular intangible on the MNE group’s income; the fact that various members of an MNE group may perform activities relating to the development, enhancement, maintenance, protection and exploitation of an intangible; the fact that contributions of various members of the MNE group to intangible value may take place in years different than the years in which any associated returns are realised; and the fact that taxpayer structures may be based on contractual terms between associated enterprises that separate ownership, the assumption of risk, and/or funding of investments in intangibles from performance of important functions, control over risk, and decisions related to investment in ways that are not observed in transactions between independent enterprises and that may contribute to base erosion and profit shifting. 178  See Ajay Gupta, ‘BEPS Action 8 (Intangibles): Arm’s Length is Still the Mantra’, 2014 WTD 180-4 (17 September 2014). 179 Ajay Gupta, ‘Rough Road Ahead for OECD Intangibles Project’, 2014 WTD 200-4 (16 October 2014). Also see Leonard Wagenaar, ‘The Effect of the OECD Base Erosion and Profit Shifting Action Plan on Developing Countries’ (2015) 69 Bulletin for International Taxation 84–92. For a discussion on location savings, see Pankaj Jain and Vikram Chand, ‘Location Savings: International and Indian Perspective’ (2015) 43 Intertax 192–98.

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c­ omparables were available and could be used to determine arm’s length prices, specific comparability adjustments for location savings should not be required.180 There was disagreement on this point with developing countries and especially India and China. Their argument was as follows: there were economic gains from moving existing operations to a low tax jurisdiction. The MNE’s ability to capture those savings constituted an intangible asset, the gains from which should accrue at least in part to the new host country. However, OECD countries and the business community were not very keen on this concept as it would be tantamount to an entry tax and might open the gateway for other ancillary advantages to be construed as intangible assets.181 Location savings remains a key issue for MNEs operating in low-cost jurisdictions, so the exclusion of this concept from the definition of intangibles was expected. Interestingly, an Indian tribunal has recently followed the OECD approach on location savings.182 There was a discussion on ex ante and ex post remuneration. The former referred to ‘the future income expected to be derived by a member of the MNE group at the time of a transaction’.183 The latter referred to ‘the income actually earned by a member of the group through the exploitation of the intangible’.184 As explained, the compensation that must be paid to members of the MNE group that contributed to the development, enhancement, maintenance, protection and exploitation of intangibles was generally determined on an ex ante basis. Such compensation may be fixed or contingent.185 Guidance was given on how to determine the appropriate arm’s length remuneration to members of a group. In applying the arm’s length analysis, difficult cases were identified.186 It was concluded187 that if the legal owner of an intangible in substance performed and controlled all of the functions related to the development, enhancement, maintenance, protection and exploitation of the intangible and if the legal owner provided all assets, including funding, necessary to these functions and bore

180 

See suggested para 1.83, p 14 of the Intangibles Second Revised Discussion Draft, n 175 above. See, for example, the discussion at IFA seminar entitled ‘Tax Issues Relating to Intangibles’ held at the 68th annual Congress of IFA in Mumbai, where it was sarcastically suggested that good weather should also be seen as an intangible. Gupta, ‘Rough Road Ahead for OECD Intangibles Project’, n 179 above. 182  See appeal before the Income-tax Appellate Tribunal in India, Watson Pharma Pvt Ltd (ITA No 1423/Mum/2014 and 1565/Mum/2014)). Here, the Tribunal ruled in favour of the taxpayer, rejecting the Indian tax administration’s views on location savings and adopting the OECD’s approach under Action 8. No adjustment was necessary on account of location savings when the arm’s length price was determined on the basis of appropriate comparables. 183  Intangibles Second Revised Discussion Draft, n 175 above, para 6.44. 184  Ibid. 185  Ibid, para 6.54. 186  Ibid, paras 6.47–6.48. Eg where intangibles were self-developed by an MNE group, where acquired or self-developed intangibles served as a platform for further development or where there were other aspects, such as marketing or manufacturing that were particularly important to value creation. 187  Ibid, para 6.68. 181 

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and controlled all of the risks, then it would be entitled to all of the anticipated, ex ante, returns derived from the MNE group’s exploitation of the intangible. To the extent that one or more members of the MNE group other than the legal owner performed functions, used assets, or assumed risks related to the development, enhancement, maintenance, protection, and exploitation of the intangible, such member(s) would be entitled to a share in the anticipated returns derived from the exploitation of the intangible by receiving arm’s length compensation. The entitlement of any member of the MNE group to ex post profits or losses as a result of unanticipated events188 would depend on the terms and conditions of the relevant contracts and on the functions performed, assets used and risks assumed in connection with these events. The Intangibles Second Revised Discussion Draft introduced an analysis of unexpected ex post returns,189 though it did not answer the question of what to do with these returns.190 Arguably, this decision was deferred to countries.191 The Intangibles Second Revised Discussion Draft reiterated the section on the application of profit split methods on intangibles, when comparables could not easily be found.192 This was among the parts of the discussion draft yet to be finalised. It has been criticised that using the terms ‘transactional profit split method’ is oxymoron.193 Characterising this method as yet another transactional approach under the benign shade of the arm’s length standard, ‘only ends up shrouding the method in a dense mist’.194 This was likely to generate confusion to tax administrators and taxpayers on how to apply the method in real-life cases. The fact that the OECD provided little guidance on how the method was to be applied exacerbated the problem. It has been argued that the OECD’s partial endorsement of the profit split method as an acceptable method when comparables are not sufficient suggests that the profit split method could in the future become the rule rather than the exception for transactions involving intangibles.195 This endorsement was anticipated for a long time ‘and is somewhat widely accepted as the best way for the OECD to abandon arm’s length in the transfer pricing for intangibles without losing too much face’.196 Both the Intangibles Revised Discussion Draft and the subsequent discussion draft have been criticised for the vague language used 188 

See examples given in para 6.66 in Intangibles Second Revised Discussion Draft, n 175 above. Ibid, paras 6.66–6.67. 190  See also criticism of US Treasury official on this point, report by Margaret Burrow, ‘Distinguishing Ex Ante–From Ex-Post Returns’, 2014 WTD 190-5 (1 October 2014). 191  It has been argued that this proposal contradicts the US cost-sharing regulations in which contractual terms play a key role. In any case, such important changes to the transfer pricing rules would be subject to the consent of national parliaments. See Jens Wittendorff, ‘More Black Smoke From the OECD’s Chimney—Third Draft on Intangibles’, n 175 above. 192  Intangibles Second Revised Discussion Draft, n 175 above, paras 6.145–1.149. 193  See Gupta, ‘Rough Road Ahead for OECD Intangibles Project’, n 179 above. 194  Ibid. 195 Yariv Brauner, ‘Transfer Pricing in BEPS: First Round—Business Interests Win (But, Not in Knock-Out’ (2015) 43 Intertax 72–84. 196  Ibid, p 78. 189 

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as regards the implementation of the rules. There was no guidance as to when ­comparables were inadequate so that one can eschew the arm’s length principle and resort to profit split methods. Yariv Brauner has argued that this was the result of the pressure that the OECD faces but ‘it leaves a magnitude of discretion that can annihilate the reform’.197 Arguably, the commentary in the Profit Split Discussion Draft could be used for guidance in this area too.198 As the BEPS Monitoring Group also noted, much work needs to be done to develop recommendations for common tax accounting standards, and define suitable allocation keys for the application of the profit split method.199 The OECD was criticised in that it still religiously proclaimed its adherence to the arm’s length principle, even though it allows methods of application which differ widely.200 This incoherence of transfer pricing rules ‘remains the most blatant indicator of the crisis of the current system’.201 The Group warned that unless a better approach could be developed, the BEPS project would have to be judged a failure. Arguably, this is a risk that the OECD is willing or forced to take. It certainly seems politically easier than admitting to the fact that perhaps it is time for formulary methods to be explored. Addressing intangibles, or appearing to do so, is crucial to the BEPS project.202 As stated in the executive summary to the Intangibles Second Revised Discussion Draft,203 the OECD planned to finalise the intangibles guidance in 2015 in conjunction with the BEPS work on risk, re-characterisation and hard-to-value intangibles. Some of the suggestions in these deliverables have also proved quite controversial.

3.3.2.  Cost Contribution Arrangements On 29 April 2015, the OECD published a discussion draft under Action 8 as part of the requirement to update the guidance on cost contribution arrangements in Chapter VIII of the OECD Transfer Pricing Guidelines.204 The guidance suggested in the CCA Discussion Draft also took into account the draft guidance suggested in the Risk and Re-characterisation Discussion Draft.205 The CCA Discussion Draft acknowledged the need to simplify the measurement of contributions and to ensure that contributions are commensurate with the benefits received under a CCA. Broadly, the revisions to the OECD Transfer Pricing Guidelines on CCAs supported the use of value contributed over the costs 197 

Ibid, p 79. See section 3.4.2 below. 199  BEPS Monitoring Group, OECD BEPS Scorecard, n 84 above, p 11. 200  Ibid. 201  Ibid. 202  J Scott Wilkie, ‘Intangibles and Location Benefits (Customer Base)’ (2014) 68 Bulletin for International Taxation 352–60, at 360. 203  See page 11 of Intangibles Second Revised Discussion Draft, n 175 above. 204 OECD, BEPS Action 8: Revisions to Chapter VIII of the Transfer Pricing Guidelines on Cost Contribution Arrangements (CCAs) (henceforth, the CCA Discussion Draft). 205  See analysis in section 3.4.4 below. 198 

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incurred. The CCA Discussion Draft reinforced the notion that the contribution of each participant to a CCA should be reflective of value contribution. A CCA was defined as ‘a contractual arrangement among business enterprises to share the contributions and risks involved in the joint development, production or the obtaining of intangibles, tangible assets or services with the understanding that such intangibles, tangible assets or services are expected to create direct benefits for the businesses of each of the participants’.206 The definition reveals, once again, the central character of intangibles as part of the BEPS project.207 The CCA Discussion Draft emphasised that a CCA was a contractual arrangement rather than necessarily a distinct juridical entity or fixed place of business of all the participants.208 While the CCA could streamline the flows of intercompany transactions, it did not affect the appropriate valuation of the separate contributions of the participants. The outcomes for transfer pricing purposes for CCA participants ‘should be consistent with those which would have arisen had the parties made similar contributions on similar terms outside of a CCA mechanism’.209 The CCA Discussion Draft described two common types of CCAs: those established for the joint development, enhancement, maintenance, protection or exploitation of intangibles or tangible assets (development CCAs) and those for obtaining services (services CCAs). The former were expected to create ongoing, future benefits for participants, while the latter would often create current benefits only. In some cases, a CCA for obtaining current services may also create or enhance an intangible which provided ongoing benefits.210 The expectation of mutual and proportionate benefit was fundamental to the acceptance by independent enterprises of an arrangement for pooling resources and skills. For a CCA to satisfy the arm’s length principle, each participant’s proportionate share of the overall contributions to the CCA should be consistent with the participant’s proportionate share of the overall expected benefits.211 The first step was to determine the participants of the CCA. Since a CCA was premised on all participants sharing not only contributions but also the risks of the CCA activities, to qualify as a participant in a CCA an entity must have the capability and authority to control the risks associated with the risk-bearing opportunity under the CCA in accordance with the definition of control of risks set out in Chapter I of the OECD Transfer Pricing Guidelines. In particular, this means that a CCA participant should have the capability to make decisions to take on the risk-bearing opportunity, to make decisions on how to respond to the risks, and

206 

CCA Discussion Draft, n 204 above, para 3. See PwC comments on the CCA Discussion Draft, available on Tax Analysts, 2015 WTD 86-21 (1 May 2015). It was noted that, contrary to the 2010 OECD Transfer Pricing Guidelines, only direct benefits were encompassed under the definition in the CCA Discussion Draft. 208  CCA Discussion Draft, n 204 above, para 3. 209  Ibid, para 6. 210  Ibid, para 8. 211  Ibid, para 11. 207 

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to assess, monitor, and direct any outsourced measures affecting risk outcomes under the CCA.212

It was emphasised that there was no rule that could be universally applied to determine whether each participant’s proportionate share of the overall contributions to a CCA activity was consistent with the participant’s proportionate share of the overall benefits expected to be received under the arrangement. The goal was to estimate the share of benefits expected to be obtained by each participant and to ensure that their contributions were in the same proportions. This may require that participants’ contributions be adjusted using balancing payments.213 For each participant it was necessary to estimate the expected benefits from the CCA. The shares of expected benefits might be estimated based on the anticipated additional income generated or costs saved or other benefits received by each participant. In practice, a relevant allocation key such as sales; units used, produced, or sold; or number of employees might be appropriate to reflect the participants’ proportionate shares of expected benefits.214 Whatever the method used to evaluate participants’ relative shares of expected benefits, adjustments to the measure used may be necessary to account for differences between the expected and actual benefits received by the participants. For the purpose of determining whether a CCA satisfied the arm’s length principle, it was necessary to measure the value of each participant’s contributions to the arrangement.215 Under the arm’s length principle, the value of each participant’s contribution should have been consistent with the value that independent enterprises would have assigned to that contribution. The CCA Discussion Draft makes it clear that contributions to CCAs are to be based on their arm’s length value rather than on their cost.216 It was, however, acknowledged that sometimes the value of services contributed to a CCA corresponds to the costs associated with providing those services—eg for low value-added services. In that case, it was recommended for practical reasons to value contributions at cost.217 Where the value of a participant’s contributions was not consistent with its share of expected benefits, balancing payments might be required.218 As CCAs can often be long-term projects, making minor or marginal adjustments or generally adjustments based on evidence from a single year may be inappropriate.219 Furthermore, while costs are to be allocated based on expected benefits, it was emphasised that all participants to the CCA must have substance and the ability to exercise some form of control over their investments. Absent such substance, the

212 

Ibid, para 13. Ibid, para 15. 214  Ibid, para 16. 215  Ibid, para 20. 216  Ibid, para 23. 217  Ibid. 218  Ibid, paras 27–30. 219  Ibid, para 30. 213 

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CCA can be disregarded.220 There was no concrete guidance as to the implications of this position. It was generically noted that guidance in Chapter VI on Hard to Value Intangibles might equally apply in situations involving CCAs and that in relevant circumstances ‘it may be appropriate for a tax administration to disregard the CCA in its entirety in accordance with the principles for non-recognition of the delineated transaction set out in Chapter I’.221 Contributions, including any balancing payments and any buy-in or buyout payments, by or for a participant of the CCA would continue to be treated for tax purposes in the same manner as would apply under the rules of the tax system applicable to each participant if the contributions were made outside a CCA. The character of the contribution would depend on the nature of the activity being undertaken by the CCA, and would determine how it was treated for tax ­purposes.222 The discussion draft goes on to provide examples of scenarios in which balancing payments could be required. Changes in the membership of a CCA may trigger a reassessment of the proportionate shares of participants’ contributions and expected benefits.223 In the case of new entrants contributing to a CCA, arm’s length compensation would be required for such contribution in the form of a buy-in payment.224 Furthermore, an entrant withdrawing from a CCA may be entitled to a buy-out payment to reflect a disposal of its interest. Again, these payments would be based on value rather than cost. The guidance remained broadly unchanged in terms of its recommendations for structuring and documenting CCAs. These included conditions for participants eligible to join a CCA, terms to be included and information that should be documented at the beginning and throughout the duration of the CCA.225 In general, whilst the requirement for participants in a CCA to have the capability and authority to control the risks associated with the risk-bearing under the CCA was consistent with the overall BEPS theme of aligning taxation with value creation and substance, this is a fundamental change for CCAs. Cost contribution arrangements might become a misnomer, as contributions to CCAs would be based on their arm’s length value rather than on their cost.226 For a CCA participant to be entitled to the returns from a CCA linked with an intangible, controlling risks and developing, exploiting and maintaining the intangible will become essential. Participants only providing funding to the CCA would receive only limited returns. Furthermore, tax authorities are expressly authorised to check the commercial reality of the arrangement and re-characterise part or all of the terms of a CCA. 220 

Ibid, paras 31–32. Ibid, para 32. 222  Ibid, para 33. 223  Ibid, para 36. 224  Ibid, paras 37–41. 225  Ibid, paras 42–45. 226  See also PwC comments, n 207 above. 221 

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It has been argued that the approach taken by the OECD will potentially increase compliance burdens and controversy. It will also often lead to double taxation due to disagreements in terms of value measurement.227 The compliance burden of designing and administering a CCA would also be increased. No guidance was given as to how control functions could be valued on an arm’s length basis. Furthermore, the fact that it was acknowledged that each participant’s contributions may vary with time could make it very difficult to accurately monitor and value the relative contributions of each participant on a continuous basis. Coupled with the right to re-characterise the terms of a CCA on the basis of the vague notion of commercial reality, the powers of tax authorities seem to have incrementally expanded.

3.4.  Actions 9 and 10: Risks and Capital and Other High Transactions Actions 9 and 10 read as follows: Develop rules to prevent BEPS by transferring risks among, or allocating excessive capital to, group members. This will involve adopting transfer pricing rules or special measures to ensure that inappropriate returns will not accrue to an entity solely because it has contractually assumed risks or has provided capital. The rules to be developed will also require alignment of returns with value creation. This work will be co-ordinated with the work on interest expense deductions and other financial payments. Develop rules to prevent BEPS by engaging in transactions which would not, or would only very rarely, occur between third parties. This will involve adopting transfer pricing rules or special measures to: (i) clarify the circumstances in which transactions can be recharacterised; (ii) clarify the application of transfer pricing methods, in particular profit splits, in the context of global value chains; and (iii) provide protection against common types of base eroding payments, such as management fees and head office expenses.

On 3 November 2014, the OECD released a discussion draft in the context of Action 10 relating to low value-adding intra-group services. Modifications to Chapter VII of the OECD Transfer Pricing Guidelines were proposed. The aim was to reduce the scope for base erosion through excessive management fees and head office expenses. On 16 December, 2014 the OECD issued two further discussion drafts under Action item 10, the first addressing the use of the transactional profit-split method, and the second dealing with transfer pricing for commodity transactions.

227  David D Stewart, ‘OECD Cost Contribution Arrangements Draft Emphasises Value’, 2015 WTD 83-1.

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On 19 December, 2014 a more general discussion draft was issued under Action items 8, 9, and 10, with guidelines on how to ensure that transfer pricing outcomes are in line with value creation. These discussion drafts will be considered in sections 3.4.1–3.4.4 chronologically—according to their dates of release.

3.4.1.  Low Value-Adding Intra-Group Services The Discussion Draft on low value-adding intra-group services228 (henceforth, the Intra-Group Services Discussion Draft) fully rewrote Chapter VII of the OECD’s Transfer Pricing Guidelines on intercompany services. Very importantly, it included a definition of ‘low value-adding intra-group services’ and provided a ‘simplified method’ for such services.229 The simplified approach was elective. Under this approach, the arm’s length price for such services would be closely related to costs. Taxpayers that did not elect to apply it would continue using the existing guidance of Chapter VII. The US and the European Union had adopted similar simplified rules on group services to deal with base erosion.230 The Intra-Group Services Discussion Draft defined low value-adding intragroup services as those that were of a supportive nature and were not part of the core business of an MNE group.231 This was an important element of the ­definition.232 Furthermore, such services did not require the use of unique and valuable intangibles and did not lead to the creation of such intangibles. They also did not involve the assumption of control of substantial or significant risk and did not give rise to the creation of significant risk.233 The guidance was not applicable to services that would ordinarily qualify as low value-adding intra-group services where such services were rendered to unrelated customers of MNE members. ‘In such cases it can be expected that reliable internal comparables exist and can be used for determining the arm’s length price for the intra-group services’.234 There was a list of services that would not qualify as low value-adding services eligible for the simplified approach. These included services constituting the core business of the MNE group, research and development (R&D) services, m ­ anufacturing, sales, marketing, distribution and corporate senior

228  Public Discussion Draft—BEPS Action 10: Proposed Modifications to Chapter VII of the Transfer Pricing Guidelines relating to Low Value-Adding Intra-Group Services, 3 November 2014—14 January 2015 (OECD). Available on: www.oecd.org/ctp/transfer-pricing/discussion-draft-action-10-low-valueadding-intra-group-services.pdf. 229  Some other important contributions of the Intra-Group Services Discussion Draft concern the expansion of the list of examples of shareholder services and what to do in the situation of a duplication of services between a service provider and a recipient. These would not be considered further: ibid, paras 7.11–7.12. 230 Jens Wittendorff, ‘The OECD’s Simplified Approach to Pricing Low-Value-Adding Services’ (2015) 77 Tax Notes International 793 (2 March 2015). 231  See suggested para 7.46 in Intra-Group Services Discussion Draft, n 228 above. 232  Also see, ibid, para 7.49 where a number of helpful examples were given. 233  See suggested para 7.46. 234  Ibid.

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­management.235 Examples of services which would qualify were set out in the suggested Commentary. These included accounting and auditing, accounts ­ receivable/payable, human resources, legal, certain information technology, among others.236 As already mentioned, the new simplified method for low value-adding intragroup services would be elective. However, if elected, it would have to be applied on a consistent group-wide basis in all countries where the MNE operates.237 This method was premised on the proposition that all low value-adding service costs incurred in supporting the business of MNE group members should be allocated to those members. Alternatively, the issues would be dealt with under the Cost Contribution Arrangements set out in Chapter VII.238 The proposed method contained the following steps, which were further explained in the suggested guidance. First, the cost incurred by all MNE group members performing these services should be determined.239 Secondly, there should be allocation of the cost pool to MNE group members. This would be done by means of allocation keys selected by the taxpayer and which would be used on a consistent basis for all costs of the same service category.240 Thirdly, in determining the arm’s length charge for low value-adding intra-group services, the MNE provider of services would apply a profit mark-up to all costs in the pool. This should be no less than two per cent and no more than five per cent of the relevant cost.241 The same mark-up should be utilised for all services irrespective of the category of service. The total charge for low value-adding services shall include the costs incurred by an MNE group member for services rendered specifically to that group member by another group member and that group member’s share in the overall pool of low value-adding services costs.242 Lastly, there was guidance on documentation that taxpayers should prepare and submit in order to qualify for the simplified approach. There was a presumption that the simplified benefit test was fulfilled if the MNE satisfied the documentation and reporting requirements set out in the proposed guidance. The recommended documentation and reporting package was to be available to the tax administration of any entity within the MNE group making or receiving a payment for such services.243 This package would consist, inter alia, of a description of the categories 235 

Ibid, para 7.47. Ibid, para 7.48. Ibid, para 7.51. 238  Ibid. 239  Ibid, paras 7.51–7.74. 240  See para 7.55 which also gives some indicative examples. Also see guidance in para 7.25, IntraGroup Services Discussion Draft, n 228 above. 241  Ibid, para 7.57. This is similar to the EU rules which provide a list of low value-adding services and a list of non-chargeable shareholder costs, and suggest a mark-up of 3 to 10 per cent (often 5 per cent) for low value-adding services. See Jens Wittendorff, ‘The OECD’s Simplified Approach to Pricing Low-Value-Adding Services’, n 230 above. 242  Intra-Group Services Discussion Draft, n 228 above, para 7.58. 243  Ibid, para 7.61. 236  237 

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of services provided, written contracts or agreements, calculations showing the determination of the cost pool and calculations showing the application of the specified allocation keys.244 Regrettably, it was not explained how the documentation and reporting package was to be combined with Action 13 on country-bycountry reporting. For example, it was not certain if separate local files would be needed. It has been suggested that the mark-up range be broadened to between two and seven per cent to account for higher mark-ups sought by developing countries.245 It has also been suggested that flexibility is needed in the definition of services and that the list should not be exhaustive. Flexibility is also needed with the allocation of costs and the cost pooling. It has been argued that companies should be permitted to have cost pools that reflect their different divisions and the recipient of the services. It has been criticised that the limitation on services provided by senior management does not recognise the mix of services provided by corporate management, which includes both routine and non-routine functions, and will bring additional burden. The OECD has further been criticised for not addressing in the Intra-Group Services Discussion Draft the impact or overlap of the proposed modifications with other BEPS Action items. Undeniably, the proposed simplified approach, combined with the documentation and reporting requirements, seek to provide greater transparency and uniformity among countries. If widely adopted, this approach would significantly mitigate the compliance costs of some multinational taxpayers. Of course, much would depend on how many countries eventually adopt these proposals.

3.4.2.  The Profit Split Discussion Draft The Profit Split Discussion Draft246 examined several key issues related to the application of transactional profit split methods, gave illustrative scenarios for ­discussion purposes on each of the issues, and posed some questions for public discussion. It was emphasised that the scenarios were provided to illustrate points for discussion only and ‘should in no way be taken to imply that transactional profit split methods will be the most appropriate method in the circumstances outlined in those scenarios’.247 Comments were invited on the relevance of transactional profit split approaches on hard-to-value intangibles.248 244 

Ibid. See David D Stewart, ‘Simplicity Versus Flexibility Argued in OECD Transfer Pricing Consultations’, 2015 WTD 56-1 (24 March 2015). 246  BEPS Action 10: Discussion Draft on the Use of Profit Splits in the Context of Global Value Chains. Available on: www.oecd.org/ctp/transfer-pricing/discussion-draft-action-10-profit-splits-globalvalue-chains.pdf. For commentary, see David D Stewart and Margaret Burow, ‘OECD Issues Drafts on Profit-Split Method and Commodity Transactions’, 2014 WTD 242-1 (17 December 2014). 247  Ibid, para 4. 248  The discussion draft included the current text of the 2010 OECD Transfer Pricing Guidelines related to the application of transactional profit splits, along with an extract from the Intangibles ­Second Revised Discussion Draft, n 175 above, examples 17 and 18. 245 

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A ‘global value chain’ was described as the full range of firms’ activities, from the conception of a product to its end use and beyond. It included activities such as design, production, marketing, distribution and support to the final consumer.249 It was noted that one-sided methods may not be able to reliably account for the interdependence of key functions and risks in global value chains, and transactional profit split methods may be more appropriate. There was a discussion of the circumstances in which profit split methods might be the most appropriate for determining arm’s length pricing. For example, this might be the case when both parties to a transaction made unique and valuable contributions, or when there was fragmentation of functions within a value chain, making it difficult to find reliable comparables. Profit split methods might also be used when an MNE’s business operations were highly integrated such that strategic risks were jointly managed and controlled by more than one party. Generally, profit split methods might be used when there was a potential lack of reliable comparables for a onesided method. It was conceded in the Profit Split Discussion Draft that transactional profit split methods may be viewed as a means of achieving closer alignment between profits and value creation. In practice, these methods were typically applied using one or more allocation keys or factors to split the profits, based on the outcome of a functional analysis that determines how value is created in the MNE group.250 The OECD Transfer Pricing Guidelines urged for the factors to be used in an economically valid way that approximated the division of profits that would have been agreed at arm’s length.251 However, it was recognised that transactional profit split methods suffer from subjectivity—‘allocation keys can be difficult to verify from objective evidence’.252 Through several scenarios, the Profit Split Discussion Draft examined how to develop objectivity in profit split factors so that transfer pricing outcomes were firmly aligned with value creation.253 It also examined how transactional profit split methods may provide a way to address significant differences between ex ante and ex post results, as an appropriate way to deal with unanticipated events where strategic risks were effectively shared between associated enterprises.254 The Profit Split Discussion Draft also considered whether profit split methods may be applied in a different way when there were losses to split instead of profits.255 Overall, the Profit Split Discussion Draft did not provide recommendations or suggest policy changes, but rather directed the discussion to important issues. In fact, it has been characterised as almost exploratory in nature.256 Numerous 249  Profit Split Discussion Draft, n 246 above, para 5, referring to OECD report Interconnected ­Economies: Benefitting from Global Value Chains. 250  Profit Split Discussion Draft, n 246 above, para 34. 251  See para 2.108 of OECD Transfer Pricing Guidelines. 252  Profit Split Discussion Draft, n 246 above, para 35. 253  Ibid, paras 33–43. 254  Ibid, paras 45–49. 255  Ibid, paras 50–53. 256 Amanda Athanasiou, ‘Observers Question BEPS Transfer Pricing Drafts’, 2015 WTD 61-4 (31 March 2015).

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­ uestions were posed on how to apply the transactional profit split method in q the context of global value chains, when this method would be the appropriate method to apply and the treatment of losses. A general criticism was that wider adoption of the transactional profit split method would lead to a further shift away from the arm’s length standard, and closer to an apportionment system. Indeed, the BEPS Monitoring Groups in its comments on the use of profit splits257 suggested that the fiction of separate legal personality should be replaced in situations where it does not reflect economic substance ‘with a holistic approach which treats corporate groups in accordance with the business reality that they are run as integrated enterprises’.258 The Group argued that the continuous evocation of the mantra of the arm’s length principle was aimed at reassuring traditionalists that no significant changes were intended, but in reality the proposals suggested a shift from the traditional approach.259 It was argued that the term ‘transactional profit split’ was contradictory and confusing, and should not be used. ‘It should be made explicit that profit split is a method of apportioning profits to ensure outcomes that are in line with the location of economic activities and value creation’.260

3.4.3.  The Commodities Discussion Draft The Commodities Discussion Draft261 acknowledged that intercompany commodity transactions may be particularly relevant for commodity-dependent developing countries where a major source of economic activity, employment, revenues, and income growth was related to the commodity sector. One of the main issues addressed was transfer pricing oriented tax base erosion resulting from cross-border controlled transactions the object of which was the sale or purchase of commodities. This was a problem acutely felt by tax administrations of commodity-dependent developing countries.262 More specifically, countries have reported the following issues. First, the use of pricing date conventions which appeared to enable the adoption by the taxpayer of the most advantageous quoted price. Secondly, significant ­adjustments

257  See BEPS Monitoring Group, Comments on BEPS Action 10: The Use of Profit Splits in the Context of Global Value Chains. Available on: bepsmonitoringgroup.files.wordpress.com/2015/02/ap10-profitsplit.pdf. 258  Ibid, p 2, para 2. 259  Ibid, para 3. 260  Ibid, p 3, para 5. 261 OECD, BEPS Action 10: Discussion Draft on the Transfer Pricing Aspects of Cross-Border Commodity Transactions. Available on: www.oecd.org/ctp/transfer-pricing/discussion-draft-action-10-­ commodity-transactions.pdf. For commentary, see David D Stewart and Margaret Burow, ‘OECD Issues Drafts on Profit-Split Method and Commodity Transactions’, 2014 WTD 242-1 (17 December 2014). 262  Commodities Discussion Draft, n 261 above, paras 1–2. The term ‘commodities’ was defined as physical products for which a quoted price was used by independent parties to set prices. See para 12.

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to the quoted price or charging of significant fees to the taxpayer in the ­commodity-producing country by other group companies in the supply chain (eg processing, transportation, distribution, marketing); and, the involvement in the supply chain of entities with apparently limited functionality, which may be located in tax opaque jurisdictions with nil or low taxation.263 It was explained that some countries had acted unilaterally to develop approaches for pricing commodity transactions in response to these concerns. The emergence of such approaches had highlighted the need for clearer guidance on the application of transfer pricing rules to commodity transactions. The Commodities Discussion Draft made a number of alternative proposals.264 First, the guidance in Chapter II of the OECD Transfer Pricing Guidelines should be clarified so that the Comparable Uncontrolled Price (CUP) method should be an appropriate transfer pricing method for commodity transactions between associated enterprises.265 It was also proposed that quoted or publicly available prices could be used under the CUP method as a reference to determine the arm’s length price for a controlled commodity transaction.266 It was acknowledged that the price-setting policy for controlled commodity transactions should be included in the transfer pricing documentation of an MNE.267 Secondly, there was a proposal to include additional guidance regarding the adoption of a deemed pricing date for commodity transactions between associated enterprises in the absence of evidence of the actual pricing date agreed upon by the parties to the transactions.268 It was recommended that, absent reliable evidence of the actual pricing date agreed by the associated enterprises, tax administrations may deem the pricing date for the commodity transaction to be the date of shipment as evidenced by the bill of lading or equivalent documents, depending on the means of transport.269 Thirdly, it was recommended that there should potentially be additional guidance on comparability adjustments to the quoted price.270 The Commodities Discussion Draft did not provide guidance regarding what adjustments would be performed if differences arose, or how to perform them. Certain adjustments may be based on information and costings which were transparent or industry standard.271 The OECD requested stakeholders to provide information regarding common adjustments or differentials applied to quoted prices and the sources of information used to determine such adjustments or differentials.272

263 

Ibid, para 2. Ibid, para 3. 265  Ibid, paras 4 and 8–12. 266  Ibid. 267  See para 12 and suggested new para 4. 268  Ibid, paras 13–15. 269  Ibid, para 15 and suggested new para 5. 270  Ibid, paras 16–17. 271  Ibid, para 16. 272  Ibid, para 17. 264 

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In general, the proposed guidance seeks to ensure that pricing reflects value creation, thereby protecting the tax base of commodity-dependent countries. It tries to ensure that parties performing value-adding functions in relation to the commodity being transferred are remunerated with arm’s length compensation. Although the Commodities Discussion Draft primarily focuses on the base ­erosion concerns of developing countries—and as such gives credence to the OECD’s pronouncements that developing countries ought to have a larger role in the BEPS project273—it also highlights the issues faced by taxpayers from the lack of resources in many developing country tax administrations. At a public consultation meeting held at the OECD on 20 March 2015, participants warned against the urge to oversimplify the transfer pricing of commodities. It was argued that the CUP method may not always be the best method and that the discussion draft did not take into account commodities traded in illiquid markets. Furthermore, the deemed pricing date was criticised for not reflecting the realities and practices in the commodities industries. A preferable method was a system of contract registration that would record the relevant terms of commodity transactions. Such contract registration would also provide both tax authorities and taxpayers with certainty about the contract’s terms.274

3.4.4. Risk and Re-Characterisation Discussion Draft on Actions 8, 9 and 10 On 19 December 2014 the OECD issued a more general discussion draft under Action items 8, 9, and 10—the Risk and Re-characterisation Discussion Draft.275 This discussion draft dealt with the recognition to be given to the related parties’ allocation of risk and the re-characterisation of transactions. It also considered the appropriateness of the adoption of special measures outside normal transfer pricing rules. The Risk and Re-characterisation Discussion Draft was divided into two parts. Part I contained a proposed revision to Section D of Chapter I of the OECD Transfer Pricing Guidelines. The proposals focused on the importance of accurately delineating the actual transactions, and included guidance on the relevance and allocation of risk. There was also guidance on determining the economically relevant characteristics of controlled transactions and on re-characterisation

273 

See analysis in Ch 4, section 4.6 of this volume. David D Stewart, ‘Simplicity Versus Flexibility Argued in OECD Transfer Pricing Consultations’, n 245 above. 275 OECD, Public Discussion Draft—BEPS Actions 8, 9 and 10: Discussion Draft on Revisions to Chapter I of the Transfer Pricing Guidelines (Including Risk, Recharacterisation, and Special Measures). Available on: www.oecd.org/ctp/transfer-pricing/discussion-draft-actions-8-9-10-chapter-1-TPGuidelines-risk-recharacterisation-special-measures.pdf. 274 

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or non-recognition of transactions. This formed the basis for comparison with uncontrolled transactions under the existing guidance found in Chapters II and III of the OECD Transfer Pricing Guidelines. Part II provided options for some special measures, with regard to intangible assets, risk and over-capitalisation. A series of questions relating to all options was set out and responses to these questions were to be taken into account when considering the appropriateness and design of each option. In order to delineate a controlled transaction, the Risk and Re-characterisation Discussion Draft focused on identifying the actual conduct of the parties. The process of identifying the actual conduct—ie, the actual commercial and financial relations between the parties—in order to accurately delineate the transaction involved identifying the economically relevant characteristics of the transaction. These included the contractual terms of the transaction, the functions performed, the characteristics of the property transferred, the economic circumstances of the parties and their business strategies. There was detailed discussion of these characteristics. The Risk and Re-characterisation Discussion Draft added a substantially new section on identifying risks in commercial or financial relations between controlled parties to a transaction. There was a discussion on the nature and sources of risk, the allocation of risks in contracts, how risks were assumed, the potential impact of risk, risk management, and identifying the actual conduct of the parties related to risk.276 Several issues core to identifying risk in commercial and financial relations between parties were discussed. These issues involved the extent to which associated enterprises could be assumed to have different risk preferences while they were also in fact acting collaboratively in a common undertaking under common control.277 The issues were broadly grouped into two categories to be considered in the context of the established framework of the arm’s length principle. The first category contained issues around the term ‘moral hazard’. This referred to the lack of incentive to guard against risk when one was protected from its consequences. The term was used ‘to introduce the concept that unrelated parties would seek to avoid moral hazard that may arise in situations where one party assumes a risk without the ability to manage the behaviour of the party creating its risk exposure’.278 The concept was thought to extend to the safeguards or incentives that unrelated parties may incorporate into contracts between them.279 Comments were invited on the implications of moral hazard for the arm’s length principle.

276  The discussion on risk seemed to borrow concepts from Chapter IX of the OECD Transfer Pricing Guidelines on business restructurings, in particular, the concepts of control over risk and allocation of risk. 277  Risk and Re-characterisation Discussion Draft, n 275 above, para 40, Additional Points. 278  Ibid, p 14. 279  Ibid.

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The second category contained issues grouped around the term ‘risk–return trade-off ’. This concept implied the equivalence on a present value basis between a higher but less certain stream of income and a lower but more certain stream of income. According to the Risk and Re-characterisation Discussion Draft, the principle supported the associated notion that it was economically rational to take on (or lay off) risk in return for higher (or lower) anticipated nominal income. There were several questions on the implications of risk–return trade-off under the arm’s length principle.280 Comments were again requested on distinctions to be made in the guidance on risk transfers applicable to the financial services sector.281 Furthermore, the Risk and Re-characterisation Discussion Draft added a substantially new section on non-recognition.282 It was noted that in exceptional circumstances the transaction may be disregarded for transfer pricing purposes.283 The concept of fundamental economic attributes of arrangements between unrelated parties was introduced.284 There could be non-recognition when the transaction did not have the fundamental economic attributes of arrangements between unrelated parties. The term non-recognition was intended to convey the same meaning as that understood to be conveyed by the term re-characterisation.285 The Risk and Re-characterisation Discussion Draft attempted to delineate the criteria for non-recognition,286 emphasising that every effort should first be made to determine the actual nature of the transaction and apply arm’s length pricing to the accurately delineated transaction. Non-recognition should not be used simply because determining an arm’s length price was difficult.287 There was a section on specific considerations which included losses, the effect of government policies and the use of customs valuations. Further, the Risk and Re-characterisation Discussion Draft added, with no changes, the s­ection on ­location savings and local market features, previously released under the ­Intangibles ­Second Revised Discussion Draft.288 280 

Ibid. Ibid. 282  Ibid, paras 83–93. 283  Ibid, para 83. 284  See more fully para 83: ‘In order for the transaction as accurately delineated to be recognised for transfer pricing purposes, the transaction should exhibit the fundamental economic attributes of arrangements between unrelated parties. An arrangement exhibiting the fundamental economic attributes of arrangements between unrelated parties would offer each of the parties a reasonable expectation to enhance or protect their commercial or financial positions on a risk-adjusted (the return adjusted for the level of risk associated with it) basis, compared to other opportunities realistically available to them at the time the arrangement was entered into. If the actual arrangement, viewed in its entirety, would not afford such an opportunity to each of the parties, or would afford it to only one of them, then the transaction would not be recognised for transfer pricing purposes. In applying the criterion, it is relevant to consider whether there exists an alternative for one or more of the parties, including the alternative of not entering into the transaction, which does provide the opportunity to enhance or protect their commercial or financial positions. It is also a relevant pointer to consider whether the MNE group as a whole is left worse off on a pre-tax basis’. Risk and Re-characterisation Discussion Draft, n 275 above. 285  Ibid. 286  Ibid. 287  Ibid, para 84. 288  Intangibles Second Revised Discussion Draft, n 175 above. 281 

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In the second part of the Risk and Re-characterisation Discussion Draft,289 options for potential special measures to address residual BEPS risks290 were considered. One of the largest sources of disagreements in the BEPS project had been whether special measures should be proposed to address abuses outside the arm’s length standard.291 The Risk and Re-characterisation Discussion Draft proposed five alternative special measures292 and invited comments. In general, the Risk and Re-characterisation Discussion Draft unequivocally suggests a reconsideration of the role of risk allocation among related group members. It shines a spotlight on the tensions inherent in the arm’s length principle—namely, the challenges in comparing a transaction between related parties that share a common economic goal with one between independent parties that often pursue competing economic goals.293

The Risk and Re-characterisation Discussion Draft reduces the importance of contractual allocations of risk while raising the importance of functions such as managing and controlling risks.294 It is evident from the proposals that lesser weight would be given to written contractual agreements and greater weight to the parties’ commercial or financial relations. Written contracts between related parties would no longer be the starting point for the analysis. Prioritising the conduct of risk management functions over legal arrangements seems to go beyond the current understanding of the arm’s length principle and is likely to lead to more disputes.295 Henceforth, businesses are likely to put significant emphasis on ­aligning substance with contracts.296 The Risk and Re-characterisation Discussion Draft certainly seeks to widen the re-characterisation doctrine and expand the test of commercial rationality which underpins the existing test. This is likely to lead to more subjectivity, increase 289 

Risk and Re-characterisation Discussion Draft, n 275 above, pp 38–45. residual risks mainly related to information asymmetries between taxpayers and tax administrations and the relative ease with which taxpayers could allocate capital to low-tax entities with minimal functions. This capital could be invested in assets used within the MNE group, creating base eroding payments to the low-tax entities: ibid, p 38, para 3. 291  See Amanda Athanasiou, ‘Experts Disagree on Transfer Pricing Special Measures’, 2014 WTD 242-3 (17 December 2014). 292  The following special measures were set out: (1) special measures for hard-to-value intangibles; (2) dealing with a capital-rich, asset-owning company that depends on another group company to generate a return from the asset; (3) ‘thick capitalisation rule’ based on a pre-determined capital ratio; (4) special measures focusing on a level of functionality that, where lacking, would cause the profits of that entity to be reallocated; (5) ensuring appropriate taxation of excess returns. See Risk and Recharacterisation Discussion Draft, n 275 above, pp 41–45. 293  Mindy Herzfeld, ‘BEPS—Phase II’ (2015) 77 Tax Notes International 14(5 January 2015). 294 See David D Stewart, ‘OECD Risk and Recharacterization Draft Could Boost Controversy’, 2015 WTD 19-4 (29 January 2015), who notes that the Risk and Re-characterisation Discussion Draft diminishes the importance of capital as a driver of returns. 295  Richard Collier, ‘BEPS: New Thinking on Risk, Excess Capital and Recharacterisation’, Tax Journal, Issue 1246, p 20 (16 January 2015) pp 20–21. 296  See comments made by US expert in that companies are enquiring whether they need to move executives to the country of residence of the residual risk-taking entity. David D Stewart, ‘US Treasury Official Suggests Refined Message for OECD Risk Draft’, 2015 WTD 3104 (17 February, 2015). 290 These

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uncertainty and controversy, and potentially lead to more double taxation. It is feared that the breadth of the definition of fundamental economic attributes will give a lot of discretion to tax authorities to reclassify a transaction on grounds that another transaction would have resulted in more taxable income arising in the jurisdiction.297 The special measures introduced in the second part of the discussion draft may also cause uncertainty and make the system worse.298 There is very little guidance, with many open-ended questions for stakeholders to provide an input. The United States has indicated that it is not prepared to support the current version of the Risk and Re-characterisation Draft but it is ‘working hard to find consensus that could also resolve conflicts on related drafts’.299 It has been argued that the Risk and Re-characterisation Discussion Draft effectively proposes a new enhanced functional analysis to determine how value is generated by a multinational group as a whole, and each entity’s capabilities and contribution to value creation.300 The new analysis reflects the nature of the interdependencies of the functions performed by entities in a multinational group, how commercial activities are coordinated, and group synergies. It requires multinational groups to calculate which entity actually performs management activities. However, the fact that the Risk and Re-characterisation Discussion Draft fails to define value makes it difficult to determine its creation, especially in the context of a multinational group.301 Nevertheless, despite the OECD’s continued loyalty to the arm’s length standard for pricing transactions between related enterprises, the arm’s length standard that will emerge in the post-BEPS world is likely to be modified. Part of the challenge is that there is no well-established definition of what value creation means. Value creation is a vague term—what this entails, where it occurs and its valuation are difficult issues to be addressed. Without agreement on these, it is very difficult to find solutions. What broadly seem to emerge from the transfer pricing BEPS deliverables so far, are undeveloped suggestions and a series of vague concepts that add undue complexity to administration and compliance.302 In an interview with Tax Analysts on 22 January 2015, OECD representatives admitted that additional work was necessary in order for the proposals to

297  Amanda Athanasiou, ‘Definition of BEPS Fundamental Economic Attributes Too Broad, Practitioners Say’, 2015 WTD 34-3 (20 February 2015). 298  Amanda Athanasiou, ‘Experts Disagree on Transfer Pricing Special Measures’, n 291 above. 299  David D Stewart, ‘Breakthrough on BEPS Risk Draft Could Lead to Larger Consensus’, 2015 WTD 46-1 (10 March 2015). 300  See Margaret Burow, ‘OECD Draft Challenges Intragroup Risk Allocations’, 2015 WTD 21-9 (2 February 2015). She discussed comments made by Alan Shapiro of Deloitte Tohmatsu Tax Co during a Deloitte webcast on 30 January 2015. 301  Ibid. It was questioned whether sales revenue, income profits, competitive advantage, synergies, economic power, asset ownership, or other measures should be considered value. 302  Amanda Athanasiou and Lee Sheppard, ‘OECD’s Discussion Draft on Transfer Pricing Goes Beyond Arm’s Length’, 2014 WTD 245-7 (22 December 2014). For criticism, also see David Stewart, ‘ABA Meeting: U.S. Troubled by Aspects of OECD Risk Draft’, 2015 WTD 21-4 (2 February 2015); Margaret Burow, ‘OECD Draft Challenges Intragroup Risk Allocations’, n 300 above.

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­ roduce coherent and workable changes to the existing rules.303 It was ­important p to c­ oordinate the implications of the transfer pricing analysis with a more general legal analysis, such as the interpretation of contracts. It was argued that the discussion draft simply clarified transfer pricing best practices and made no radical changes to existing rules, nor was there a departure from the arm’s length standard. Although the importance of legal contracts in a transfer pricing analysis was arguably diminished by giving tax authorities more discretion to disregard them, the scope of this was played down in the interview. It was argued that the language of the Risk and Re-characterisation Discussion Draft simply emphasised that the legal contracts must be in line with the parties’ behaviour under those contracts to be an accurate reflection of how the parties actually operated. ‘The contracts definitely play a role … But paper reality is not what we are pricing. We are pricing the business reality of the transaction’.304 Contracts and conduct were both very important elements of looking at the actual transaction, and had to be seen together in the context of the commercial and financial relationships between the group members. A tenuous distinction between delineating a transaction and re-characterising it was made. Re-characterisation differed from accurately delineating the transaction and applied when the transaction had been accurately delineated and the analysis was factually correct, but the transaction did not seem to make economic sense. This has been criticised for ignoring the fact that a transfer pricing analysis allows for some variability in determining pricing. It also appears to provide tax authorities with extensive latitude to substitute their own interpretation of the facts for the taxpayer’s. There was limited approval of the Risk and Re-characterisation Discussion Draft from the BEPS Monitoring Group.305 This was because, although the discussion draft identified many of the difficulties caused by the separate entity principle which the Group had in the past heavily criticised, the discussion draft did not clearly articulate an alternative. The Group again expressed its support for the profit split method, regularised and systematised ‘by clarifying the methodology for defining the aggregate tax base to be split and specifying definite, concrete and easily determinable objective allocation keys for all commonly used business models’.306 The remaining items of the Action Plan are examined in the next chapter. There is also an overview of how the BEPS project affects developing countries, as well as their involvement in the consultation process.

303  Mindy Herzfeld, ‘Input Needed on Transfer Pricing Drafts’, 2015 WTD 21-2 (2 February 2015). The interview was with Marlies de Ruiter and Andrew Hickman of the OECD’s Centre for Tax Policy and Administration. See, also, Andrew Velarde, ‘BEPS Transfer Pricing Draft Struck Nerve, Official Says’, 2015 WTD 34-1 (20 February 2015). 304  Ibid. 305  See BEPS Monitoring Group, Comments on BEPS Actions 8, 9, and 10: Revisions to Chapter I of Transfer Pricing Guidelines (including Risk, Recharacterisation, and Special Measures). Available on: bepsmonitoringgroup.files.wordpress.com/2015/02/ap8-9-10-risk-special-measures.pdf. 306  Ibid, p 2.

4 Procedural Rules, Country-by-Country Reporting, Dispute Resolution, Multilateralism and Developing Countries: Actions 10–15 The previous chapters examined Action items 1 to 10 of the BEPS Action Plan. Most of the remaining items of the Action Plan considered in this chapter deal with procedural reforms, the most prominent one being Action 13, on countryby-country reporting and transfer pricing documentation. In Action 11, there is an attempt to establish methodologies to collect and analyse data and counteractions. Rules on disclosure of aggressive tax planning arrangements are reviewed in Action 12. Suggestions to make dispute resolution more effective and to develop multilateral instruments are the final Action items, Actions 14 and 15, considered in this chapter. The chapter concludes with a brief review of the role of developing countries in the consultation and decision-making processes of the BEPS project and the overall impact that the project may have had on them.

4.1.  Action 11: Establish Methodologies to Collect and Analyse Data on BEPS and the Actions to Address it Action 11 mandates as follows: Develop recommendations regarding indicators of the scale and economic impact of BEPS and ensure that tools are available to monitor and evaluate the effectiveness and economic impact of the actions taken to address BEPS on an ongoing basis. This will involve developing an economic analysis of the scale and impact of BEPS (including spillover effects across countries) and actions to address it. The work will also involve assessing a range of existing data sources, identifying new types of data that should be collected, and developing methodologies based on both aggregate (e.g. FDI and balance

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of payments data) and micro-level data (e.g. from financial statements and tax returns), taking into consideration the need to respect taxpayer confidentiality and the administrative costs for tax administrations and businesses.

In the summer of 2014, a short briefing paper was published by the OECD on Action 11, which summarised the issues on which it requested input from ­stakeholders.1 There were four categories. First, recommendations were sought on indicators of the scale and economic impact of BEPS, including identifying and assessing a range of existing data sources. Secondly, recommendations were also sought on the development of an economic analysis of the scale and impact of BEPS (including spillover effects across countries) including developing methodologies based on both aggregate and micro-level data. Furthermore, the OECD asked for recommendations on how to develop an economic analysis of the effectiveness and impact of actions to address BEPS. Lastly, there was an enquiry as to the necessary tools to monitor and evaluate the effectiveness and economic impact of the actions taken to address BEPS on an ongoing basis, including identifying and assessing new types of data needed for the tools.2 On 7 October 2014, the OECD published the comments received on Action 11. Compared to other Action items, few inputs were provided, including responses from two governments such as China and Costa Rica and the BEPS Monitoring Group. The topic was considered rather academic. It was suggested that there should be another opportunity to comment when the OECD set forth proposed BEPS metrics in a future consultation document.3 The BEPS Monitoring Group argued that the main problem was the lack of suitable data and problems of access to such data when they do exist.4 Efforts to quantify the scale and impact of BEPS, and hence the effects of anti-BEPS measures, could only be properly explored if researchers all over the world and the public at large had access to suitable data. Furthermore, it was argued that all existing data sources had critical shortcomings, mainly because of the limited number of countries they covered or the limited amount of detail they provided. The BEPS Monitoring Group emphasised that the data generated by the country-by-country reporting of multinational enterprises should become publicly available to enable research on BEPS.

1 OECD, Request for input—BEPS Action 11: Establish methodologies to collect and analyse data on BEPS and the actions to address it. Available on: www.oecd.org/ctp/public-request-for-input-bepsaction-11.pdf. 2  Ibid, para 5. 3 See PwC commentary, available on: www.pwc.com/gx/en/tax/tax-policy-administration/beps/ data-and-methodologies.jhtml. 4  BEPS Monitoring Group, Action 11: Establishing Methodologies to Collect and Analyse Data on BEPS and the Actions to Address It. Available on: bepsmonitoringgroup.wordpress.com/the-oecd-bepsaction-plan/.

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On 16 April 2015, the OECD released its discussion draft on improving the analysis of BEPS.5 This set out the context and background to the work on Action 11, and included three chapters that focused on key areas. In chapter 1, there was an assessment of existing data sources relevant for BEPS analysis, describing the available data and their limitations for measuring the scale and impact of BEPS and BEPS countermeasures. The data included macroeconomic sources (eg national accounts, balance of payments and foreign direct investment) as well as microeconomic sources (eg corporate income tax return information, customs data and company financial information). This chapter concluded that the significant limitations of existing data sources meant that, at present, attempts to construct indicators or undertake an economic analysis were severely constrained and, as such, should be heavily qualified. Chapter 2 considered potential indicators of the scale and economic impact of BEPS and their various strengths and limitations. While there was a large and growing body of evidence of the existence of BEPS, through empirical analysis and specific information that had emerged from numerous legislative and parliamentary enquiries, the scale of BEPS and changes over time were difficult to measure. It was suggested to have a dashboard of indicators because no single indicator could present a snapshot of the existence and scale of BEPS.6 This chapter outlined a number of potential indicators that might assist in tracking the scale and economic impact of BEPS over time. These could only provide ‘general indications’ and the interpretation of any such indicators had to be heavily qualified by numerous caveats. In chapter 3, there was a consideration of existing empirical analyses of BEPS. Two complementary approaches to estimating the scale of BEPS were proposed as alternatives. One approach was to estimate an overall revenue effect of BEPS by extrapolating from studies of profit shifting using the estimated tax responsiveness of shifted financial profit to tax rate differentials (the aggregate tax rate differential approach). Another approach was to estimate the revenue effects by reference to the individual BEPS channels focusing on Actions 2 to 10 (the specific BEPS channels approach). Both approaches had advantages and disadvantages, and could be drawn upon as part of the economic analysis to be undertaken under Action 11. Overall, the options included in this discussion draft did not represent conclusions on the assessments or proposed measures, but were intended to provide

5  See OECD, ‘BEPS Action 11, Improving the Analysis of BEPS’, available on: www.oecd.org/ctp/ tax-policy/discussion-draft-action-11-data-analysis.pdf. For commentary, see PwC analysis of the ­discussion draft, reported by Tax Analysts, 2015 WTD 77-25 (21 April 2015). 6  The seven potential indicators were the following: concentration of high levels of net foreign direct investment (FDI) relative to GDP; differential profit rates compared to effective tax rates; differential profit rates between low-tax locations and worldwide MNE operations; domestic vs foreign profit rate differentials; differential profit rates between MNE group domestic and foreign operations; differential effective tax rates between MNE affiliates and comparable domestic firms; concentration of high levels of royalty payments received relative to R&D spending; interest expense to income ratios of MNE affiliates in high-tax locations: see para 78 et seq of Action 11 discussion draft, n 4 above.

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stakeholders with substantive options for analysis and comment. The discussion draft identified specific questions where input was required in order to advance the work on Action 11. This discussion draft was met with mixed reactions. Some praised the OECD for tackling a difficult topic and others criticised it for not addressing the topic more thoroughly before launching the BEPS project in 2013.7 It was generally ­recognised that the OECD’s task in this Action item was incredibly challenging. It was readily conceded that economists do not ‘always agree on fundamental questions such as what activities generate profits and how to distinguish between the artificial and natural separation of profits from activities’.8 How legal rules could be fairly devised to address these issues when there is a wider underlying disagreement by economists is highly questionable. Arguably, there should have been an attempt to quantify the size and scale of BEPS first before devoting so many resources into solving it.9 Another criticism was that the discussion draft focused mainly on measuring BEPS for MNEs. The same approach may not work on small and medium-sized enterprises. Furthermore, the inherently difficult task of obtaining data for purely tax-driven structures was mentioned. It was recommended that there should be a broader review of the effects of BEPS on economic growth to determine the actual impact of BEPS actions—ie whether they are improving or worsening economic welfare. A broader assessment should also take into account compliance and administrative costs as well as possible unintended consequences of the BEPS project, such as the increased risk of double taxation and of companies moving people and assets into tax havens in response to BEPS rules that align profits with tangible activities.10

4.2.  Action 12: Require Taxpayers to Disclose their Aggressive Tax Planning Arrangements Action 12 reads as follows: Develop recommendations regarding the design of mandatory disclosure rules for aggressive or abusive transactions, arrangements, or structures, taking into consideration the administrative costs for tax administrations and businesses and drawing on experiences of the increasing number of countries that have such rules. The work will use a modular design allowing for maximum consistency but allowing for country s­ pecific needs and

7  See Stephanie Soong Johnston, ‘OECD Draft on Measuring BEPS Receives Mixed Reactions’, 2015 WTD 78-2 (23 April 2015). 8 Ibid. 9  Ibid, see comments by Heather Self. 10  Ibid, see comments by Peter Merill.

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risks. One focus will be international tax schemes, where the work will explore using a wide definition of ‘tax benefit’ in order to capture such transactions. The work will be co-ordinated with the work on co-operative compliance. It will also involve designing and putting in place enhanced models of information sharing for international tax schemes between tax administrations.

In this Action item, the OECD attempts to examine the usefulness of disclosure initiatives in addressing the lack of comprehensive and relevant information on tax planning strategies available to tax authorities. The Mandatory Disclosure Discussion Document11 was published by the OECD on 30 March 2015. It provided an overview of mandatory disclosure regimes, based on the experiences of countries that had such regimes, and set out recommendations for a modular design of a mandatory disclosure regime, including recommendations on rules designed to capture international tax schemes. The design recommendations would take into account the role played by other compliance and disclosure initiatives such as the initiative on co-operative compliance.12 Both initiatives were intended to improve transparency, risk assessment and ultimately taxpayer compliance, although co-operative compliance programmes often focused on the largest corporate taxpayers. It was argued that mandatory disclosure could reinforce the effectiveness of a co-operative compliance regime by ensuring that there was a level playing field in terms of the disclosure and tax transparency required from all taxpayers.13 The Mandatory Disclosure Discussion Draft sought to set out a standard framework for a mandatory disclosure regime that would ensure consistency while providing sufficient flexibility to deal with country-specific risks, allowing tax administrations to control the quantity and type of disclosure. Following the introduction, there was an overview of the key features of a mandatory disclosure regime and a consideration of its interaction with other disclosure initiatives and compliance tools. In the next chapter, the framework and features for the modular design of a mandatory disclosure regime were set out. It was noted that there were other disclosure and information exchange initiatives being considered in the Action Plan, such as country-by-country reporting under Action 13 and the work on spontaneous exchange of rulings as part of the work on Action 5. Also, the Forum on Tax Administration was developing a framework for cooperation between tax administrations. Recommendations for the design of enhanced models of information sharing would need to take into account the outcome of these initiatives and developments.

11 OECD, BEPS Action 12: Mandatory Disclosure Rules. Available on: www.oecd.org/ctp/aggressive/ discussion-draft-action-12-mandatory-disclosure-rules.pdf. 12  See, for example, reports listed in paras 8–9: Study into the role of Tax Intermediaries (OECD, 2008); Tackling Aggressive Tax Planning through Improved Transparency and Disclosure (OECD, 2011); Co-operative Compliance: A Framework—From Enhanced Relationship to Co-Operative Compliance (OECD, 2013). 13  Mandatory Disclosure Discussion Draft, n 11 above, para 10.

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The objectives of existing different mandatory disclosure rules were ­summarised as follows: to obtain early information about tax avoidance schemes in order to inform risk assessment; to identify schemes, and the users and promoters of schemes in a timely manner; and to act as a deterrent, to reduce the promotion and use of avoidance schemes.14 There were a number of key design principles. First, mandatory disclosure rules should be clear and easy to understand. Secondly, mandatory disclosure rules should balance additional compliance costs to taxpayers with the benefits obtained by the tax administration. Thirdly, mandatory disclosure rules should be effective in achieving the intended policy objectives and accurately identify relevant schemes. Fourthly, information collected under mandatory disclosure should be used effectively.15 It was emphasised that the design of a mandatory disclosure regime had to be flexible to the needs and risks of countries—that is why a modular approach was preferred. It was noted that existing mandatory disclosure regimes could be described as falling into two basic categories: a transaction-based approach and a promoter-based approach. The transaction-based approach, adopted by the US, first identified transactions that the tax administration considered as giving rise to tax revenue or policy risks (a reportable scheme) and then required disclosure from taxpayers who derived a tax benefit from it, and any person who provided material assistance in relation to that reportable scheme. The promoter-based approach had a greater focus on the role played by promoters of tax planning schemes but it also considered what types of reportable scheme promoters and taxpayers were required to disclose.16 In reality, the distinction between transaction and promoter-based approaches may not be that significant, because none of the existing mandatory disclosure regimes followed a purely transaction or promoter-based approach.17 While acknowledging the differences between regimes, the design recommendations in the Mandatory Disclosure Discussion Draft were based on the core features common to all these regimes.18 Certain important design features had to be considered for either approach, such as who reports, what information they report and when. The question of ‘who has to report’ was reviewed first.19 Two options were considered: either both the promoter and the taxpayer have the obligation to disclose separately or, either the promoter or the taxpayer has the obligation to disclose.20 Countries had to decide whether or not they would introduce a dual reporting requirement that applied to the promoter and taxpayer, or whether they would 14 

Ibid, para 16. Ibid, paras 19–24. 16  Ibid, para 57. 17  Ibid, para 59. 18  Ibid, para 60. 19  Ibid, para 61–75. 20  Ibid, para 76. 15 

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introduce a reporting obligation that falls primarily on the promoter.21 Where the primary reporting obligation fell on the promoter, it was recommended that the reporting obligation would switch to the taxpayer where the promoter was offshore, or where there was no promoter or the promoter asserted legal professional privilege. Countries were free to introduce their own definition of promoter or advisor but some guidelines were given.22 As for the question of ‘what has to be reported’, countries could adopt a singlestep approach or a multi-step or threshold approach in defining the scope of a disclosure regime.23 A de minimis filter was also considered as an alternative to, or in addition to, a broader threshold test and could operate to remove smaller transactions, below a certain amount. This would narrow the ambit of the mandatory disclosure regime and reduce the risk of over-disclosure.24 The Mandatory Discussion Draft analysed the concept of the hallmark as a tool to identify the features of schemes that tax administrations were interested in. There could be both generic and specific hallmarks. Generic hallmarks would target features that were common to promoted schemes, such as the requirement for confidentiality or the payment of a premium fee. Generic hallmarks would be used to capture new and innovative tax planning arrangements that might be easily replicated and sold to a variety of taxpayers. Specific hallmarks would be used to target known vulnerabilities in the tax system and techniques that were commonly used in tax avoidance arrangements such as the use of losses.25 Generic hallmarks might increase the amount of reportable transactions and as a corollary taxpayer costs. By contrast, specific hallmarks or listed transactions would allow tax administrations to target known or common areas of risk and provide flexibility in terms of enabling a tax administration to strike a balance between costs and capacity issues.26 In introducing mandatory disclosure regimes, countries had the option to use either a single-step approach or a multi-step/threshold approach. It was, however, recommended that mandatory disclosure regimes should include a mixture of generic and specific hallmarks.27 Countries could choose whether or not to adopt a hypothetical approach or adopt purely factual objectives tests.28 When a scheme or transaction triggered one hallmark, that should be sufficient to require disclosure.29

21 

Ibid. Ibid, para 77 referring to principles set out in para 71. 23  Ibid, paras 78–86. 24  Ibid, paras 87–90. 25  See paras 91–92 et seq. 26  Ibid, para 132–33. 27  Ibid, para 135. It was noted that generic hallmarks should include a confidentiality and premium/ contingent fee hallmark. A country may also want to adopt additional generic hallmarks such as the one applying to standardised tax products. 28  Ibid, para 136. 29  Ibid, para 137. 22 

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As for the question of ‘when information should be reported’, there were two suggested options. There could be a timeframe linked to the availability of a scheme or a timeframe linked to its implementation.30 It was recommended that where the promoter had the obligation to disclose, then the timeframe for disclosure should be linked to the availability of the scheme. A short timescale for reporting a scheme was recommended.31 Where a taxpayer had the obligation to disclose it was recommended that the disclosure should be triggered by the implementation rather than the availability of a scheme.32 As far as the consequences of compliance and non-compliance with the reporting requirements, it was recommended that countries should be explicit in their domestic law about the consequences of reporting a scheme or transaction under a disclosure regime ie that this does not imply acceptance of the scheme or its purported benefits. Furthermore, in order to enforce compliance with mandatory disclosure rules, countries should introduce financial penalties that would apply if there was failure to comply with any of the obligations introduced. Countries were free to introduce penalty provisions (including non-monetary penalties) aligned with their general domestic law provisions.33 Thereafter, there was a comprehensive analysis of procedural and tax administration matters. Recommendations were made as to what information tax administrations should require a promoter or taxpayer to disclose.34 As for international tax schemes, changes to the design of a disclosure regime were recommended in order to better target cross-border tax planning. Inter alia, hallmarks should be developed which focus on the specific risks posed by crossborder tax planning but which are wide enough to capture different and innovative tax planning techniques (cross-border outcomes). There should be a broad definition of arrangement that would treat any arrangement involving a domestic taxpayer as a reportable scheme where that arrangement included a cross-border outcome (regardless of the jurisdiction where that outcome arose). Threshold conditions may need to be removed. There was a comprehensive review of the suggestions in chapter IV of the Mandatory Disclosure Discussion Draft.35 The final work on Action 12 was to be completed by September 2015. Interested parties were invited to send comments on this discussion draft. 30 

Ibid, para 140. Ibid, para 156. 32  Ibid, para 157. If only the taxpayer disclosed (ie because there was no promoter or the promoter was offshore) the timescale for reporting was recommended to be short to maximise the tax administration’s ability to act against a scheme quickly. 33  Ibid, paras 174–200. 34  Ibid, paras 220–222. It was recommended that the information should include: the identification of promoters and scheme users; the details of the provisions that make the scheme reportable; a description of the arrangements and the name by which they are known (if any); details of the statutory provisions on which the tax advantage was based; a description of the tax benefit or advantage; a list of clients (promoter only) where domestic law allows it, and the amount of expected tax benefit. In addition, any mandatory disclosure provisions would need to be supported by information powers necessary to enable a tax administration to enquire into the reasons for a failure to disclose, or enquire into the identity of promoters and intermediaries or request follow-up information etc. 35  Ibid, paras 223–74. 31 

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It has been argued that an effort should be made so that mandatory d ­ isclosure rules do not just focus on small and medium-sized enterprises and wealthy individuals, but also cover MNEs. Existing domestic rules tend to target ­standard schemes which are widely marketed by promoters, whereas MNEs generally use arrangements tailored to their specific needs, even if based on standard techniques. The BEPS Monitoring Group gave as an example the tax clearances arranged by PwC in Luxembourg over a period of eight years for 343 MNEs that were not notified under the UK’s disclosure regime.36 The Group has urged for any disclosure rules to be adapted to international corporate tax avoidance and to include hallmarks to that effect. ‘Like all methods of improving compliance, mandatory disclosure must balance deterrence with cooperation. However, there should be safeguards against the pitfalls experienced by some forms of “cooperative compliance”, which have led to public concerns about “sweetheart deals”’.37 Provisions for access to information derived from notification by a wide range of other tax authorities, and standards for reporting to the public of information and data from disclosure arrangements would help.38 Such measures would not only improve transparency but also facilitate the independent evaluation of the effects of mandatory ­disclosure schemes.

4.3.  Action 13: Re-Examine Transfer Pricing Documentation Under Action 13 of the Action Plan, the OECD is to: Develop rules regarding transfer pricing documentation to enhance transparency for tax administration, taking into account the compliance costs for business. The rules to be developed [would] include a requirement that MNEs provide all relevant governments with needed information on their global allocation of the income, economic activity and taxes paid among countries according to a common template.

In January 2014, the OECD released a discussion draft on a proposed template for country-by-country reporting to tax authorities—the CbC Discussion Draft.39 This elaborated on the OECD’s White Paper on Transfer Pricing Documentation40 which had been released on 30 July 2013. The CbC Discussion Draft contained an initial draft of the revised guidance on transfer pricing documentation and

36  BEPS Monitoring Group, Comments on BEPS Action 12: Mandatory Disclosure Rules, available on: bepsmonitoringgroup.files.wordpress.com/2015/05/ap12-mandatory-disclosure-rules.pdf. 37  Ibid, p 1. 38  Ibid. 39 OECD, Discussion Draft on Transfer Pricing Documentation and CbC Reporting (30 January 2014). Available on: www.oecd.org/ctp/transfer-pricing/discussion-draft-transfer-pricing-documentation. pdf. 40 OECD, White Paper on Transfer Pricing Documentation. Available on: www.oecd.org/ctp/transferpricing/white-paper-transfer-pricing-documentation.pdf.

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country-by-country reporting, and was intended to replace Chapter V of the existing OECD Transfer Pricing Guidelines. As reflected in earlier proposals, the OECD followed a two-tier approach that would involve a global master file, together with local country files. In the CbC Discussion Draft, it was proposed that the master file should include comprehensive information about the global operations of an MNE and should contain standardised information relevant to all MNE group members.41 Although the country-by-country data required in the master file may be helpful for risk assessment processes, nevertheless, such information should not be used as a substitute for a detailed transfer pricing analysis of individual transactions and prices.42 The local country files would include transactional information relevant to each country. As a result, MNEs would be required to provide extensive information for each entity in the group. The information required in the local file would supplement the master file and would be relevant to the transfer pricing a­ nalysis. Such information would include relevant financial information, a comparability analysis and the selection and application of the most appropriate transfer pricing method.43 Although the CbC Discussion Draft provided for the countryby-­country template to be included in the master file, it sought stakeholders’ comments on whether the template should instead be provided to tax authorities as a separate document.44 In the CbC Discussion Draft it was recommended that transfer pricing documentation requirements should include specific materiality thresholds.45 Also, the documentation ought to be periodically reviewed, probably annually, in order to determine whether functional and economic analyses are still accurate and relevant and to confirm the validity of the applied transfer pricing methodology.46 As a general matter, the CbC Discussion Draft recommended that the master file should be prepared and submitted to all tax administrations in English. However, it was noted that transfer pricing documentation must be useful to local country tax administrations seeking to undertake a risk assessment, so at least the

41  As stated in paragraph 19 of the CbC Discussion Draft, n 39 above, the information required in the master file would provide a ‘blueprint’ of the MNE group and contain relevant information that can be grouped in five categories: (a) the MNE group’s organisational structure; (b) a description of the MNE’s business or businesses; (c) the MNE’s intangibles; (d) the MNE’s intercompany financial activities; and (e) the MNE’s financial and tax positions. See, also, suggested template in Annex I. 42  CbC Discussion Draft, n 39 above, para 21. 43  See para 23 and the suggested template in Annex II of the CbC Discussion Draft, n 39 above. 44  Ibid, para 20. 45  Ibid, para 29. These materiality requirements should take into account the size and nature of the local economy, the importance of the MNE group in that economy, and the size and nature of local operating entities, in addition to the overall size and nature of the MNE group. 46  Ibid, para 33. In order to simplify the compliance burden, it was suggested that when operating conditions remain unchanged, the searches in databases for comparables supporting part of the local file should be updated every three years rather than annually. However, financial data for the comparables should nonetheless be updated every year. See para 34 in CbC Discussion Draft, n 39 above.

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local file should be prepared in the relevant local language.47 The use of penalties for non-compliance was also recommended,48 as well as compliance incentives such as penalty protection or a shift in the burden of proof.49 As far as confidentiality was concerned, tax administrations were encouraged to ensure that there was no public disclosure of trade secrets, scientific secrets, or other confidential information. Tax administrations were also encouraged to use discretion in requesting this type of information and to assure taxpayers that the information presented in the documentation would remain confidential.50 ­Transfer pricing documentation requirements were features of local law and should continue to be so. Therefore, in order to implement the recommended two-tiered approach, countries would have to modify their domestic laws in line with these recommendations51 to adopt consistent and uniform formats.52 Comments were requested regarding the most appropriate mechanism for making the master file and country-by-country reporting template available to relevant tax administrations.53 Possibilities included the direct local filing of information by MNE group members subject to tax in the jurisdiction, or the filing of information in the parent company’s jurisdiction and the sharing of it under treaty information exchange provisions or some combination of the above. During the consultation period,54 the CbC Discussion Draft was criticised in that it would generate compliance costs and that the reporting standards went beyond what governments needed for transfer pricing risk assessment. The business community complained about the enormous quantity of data requested. It was argued that much of the data requested was not relevant to a transfer pricing analysis based on the arm’s length standard. Moreover, it was feared that by providing local tax administrations with all this data, it would ‘lead to individual tax authorities applying a formulary apportionment standard, rather than the arm’s-length standard’.55 It was recommended that the country report be limited to high-level data only, which was required to establish the footprint of an MNE.56 47 

Ibid, para 35. Ibid, paras 36–40. 49  Ibid, para 40. Also see para 38, where countries were discouraged from imposing sizeable documentation­-related penalties on taxpayers that made a reasonable effort, in good faith, to demonstrate through reliable documentation that their controlled transactions satisfy the arm’s length principle. 50  Ibid, para 41. 51  Ibid, para 44. 52  Ibid, para 45. 53  Ibid. 54  See, generally, comments received on the CbC Discussion Draft, published by the OECD. ­Available on: www.oecd.org/ctp/transfer-pricing/comments-discussion-draft-transfer-pricing-­documentation. htm. 55 Lee A Sheppard, ‘OECD BEPS Country-by-Country Reporting Is Too Burdensome, HMRC Official Says’, 2014 WTD 28-1 (11 February 2014). Also see Mindy Herzfeld, ‘Country-by-Country Reporting—Drawing the Battle Lines’, 2014 WTD 46-2 (10 March 2014); Mindy Herzfeld, ‘Countryby-Country Reporting—The Debate Rages on’, 2014 WTD 101-2 (27 May 2014). 56  Margaret Burow, ‘Stakeholders Find Common Ground on OECD Country-By-Country Reporting Draft’, Tax Analysts, 2014 WTD 51-3 (17 March 2014). 48 

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In addition, most of the business community were in favour of a ­materiality ­threshold but stressed the importance of a clear definition of materiality. It was also suggested that for some EU headquartered MNEs, the compliance burden was exacerbated by the differences between the EU transfer pricing standards and the OECD standards.57 Confidentiality was also a concern, if the master file and the country-by-­ country reporting template were to be shared with a local tax authority. This was because some tax authorities have no confidentiality provisions under their local laws, or under tax treaties, if there are any. Some of the data in the country-bycountry template might be sensitive and as such its disclosure ought to be limited, protected and monitored. The preference by multinationals was for this type of information to be shared under the exchange of information provisions of treaty networks. It was argued by many that the best place to file the master file and country-by-­country template was with the home taxing authority and should only be shared through the exchange of information provisions.58 Businesses also showed concerns as to how the contents of the country-by-country report would be used and how disputes would be resolved to avoid multiple layers of taxation.59 By contrast, several advocacy groups and NGOs argued that the OECD did not go far enough in mandating disclosure of information that would reduce crossborder tax evasion.60 There was preference for a general disclosure standard for all large transnational corporations.61 Confidentiality ought to be restricted only to information crucial for business operations and success. It was even argued that it should be made as easy as possible for local tax authorities to obtain access to information and for the information provided to be allowed to be used for purposes other than income tax reporting.62 China also advocated direct filing to countries as the preferred alternative.63 In March 2014, it was revealed that to ease the compliance burden, the OECD would change the proposed country-by-country reporting template to require aggregate country-wide reporting instead of entity-by-entity reporting.64

57  Herzfeld, ‘Country-by-Country Reporting—Drawing the Battle Lines’, n 55 above. On the EU standards, see section 6.7 in Ch 6 of this volume. 58  Ibid. Also see Dana Glenn, ‘Costs and Confidentiality Are Biggest Concerns With OECD Discussion Draft, Practitioners Say’, 2014 WTD 32-2 (18 February 2014). 59  Margaret Burow, ‘Dispute Resolution Tops Business Community’s Concerns with Country-ByCountry Reporting’, Tax Analysts, 2014 WTD 108-7 (5 June 2014). 60  Herzfeld, ‘Country-by-Country Reporting—Drawing the Battle Lines’, n 55 above. 61  See, for example, comments of the BEPS Monitoring Group, Response to OECD Discussion Draft on Transfer Pricing and Documentation and Country-by-Country Reporting, pp 1–2. Available on: ­bepsmonitoringgroup.files.wordpress.com/2014/03/bmg-cbc-response1.pdf. 62  Also see comments from Christian Aid and Oxfam, reported in Tax Analysts, respectively, by ­Herzfeld, ‘Country-by-Country Reporting—Drawing the Battle Lines’, n 55 above and Stephanie Soong Johnston, ‘Stakeholders Lock Horns Over Execution of OECD’s CbC Reporting Proposal’, 2014 WTD 97-3 (20 May 2014). 63  Herzfeld, ‘Country-by-Country Reporting—The Debate Rages on’, n 55 above. 64  William R Davis, ‘Changes Coming to OECD Country-by-Country Reporting Template’, 2014 WTD 62-1 (1 April 2014).

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­ urthermore, in May 2014, the OECD held a public consultation which helped F address some of the concerns of various stakeholders. It was reported65 that taxpayers would be given flexibility in the sources of data they can use in preparing the recommended transfer pricing documentation. The amount of information requested by the templates would be reduced, and small and medium-sized enterprises would be excluded from the more burdensome filing requirements. Information would be requested only on a consolidated basis by country66 and the master file and country-by-­country report would be kept separately. All other issues remained unresolved.67 What was certain was that the evolution of the process of developing reporting requirements and mechanisms was perceived to be critical to advancing the BEPS project.68 While it might also benefit transfer pricing practitioners and tax ­administrators,69 there were doubts as to whether in fact country-by-country reporting would discourage MNEs from profit shifting.70 There were also concerns that the costs of country-by-country reporting would exceed the benefits. In fact, country-by-country reporting could become particularly expensive if it was based on a new set of reporting rules very different from existing financial and tax accounting rules and if companies considered it necessary to justify and explain extensively their reports to the public.71 With hindsight of the comments received, in its subsequent report released on 16 September 2014 (the CbC Revised Discussion Draft),72 the OECD moved from a two-tier to a three-tier approach. The three-tier approach comprised a master file, a local file, and a separate country-by-country template that had been proposed

65  It was reported that the OECD released confidential copies of a revised draft on Action 13 in advance of the 19 May 2014 public consultation. See Margaret Burow, ‘Tax Analysts Exclusive: Revised Transfer Pricing Discussion Draft Kept under Wraps’, 2014 WTD 103-1 (29 May 2014). 66  As noted by Burow, there was a new paragraph in the revised draft stating that taxpayers would have the option to prepare the master file either for the MNE group as a whole or by line of business or product group, depending on which presentation would provide the most relevant transfer pricing information to tax administrators. Burow, ‘Tax Analysts Exclusive: Revised Transfer Pricing Discussion Draft Kept under Wraps’, n 65 above. 67  Regarding the issue of the language for the local file, see Amanda Athanasiou, ‘Language for Local File Lost in Translation at Consultation on Transfer Pricing Discussion Draft’, 2014 WTD 101-1 (27 May 2014). 68  Marie Sapirie, ‘A Preview of Country-by-Country Reporting’, 2013 WTD 203-2 (21 October 2013). 69 Mindy Herzfeld, ‘An Alternative View of Country-by-Country Reporting’, 2014 WTD 76-3 (21 April 2014). 70  Maria Theresia Evers, Ina Meier and Christoph Spengel, ‘Transparency in Financial Reporting: Is Country-by-Country Reporting Suitable To Combat International Profit Shifting?’ (2014) 68 Bulletin for International Taxation 296. 71  Ibid, citing Michael Devereux, Transparency in Reporting Financial Data by Multinational Corporations, Project Report, Oxford University Centre for Business Taxation, p 24 et seq (2011). 72 See OECD, Guidance on Transfer Pricing Documentation and Country-by-Country Reporting (2014). Available on: www.oecd.org/tax/guidance-on-transfer-pricing-documentation-and-countryby-country-reporting-9789264219236-en.htm. For commentary, see inter alia, Andrew Casley, Kevin Norton and Michael Krhoda, ‘The OECD’s New Transfer Pricing Documentation Standard: An Overview and Possible UK Implementation’ (2015) 22 International Transfer Pricing Journal 3–10.

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in the OECD’s earlier work on this topic. The country-by-country information was to be reported to tax authorities at a very high level and for risk assessment only. The amount of information being requested for risk assessment purposes was significantly curtailed and the standards for transfer pricing documentation were revised under the CbC Revised Discussion Draft. MNEs would be required to file a master file containing a high-level overview of their global operations and transfer pricing policies. This would be available to all relevant country tax administrations.73 It is obvious that the OECD steered the master file towards being a high-level general document. There would also be a local file which provides detailed information concerning specific intercompany transactions. The requirements of the local file have also been refined. The local file would focus ‘on information relevant to the transfer pricing analysis related to transactions taking place between a local country affiliate and associated enterprises in different countries and which are material in the context of the local country’s tax system’.74 In determining what transactions would need to be part of the local file, tax jurisdictions had to draft materiality standards that were objective, commonly understood and accepted in commercial practice. The description of the local file requirements was refined. The detailed data requirements for each ‘material category of controlled transactions’ of the local entity now required, inter alia, copies of material intercompany agreements, copies of advance pricing agreements and other tax rulings to which the local tax authority was not a party, an indication of the most appropriate transfer pricing method with regard to the category of transaction, a summary of the important assumptions made in applying the transfer pricing methodology, etc.75 The country-by-country report would be based on a common template and would give all countries a broad picture of how a company operated. It required aggregate tax jurisdiction-wide information on the global allocation of the MNE’s income, taxes paid, and certain indicators of the location of economic activity within the MNE group. It also required MNEs to report their total employment capital, retained earnings and tangible assets in each tax jurisdiction. Furthermore, MNEs had to identify each entity within the group doing business in a tax jurisdiction and to provide an indication of the business activities each entity was engaged in.76 It was expressly stated that the country-by-country report would be used as a high-level risk assessment tool and not as the basis to propose transfer

73  See paras 18–21 of new Chapter V of OECD Transfer Pricing Guidelines, set out in the CbC Revised Discussion Draft, n 72 above. 74  Ibid, para 22 of new Chapter V of OECD Transfer Pricing Guidelines. 75  See Annex II to Chapter V Transfer pricing documentation—Local file, set out in p 31 et seq in the CbC Revised Discussion Draft, n 72 above. 76  Ibid, paras 24–26 of new Chapter V of OECD Transfer Pricing Guidelines.

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­ ricing adjustments using a global formulary apportionment of income.77 Tax p ­administrations should also take reasonable steps to ensure that the information was not released to the public.78 Arguably, the final version of the template was designed to highlight those lowtax jurisdictions where a significant amount of income was allocated, without some ‘proportionate’ presence of employees.79 There was likely to be increased pressure to ensure that profit allocations to a particular jurisdiction were supported by the location in that state of sufficient and appropriately qualified employees, making a substantial contribution to the creation and development of intangibles.80 Also, transfer pricing documentation was to be submitted to tax administrations in the language established under local laws, but tax jurisdictions were encouraged to permit filing in commonly used languages if this did not compromise the usefulness of the documents.81 Where tax administrations believed that translation of documents was necessary, they should make specific requests for translation and provide sufficient time to make such translation as comfortable a burden as possible.82 It was uncertain and open for discussion how the master file and country-bycountry report, once prepared, would be shared among participating country tax authorities. Concerns had already been noted about the confidentiality of the data. The CbC Revised Discussion Draft stipulated that tax administrations should take all reasonable steps to ensure that there was no public disclosure of confidential information and other commercially sensitive information contained in the documentation package. Tax administrations should also assure taxpayers that the information presented in transfer pricing documentation would remain c­ onfidential.83 This stipulation was in rather vague terms and did not meet the concerns of stakeholders for more certainty. The CbC Revised Discussion Draft referred to the OECD Guide ‘Keeping It Safe’ on the protection of ­confidentiality.84 This contained useful guidelines which were more suitable to bilateral scenarios and not necessarily tailored to the multi-jurisdictional r­ eporting context envisaged in the CbC Revised Discussion Draft. There were indications that ­information would 77  Ibid, para 25 of new Chapter V of OECD Transfer Pricing Guidelines. For a discussion of the concerns that the information provided under country-by-country reporting might lead to formulary apportionment see Maria Amparo Grau Ruiz, ‘Country-by-Country Reporting: The Primary Concerns Raised by a Dynamic Approach’ (2014) 68 Bulletin for International Taxation 557–66. 78  See paras 18–21 of new Chapter V of OECD Transfer Pricing Guidelines, set out in the CbC Revised Discussion Draft, n 72 above. 79  Richard Collier and Philip Greenfield, ‘Thoughtful commentary—by tax experts, for tax experts’, Tax Journal, Issue 1232, p 8 (26 September 2014) pp 10–11. 80  Ibid. 81  See CbC Revised Discussion Draft, n 72 above, para 29. 82  Ibid, para 39. 83  Ibid, para 44. Where disclosure was required in public judicial decisions, every effort should be made to ensure that confidentiality would be maintained and that information would be disclosed only to the extent needed. 84  Ibid, para 45. The OECD Guide ‘Keeping It Safe’ is available on: www.oecd.org/ctp/exchange-oftax-information/keeping-it-safe-report.pdf.

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only be exchanged pursuant to treaty or tax information exchange ­agreement provisions.85 The above new guidelines were to be reviewed before the end of 2020 to determine their effectiveness and whether to add transactional reporting of payments of interest, royalties and service fees between associated enterprises. This was something requested by Argentina, Brazil, China, India, South Africa, Turkey and other emerging economies. On 6 February 2015, the OECD released a follow-up report on Action 13 (the CBC Follow-Up Discussion Draft), which provided some much-anticipated guidance on the implementation of country-by-country reporting.86 It dealt with the following four issues: (i) the timing of preparation and filing of the country-bycountry report; (ii) which MNE groups should be required to file the countryby-country report; (iii) the necessary conditions underpinning the obtaining and the use of the country-by-country report by jurisdictions; and (iv) the framework for government-to-government mechanisms to exchange country-by-country reports, together with the work plan for developing an implementation package.87 As regards filing, periods within the scope of country-by-country reporting would be those beginning on or after 1 January 2016. As companies would have 12 months to file the report, the first filings would be due by 31 December 2017.88 There was an exemption for groups with an annual consolidated group revenue of less than €750 million. There were no other exemptions. The threshold would be reviewed in the overall 2020 review.89 Three conditions were outlined for countries obtaining and using the ­country-by-country report: confidentiality, consistency and appropriate use.90 Countries should have in place and enforce legal protections for the confidentiality of the reported information.91 They should use the template provided in the CbC Revised Discussion Draft—they should not require more or less information than in the template. Countries were reminded of the appropriate use of the

85  See PwC Tax Policy Bulletin, ‘OECD finalises guidance on transfer pricing documentation and country-by-country reporting’, p 5, available on: download.pwc.com/ie/pubs/2014-pwc-ireland-oecdguidance-tp-and-cbc-reporting-25-09-2014.pdf. 86  Action 13: Guidance on the Implementation of Transfer Pricing Documentation and Countryby-Country Reporting. Available on: www.oecd.org/ctp/beps-action-13-guidance-implementationtp-documentation-cbc-reporting.pdf. For commentary, see Amanda Athanasiou, ‘OECD Releases Implementation Guidance for CbC Reporting’, 2015 WTD 26-3 (9 February 2015). 87  CbC Follow-Up Discussion Draft, n 86 above, para 4. 88  Ibid, para 7. 89  Ibid, paras 8–12. 90  Ibid, para 13. 91  As noted in para 13, ‘[s]uch protections would preserve the confidentiality of the CbC Report to an extent at least equivalent to the protections that would apply if such information were delivered to the country under the provisions of the Multilateral Convention on Mutual Administrative Assistance in Tax Matters, a TIEA or a tax treaty that meets the internationally agreed standard of information upon request as reviewed by the Global Forum on Transparency and Exchange of Information for Tax Purposes. Such protections include limitation of the use of information, rules on the persons to whom the information may be disclosed, ordre public, etc’.

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country-by-country report: it should only be used to assess high-level transfer pricing risk. The guidance indicated that the ultimate parent of the group that meets the revenue threshold would be required to file the report in its home state. This home state would exchange the information on an automatic basis with other countries in which the MNE operates and that meet the above conditions. If a country failed to provide information to another jurisdiction that meets the conditions, a secondary mechanism would be accepted as appropriate, through local filing or by moving the obligation of requiring the filing of the country-by-country reports and automatically exchanging these reports with the next tier parent country.92 As part of an implementation package, the OECD has agreed to develop further guidance on the key elements of statutory legislation that countries would be able to adopt for use in their own legal systems. It would also develop implementing arrangements for the automatic exchange of the country-by-country reports under international agreements, bilateral and multilateral.93 While these clarifications were welcomed, country-by-country reporting was still criticised for the complexity it would bring to corporate tax departments. Notwithstanding some of the refinements made, the proposed measures continue to be heavily skewed towards tax authorities. There is a concern that country-bycountry reporting will be further expanded, particularly in developing countries. Furthermore, sensitive information may still be leaked to the public and some jurisdictions may not have the capability to use and understand the information. In fact, confidentiality risks are higher when large volumes of information are exchanged.94 There are concerns that the US might stop sending information if EU law were changed to make tax information not confidential.95 It has also been noted that new reporting requirements are likely to change taxpayer behaviour. For example, as advance pricing agreements must be reported in the master file, they may not remain an attractive option for taxpayers.96 Moreover, it has been argued that data gathered through country-by-country reporting would not suffice to give a full picture of the size and scope of BEPS. Action 11 is likely to be crucial to the success of the overall BEPS project.97 Another issue that still remains to be clarified is how an MNE group would be defined. Again, there does not seem to be a clear consensus on the meaning of an 92 

Ibid, para 14. Ibid, para 15. For a discussion on the challenges that the OECD will face in getting the USA and other jurisdictions to implement country-by-country reporting, see Mindy Herzfeld, ‘Implementing CbC Reporting (or Not) in the United States’, 2015 WTD 35-2 (23 February 2015). 94  Marie Sapirie, ‘US Expresses Concerns About Country-By-Country Reporting’, 2015 WTD 37-3 (25 February 2015). Also see Mindy Herzfeld, ‘Implementing CbC Reporting (or Not) in the United States’, n 93 above. 95  Lee A Sheppard, ‘BEPS Overwhelming Tax Administration’, 2015 WTD 74-1 (17 April 2015). 96  See Margaret Burow, ‘BEPS could be a “nightmare” for corporate tax departments’, 2015 WTD 31-5 (17 February 2015). 97  Stephanie Soong Johnston and David D Stewart, ‘CbC Reporting a Good Start but Not Enough to Analyse BEPS’, 2015 WTD 96-1 (19 May 2015). 93 

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MNE, not just in the context of Action 13 but also in the context of the whole of the BEPS project.98 If the new transfer pricing documentation requirements are to apply to MNEs solely on the basis of national laws and, to an extent, national definitions of control, then any benefits that might accrue to tax authorities and businesses from country-by-country reporting would be greatly diminished. Different definitions of control might lead to divergent reporting needs in different jurisdictions—double reporting or double non-reporting. That would render the deliverables under Action 13 a Pyrrhic victory.

4.4.  Action 14: Make Dispute Resolution Mechanisms More Effective Action 14 considers how to improve dispute resolution mechanisms. It reads as follows: Develop solutions to address obstacles that prevent countries from solving treaty-related disputes under MAP [Mutual Agreement Procedure], including the absence of arbitration provisions in most treaties and the fact that access to MAP and arbitration may be denied in certain cases.

Unlike the other Action items, Action 14 does not deal with problems of base erosion and profit shifting, but instead with taxpayer problems which in the post-BEPS world are likely to increase and require improved dispute resolution mechanisms. The Action Plan recognises that the actions to counter BEPS must be complemented with actions to ensure certainty and predictability for businesses. The OECD had looked at this issue previously, resulting for example in its Manual on Effective Mutual Agreement Procedures (MEMAP). On 18 December 2014, the OECD released a discussion draft examining how to make dispute resolution mechanisms more effective.99 The Dispute Resolution Discussion Draft recognised that the BEPS project presented a unique opportunity to make a difference in this area and to overcome traditional obstacles. Although there was no consensus on moving towards universal mandatory binding arbitration, it was recommended that complementary solutions should be provided which would have a practical, measurable impact.100 This Dispute Resolution Discussion Draft was the preliminary result of the work done to identify comprehensively the obstacles that prevented countries from resolving disputes through the mutual agreement procedure (MAP) and

98  Mindy Herzfeld, ‘What is an MNE Group? The Scope of CbC Reporting’ (2015) 78 Tax Notes International 204 (20 April 2015). 99 OECD, BEPS Action 14: Make Dispute Resolution Mechanisms more Effective. Available on: www.oecd.org/ctp/dispute/discussion-draft-action-14-make-dispute-resolution-mechanisms-more-­ effective.pdf. 100  Ibid, para 3.

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to develop possible measures to address these obstacles. It must be read in the broader context of the intention to introduce a three-pronged approach designed to represent a step change in the resolution of treaty-related disputes through the MAP. This three-pronged approach would consist first, in political commitments to effectively eliminate taxation not in accordance with the Convention; secondly, provide new measures to improve access to the MAP and improved procedures; and thirdly, establish a monitoring mechanism to check the proper implementation of the political commitment.101 It was expected that the work on Action 14 would result in a political commitment to substantially improve the MAP process. The political commitment and the measures through which it would be implemented would be guided by the following four principles: 1. Ensuring that treaty obligations related to the mutual agreement procedure are fully implemented in good faith. 2. Ensuring that administrative processes promote the prevention and resolution of treaty-related disputes. 3. Ensuring that taxpayers can access the mutual agreement procedure when eligible. 4. Ensuring that cases are resolved once they are in the mutual agreement procedure. For each of the above four principles, the Dispute Resolution Discussion Draft listed obstacles that might prevent the principle from being fully implemented and put forward options as to how these obstacles could be addressed. It was stated that specific measures would constitute a minimum standard to which participating countries would commit.102 Also, the final results of the work on Action 14 would include additional measures that some countries may commit to adopt in order to address obstacles to an effective MAP in a more comprehensive way. There would be monitoring of the overall functioning of the MAP process, including assessment of the measures to which countries had committed.103 One obstacle to ensuring that treaty obligations related to MAP were fully implemented in good faith was the absence of an obligation to resolve MAP cases under Article 25. The importance of resolving cases under MAP could be clarified in the treaty commentary.104 Another potential obstacle was the absence of paragraph 2 of Article 9 of the OECD Model in some treaties, which caused some countries to take the position that they were not obliged to make corresponding adjustments following a primary transfer pricing adjustment by a treaty partner. Thus, treaties could be amended to specifically include Article 9(2).105

101 

Ibid. Ibid, para 7. Ibid, para 8. 104  Ibid, para 10. 105  Ibid, para 11. 102  103 

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Moreover, the effectiveness of MAP may be undermined by a variety of factors, such as the lack of independence of the competent authority and inappropriate influence of considerations related to the negotiation of possible treaty changes,106 lack of resources,107 or inappropriate performance indicators for the competent authority function and staff.108 In addition, competent authorities may not actively use their authority under Article 25(3) of the OECD Model to try reaching a mutual agreement on matters of a general nature involving treaty interpretation or application.109 Finally, field auditors in some countries may seek to enter into audit settlements requiring a taxpayer to forego access to MAP, and some countries may not have implemented bilateral advance pricing arrangement programs.110 Addressing each of these shortcomings could help ensure an environment in which competent authorities are able to fully and effectively carry out their mandate. It was important to ensure that taxpayers could access MAP when eligible. Obstacles to MAP access included, inter alia, the complexity and lack of transparency of the procedures to access and use MAP,111 excessive or unduly onerous documentation requirements,112 time limits to access MAP113 and the requirement that the disputed tax be paid in order to access MAP.114 Also, the right to access MAP might be unclear when domestic or treaty-based anti-abuse rules or remedies have been applied. MAP access might also be denied by the unilateral decision of one competent authority that a taxpayer’s objection was not justified. Certain of the main obstacles to the resolution of treaty-related disputes through MAP were issues related to MAP processes—‘i.e. procedural and other blockages that impede the timely and effective resolution of MAP cases that have been accepted for bilateral competent authority consideration’.115 These included the lack of a principled approach to the resolution of MAP cases,116 lack of co-operation, transparency or good competent authority working relationships,117 and the absence of a mechanism, such as MAP arbitration, to ensure the resolution of all MAP cases.118 In addition, it was questioned how to address issues related to multilateral MAPs and APAs which deviated from the traditionally bilateral MAP.119 Issues related to the consideration of interest and penalties in MAP were also of significant importance.120 106 

Ibid, paras 14–15. Ibid, para 16. 108  Ibid, para 17. 109  Ibid, para 18. 110  Ibid, paras 19–23. 111  Ibid, para 25. 112  Ibid, paras 26–27. 113  Ibid, para 34. 114  Ibid, para 33. 115  Ibid, para 36. 116  Ibid, paras 37–38. 117  Ibid, para 39. 118  Ibid, paras 41–45. 119  Ibid, paras 58–59. 120  Ibid, para 60. 107 

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The Dispute Resolution Discussion Draft explored various options for i­mproving these issues within the MAP process, though it refrained from making any strong recommendations. The solutions proposed were primarily in the form of suggestions for amending the treaty commentary or statements regarding what different tax administrations could commit to, in order to advance dispute resolution procedures.121 Furthermore, the monitoring process would include assessment of the measures to which countries had committed. It was envisaged that an appropriate forum of competent authorities could be responsible for such monitoring. Such a forum would also facilitate experience sharing and capacity building and, more generally, work to foster co-operative and collaborative competent authority relationships.122 The various options suggested were criticised as being under-developed.123 Perhaps the disappointing aspect of the Dispute Resolution Discussion Draft was that there was no consensus on moving towards mandatory arbitration.124 Enhanced dispute resolution options such as administrative appeals, mediation and arbitration, as well as alternative means of preventing and resolving disputes and audits should also have been developed. Without such changes, there is a real prospect of a dramatic increase of disputes leading to double taxation. The BEPS Monitoring Group125 welcomed the statement that disputes should be resolved in a ‘principled, fair and objective manner’, but urged for these criteria to be explained in more detail in the Commentary.126 Transparency, including publication of decisions, was very important. Also, the rules themselves should be capable of being applied consistently and objectively, rather than leave wide scope for interpretation. ‘Rules which give decision makers wide scope for ­interpretation, or which permit a variety of acceptable alternatives, do not lend themselves to

121  It was also noted that administrative processes that promoted the prevention and resolution of treaty-related disputes were being comprehensively examined in the parallel work being undertaken by the Forum on Tax Administration’s MAP forum. 122  See para 8 of the Dispute Resolution Discussion Draft, n 99 above. 123  For a comprehensive analysis, see the KPMG submission, available on: www.kpmg.com/Global/ en/IssuesAndInsights/ArticlesPublications/taxnewsflash/Documents/kpmgcomments-beps14jan19-2015.pdf. For all the comments received on this action, see OECD website: www.oecd.org/tax/dispute/publiccomments-action-14-make-dispute-resolution-mechanisms-more-effective.pdf. 124  Kristen A Parillo, ‘OECD Proposes Improvements to Treaty Dispute Resolution Process’, 2014 WTD 244-2 (22 December 2014). 125  See BEPS Monitoring Group, Comments on BEPS Action 14: Make Dispute Resolution Mechanisms More Effective. Available on: bepsmonitoringgroup.files.wordpress.com/2015/01/ap-14-disputeresolution.pdf. 126 The suggested explanation to accompany these criteria was the following: ‘principled: this requires that outcomes should take the form of reasoned decisions, based on analysis of the facts of the case, the applicable rules and how they have been interpreted and applied to the specific case; fair: like cases should be treated alike, and decisions should be published, to ensure consistency; objective: decision-makers should be independent of the disputing parties and have no vested interests or conflicts of interest; and rules to be applied should be formulated so as to be easily applicable to specific cases based as far as possible on their facts rather than requiring value-judgments’: ibid, p 1.

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­objective decision-making’.127 According to the Group, highest ­priority should be given to ensuring that international tax rules were agreed which were simple, concrete, and clear to apply. This was more important than strengthening the existing dispute resolution mechanism. As an immediate response, the G20 should consider ‘a transition mechanism, to supervise the process of implementation of the BEPS reforms, monitor the way the rules are introduced by states, and provide advice and perhaps even interpretations’.128 The fact that the BEPS project also included developing countries with very limited competent authority resources makes this an imperative. What is undeniable is that BEPS will increase the issues under dispute, many of which are of high value. Also, the disputes are likely to be multinational and involve economic double taxation more than legal double taxation. For Action 14 to be successful, dispute resolution has to be swift and effective. Also, the right of taxpayers to intervene in the dispute resolution process needs to be ensured. So far, this right has been neglected.129 During the public consultation meeting on 23 January 2015, the fact that the Dispute Resolution Discussion Draft did not recommend specific dispute resolution measures but merely outlined possibilities was found to be disappointing.130 Stakeholders criticised the failure to endorse mandatory binding arbitration for mutual agreement procedure cases. Arbitration could be designed in different ways to suit countries’ preferences. The US baseball-style arbitration approach may not be the right choice for all countries. It was argued that taking a quasijudicial approach, offering expedited access to arbitration, or giving arbitration decisions precedential value could make arbitration more appealing to countries that did not like the baseball-style approach. A US Treasury representative suggested that there should be an in-depth study of the various types of arbitration to examine the pros and cons of each approach and determine whether any of the approaches would exacerbate the concerns some countries have. It was noted that MAP case requests had almost doubled and many businesses saw this Action item ‘as the linchpin that [would] make everything else in the BEPS project work’.131 It was recognised that there was an alarmingly large and growing number of outstanding MAP cases. The key to preventing treaty-related disputes would be a comprehensive review of all phases of the dispute resolution process, starting with the tax examinations that gave rise to disputes.132

127 

Ibid, p 2. Ibid, p 6. Jacques Malherbe, ‘The Issues of Dispute Resolution and Introduction of a Multilateral Treaty’ (2015) 43 Intertax 91, 93. 130  Kristen A Parillo and Ajay Gupta, ‘Business Sector Decries OECD’s Lack of Support for Arbitration’, 2015 WTD 16-2 (26 January 2015). 131  Ibid. As also noted by one of the industry representatives, businesses and their advisers were already drowning in MAP cases, and BEPS was a river about to be diverted in their direction. 132  Ibid. 128 

129 

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There was talk of ‘bad’ institutional behaviour giving rise to double taxation, such as tax authorities making transfer pricing adjustments too readily. Other ‘bad’ institutional behaviour included the lack of empowerment among some competent authorities to actually relieve double taxation, undue influences that may be exercised on competent authorities and the limited resources available. It was also noted that the Dispute Resolution Discussion Draft’s proposals seem to put unrealistic expectations on the ability of some countries, particularly smaller or developing countries to deal with tax disputes. The MAP Forum, established in 2013 by the competent authorities in the OECD Forum on Tax Administration member states, was recommended as the most effective place for addressing these problems and evaluating fundamental tax administration policies and practices. In February 2015, the OECD announced that it would issue a ‘strengthened’ ­follow-up draft with more specific proposals to address the impediments to resolving mutual agreement procedure cases.133 The follow-up draft would include a range of options that recognise the different views among various countries on how to improve MAP—particularly on the question of moving towards universal mandatory binding arbitration provisions. At the same time, the follow-up draft would reflect the common goal of finding ways to improve the effectiveness and efficiency of dispute resolution mechanisms. Although the next draft may contain stronger language recommending mandatory arbitration, the proposal still faces considerable opposition from many countries. It has since been reported that about 25 countries have expressed an interest in implementing mandatory arbitration provisions through a multilateral instrument as part of BEPS. The US is in favour of mandatory arbitration but is reluctant to include GAAR disputes as being eligible for arbitration.134 Developing countries also seem to be reluctant to endorse arbitration, mainly due to the high costs of arbitral proceedings in comparison to MAP.135 At an interview with ­Pascal Saint-Amans, the head of the Centre for Tax Policy and Administration at the OECD, the continuing difficulty of convincing other countries to accept arbitration was reiterated. It was hinted that monitoring and peer reviewing were likely to

133  Kristen A Parillo, ‘OECD Will Add “Muscle” to Next BEPS Dispute Resolution Draft’, 2015 WTD 30-1 (13 February 2015). 134  Kristen A Parillo, ‘About 25 Countries Interested in Treaty Arbitration, Rolfes Says’, 2015 WTD 52-2 (18 March 2015) and David D Stewart, ‘Post-BEPS Priority is Improving Tax Administration, Stack Says’, 2015 WTD 57-1 (25 March 2015). It has been reported that the US is trying to educate other countries about what mandatory arbitration means, in the hope that education can ultimately lead to acceptance. See Mindy Herzfeld, ‘Status Check on BEPS’ (2015) 77 Tax Notes International 1125 (30 March 2015). 135  See Jasmin Kollmann, Petra Koch, Alicja Majdanska and Laura Turcan, ‘Arbitration in International Tax Matters’ (2015) 77 Tax Notes International 1189 (30 March 2015). It has been reported that the UN is planning to release a paper on arbitration for developing countries. See David D Stewart, ‘UN Work Needed to Add Credibility to Transfer Pricing Rules’, 2015 WTD 61-5.

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be the only available options.136 These options are, however, also challenging due to the subjective nature of the task.137

4.5.  Action 15: Develop a Multilateral Instrument Action 15 of the BEPS Action Plan explores the feasibility of developing a ­multilateral instrument to address treaty-related BEPS issues. The Action item reads as follows: Analyse the tax and public international law issues related to the development of a multilateral instrument to enable jurisdictions that wish to do so to implement measures developed in the course of the work on BEPS and amend bilateral tax treaties. On the basis of this analysis, interested Parties will develop a multilateral instrument designed to provide an innovative approach to international tax matters, reflecting the rapidly evolving nature of the global economy and the need to adapt quickly to this evolution.

The first discussion draft on this Action item was released in September 2014.138 The Multilateral Instrument Discussion Draft analysed the tax and public international law issues related to the development of a multilateral instrument without infringing sovereign autonomy in tax matters. Such an instrument would enable countries to implement treaty-based BEPS issues in a quicker and more efficient way. In the absence of any special measures, BEPS-related changes through bilateral tax treaties would take many years to introduce across the network of double tax treaties, as individual treaties would need to be renegotiated. As noted, ‘globalisation makes the bilateral approach obsolete: the mobility of factors and the existence of global value chains are likely to generate multi-country disputes and require multilateral MAP, which could better be addressed in a multilateral treaty’.139 As far as next steps were concerned, the OECD recommended convening an international conference in early 2015 to develop the multilateral instrument. An international conference would negotiate the content and actual text of the multilateral instrument and would be open to all interested countries, under the aegis of the OECD and the G20. The mandate of the conference would be limited in scope

136  ‘Conversations: Jeffrey Owens and Pascal Saint-Amans’ (2015) 77 Tax Notes International 797 (2 March 2015). 137  It has been reported that the Action 14 working group had been considering how to implement the discussion draft’s proposed peer review process for monitoring countries’ adherence to their political commitment to improve MAP and the minimum standard for operating their treaty dispute resolution program. See Parillo, ‘About 25 Countries Interested in Treaty Arbitration, Rolfes Says’, n 134 above. 138  OECD/G20 Base Erosion and Profit Shifting Project, Action 15: A Mandate for the Development of a Multilateral Instrument on Tax Treaty Measures to Tackle BEPS. Available on: www.oecd.org/ctp/ beps-action-15-mandate-for-development-of-multilateral-instrument.pdf. 139  Jacques Malherbe, ‘BEPS: The Issues of Dispute Resolution and Introduction of a Multilateral Treaty’ (2015) 43 Intertax 91–95, 94.

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(implementing the BEPS Action Plan) and in time (no more than two years).140 As an example of a successful multilateral instrument, the Convention on Mutual Administrative Assistance in Tax Matters was mentioned.141 Some issues relating to the development of a multilateral instrument were identified. It was suggested that the development of such an instrument was desirable as it would overcome the hurdle of cumbersome bilateral negotiations and produce important efficiency gains. This would especially enable developing countries to reap the benefits from the BEPS project more fully, without having to exhaust themselves with tax treaty negotiations or re-negotiations.142 Furthermore, a multilateral instrument would increase consistency and help ensure the continued reliability of the international tax treaty network, providing additional certainty for businesses. It was argued that such an instrument would focus the attention of a large number of highly-qualified treaty negotiators on a single document that could incorporate the language deemed most appropriate by all countries. At the same time, it was noted that flexibility, respect for bilateral relations and a targeted scope were crucial; otherwise the process would stagnate or would involve too few countries. Broad participation was also essential to ­success—in order to ensure a level playing field.143 It was acknowledged that developing a multilateral instrument posed several challenges, although the OECD was positive in that legal mechanisms existed to address these challenges. The most promising approach was to have a multilateral instrument that would co-exist with bilateral tax treaties. ‘Like existing tax treaties, this instrument would be governed by international law and would be legally binding on the parties’.144 It was later on clarified that the instrument would follow established negotiating processes and ratification would require conventional domestic procedures. However, rather contradictorily to the previous statement as to the binding effect of the instrument, it was stated that the relationship between parties to a multilateral instrument that were not parties to a bilateral tax treaty between themselves would not be affected—‘a multilateral instrument will only govern the relationship between parties that have concluded bilateral tax treaties amongst themselves’.145 In other words, a multilateral treaty was not envisaged as a stand-alone instrument.146 The only possible exception would be a multilateral dispute resolution mechanism. This rather pragmatic stance, arguably reflective of the difficulties of achieving full consensus in this area, raises many issues. To an extent, this position nullifies the possible (intended) impact of the multilateral instrument, if it only has an

140 

Multilateral Instrument Discussion Draft, n 138 above, p 14. Ibid. 142  Ibid, pp 15–16. 143  Ibid, p 17. 144  Ibid, p 17. 145  Ibid, p 18. 146  Malherbe (2015), n 139 above, p 94. 141 

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impact on countries that are already covered by a tax treaty. Even when bilateral tax treaties do exist, there would also be a number of technical challenges. For example, there could be variations in scope between similar provisions of existing bilateral treaties, or linguistic discrepancies. For these, there should be compatibility clauses or primacy clauses in the multilateral instrument,147 or superseding language,148 defining its relationship with prior, or even future, bilateral treaties. Mechanisms to resolve the technical challenges that might arise and relevant precedents in other areas of international law were described in more detail in the Annex to the Multilateral Instrument Discussion Draft, which included a ‘toolbox’ for a multilateral instrument for the swift implementation of BEPS measures.149 It was emphasised that the multilateral instrument should be highly targeted and efficient,150 yet it was later on conceded that ‘a flexible approach will be paramount’.151 In fact, it was suggested that the multilateral instrument ‘should allow for the tailoring of the level of certain commitments towards all the other parties and/or depending on the partner country’.152 In chapter 2 of the Discussion Draft there was an analysis of possible BEPSrelated themes that could lend themselves to multilateral application: multilateral MAP, dual-residence structures, hybrid mismatch arrangements, triangular cases involving PEs in third states and treaty abuse.153 It was stated that such treatyrelated BEPS measures could be drafted and implemented as stand-alone measures but could also be included in a multilateral instrument that complemented and co-existed with bilateral tax treaties. It was conceded, however, that some treaty-related BEPS measures may implicate concerns that were bilateral in nature which would require additional flexibility.154 Later on in the discussion draft it was stated that ‘[f]or the moment, it is important to keep the multilateral instrument narrowly targeted, and at the same time start a reflection on what further incremental opportunities may be available’.155 Again, this seems like a pragmatic conclusion suggesting multilateralism à la carte. Interestingly, the Multilateral Instrument Discussion Draft also recommended close examination of the relationship of a multilateral instrument with EU law and other multilateral agreements such as the Nordic tax treaty.156 The possible implications of this, vis-à-vis EU law, are considered in Chapter six of this volume.157 What seems to emerge from the Multilateral Instrument Discussion Draft is that strict uniformity is likely to give way to optionality and flexibility. This is a 147 

Multilateral Instrument Discussion Draft, n 138, p 19. Ibid, p 20. 149  Ibid, p 29 et seq. 150  See, for example, p 18. 151  Ibid, p 21. 152  Ibid. 153  Ibid, pp 23–26. 154  Ibid, p 25. 155  Ibid, p 26. 156  Ibid, p 21. 157  See analysis in section 6.7 of this volume. 148 

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pragmatic outcome. There is likely to be a variable amount of clarity and certainty to which businesses could adjust to. There would—presumably—be some core provisions universally applicable and other provisions which would be optional (opt-outs and opt-ins). However, there are no indications as to what is likely to be optional and what is likely to be compulsory. While it is understandable that the OECD wishes to streamline the implementation of BEPS-induced changes in the international tax treaty landscape, multilateralism—certainly a dynamic and innovative solution—may not be as easy to achieve, at least not immediately. It has been argued that too much optionality would weaken the multilateral instrument and make it as complex as a series of protocols amending bilateral treaties.158 Furthermore, reservations to a multilateral treaty raise practical difficulties as the instrument loses its uniformity between Contracting States. If a Contracting State’s reservations are too great, other Contracting States may refuse to allow the multilateral treaty to enter into force vis-à-vis the Contracting State making those reservations. In other words, the multilateral treaty would risk becoming ‘fractioned’ or ‘divisible’. Therefore, rather than allowing reservations, it is arguably preferable, especially when divergences are too strong, to have two or more multilateral agreements and/or for these instruments to be limited to a given sector. The above analysis suggests that multilateralism, at least in its pure sense, is unlikely to be applicable in the international context, even post-BEPS. What we might see develop is a watered down version of multilateralism. Apart from established areas dealing with exchange of information and administrative assistance, bilateral tax treaties would still rule the day, with all their limitations. Let us not forget that in the European Union, the bilateralism of tax treaties has survived the Court of Justice following the D case.159 While there have been a few examples of multilateral instruments addressing procedural rules (eg exchange of information or administrative assistance), with the exception of the Nordic treaty, this would be the first time that a multilateral instrument of such a scale addresses substantive rules. The goal is certainly laudable but rather disappointingly, the Multilateral Instrument Discussion Draft does not give any specific guidance as to how such multilateral instrument is to be developed, drafted, implemented and, in the future, revised or amended.160 Perhaps input should be sought not just from tax lawyers but also from experts in public international law and treaty law.

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Malherbe (2015), n 139 above, pp 94–95. Case C-376/03 D v Rijksbelastingdienst (D case) [2005] ECR I-5821. Also see analysis in Ch 6, section 6.7 of this volume. 160  Malherbe (2015), n 139 above, at pp 93–94, makes a number of suggestions as to how a multinational instrument could be implemented. One solution would be a mere adjustment of the OECD Model Commentary. Arguably, this would not be binding and if binding, there would be issues with tax treaties already signed. Another more unrealistic solution would be to sign a general multilateral treaty replacing the network of bilateral treaties. Alternatively, there could be a framework multilateral treaty to which various countries could adhere by declaration without modifying its terms. There could 159  See

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On 6 February 2015, the OECD and the G20 agreed to a mandate to begin negotiations on a multilateral instrument to streamline implementation of treatyrelated BEPS measures. The formation of a negotiating ad hoc group hosted by the OECD was authorised. The group would be open to participation from all states and would hold its first meeting by July 2015. The goal was to finalise the drafting of the instrument by the end of 2016.161 On 28 May 2015, it was announced that an ad hoc group of over 80 countries had begun work on developing a multilateral instrument. Substantive work was scheduled to begin at an inaugural meeting in November 2015.162

4.6.  BEPS and Developing Countries It is undeniable that BEPS affects developing countries. According to the OECD, engagement with developing countries has been extensive since the beginning of the project.163 Over 80 developing countries and other non-OECD/non-G20 economies have been consulted through at least four in-depth regional consultations and five thematic global fora, attended by more than 110 jurisdictions as well as representatives from civil society and the business community. The input received from developing countries has been fed into the development of the BEPS Action Plan by the technical groups carrying out the work on BEPS. Developing countries have contributed to the discussion on most of the deliverables and have provided influential input especially as regards the template for country-bycountry reporting for the purposes of Action 13 and the work on treaty abuse under Action 6. The OECD’s engagement with development countries is also buttressed by the signing of several memoranda of understanding (MOUs) with international and regional organisations.164 In addition to including developing countries in the consultation and decisionmaking process, the OECD has also published a number of papers on topics directly affecting developing countries. also be a binding multilateral treaty amending bilateral treaties but on which countries could formulate reservations. Malherbe, at p 95, also discusses some of the issues that could arise with the drafting of the treaty and its future amendments. He questions whether the revision of the treaty would require unanimity or consent by majority. If the latter, then minority states may want to withdraw: ibid. 161  See first steps towards implementation of OECD/G20 efforts against tax avoidance by multinationals, and OECD Secretary-General Report to G20 Finance Ministers (Istanbul, Turkey, February 2015). Available on: www.oecd.org/tax/oecd-secretary-general-tax-report-g20-financeministers-february-2015.pdf. 162  See announcement published in Tax Analysts, 2015 WTD 103-18 (28 May 2015). 163  See www.oecd.org/tax/beps-about.htm. 164  An MOU was signed between the Centre de rencontres et d’études des dirigeants des administrations fiscales (CREDAF) and the OECD on 16 March 2015. CREDAF joined the African Tax Administration Forum (ATAF) and the Center for Inter-American Tax Administrators (CIAT) which already have MOUs with the OECD aimed at strengthening the partnership to improve tax policy, and helping build greater capacity within the respective regions. See report in Tax Analysts, ‘OECD Global Forum Welcomes Participation by Developing Countries’, 2015 WTD 57-14 (24 March 2015).

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In March 2014, the OECD published a consultation document in response to a call from the G8 to find ways to address the concerns expressed by developing countries on the quality and availability of information on comparable transactions that was needed to administer transfer pricing effectively. The paper considered transfer pricing comparability data and developing countries.165 It provided some useful ideas for dealing with practical difficulties in benchmarking returns for parties in developing countries.166 Furthermore, in the summer of 2014, the OECD published a two-part report that sought to map out the impact of BEPS on low income countries.167 The report highlighted the numerous challenges faced by developing countries in tackling BEPS. It was noted that some developing countries lack the necessary legislative measures needed to address BEPS and any measures they have are often hindered by lack of information. Furthermore, developing countries faced difficulties in building the capacity needed to implement highly complex rules and to challenge well-advised and experienced MNEs. This was likely to lead to simpler, but potentially more aggressive tax avoidance than is typically encountered in developed economies. As part of its interim conclusions, in the first part of this report it was recognised that BEPS had the potential to have a considerable impact on domestic resource mobilisation in developing countries. The second part to this report was meant to provide guidance to developing countries to meet the challenges of the most relevant BEPS issues they face. Some generic guidance was indeed given, though most issues were referred for further consideration. Inter alia, it was noted that political-level engagement on BEPS issues in many developing countries was at an early stage. It was important for this engagement to be improved. Furthermore, it was recommended that G20 countries should analyse the spillover effects of changes to the design of their own tax systems on those of developing countries, also considering tax incentives. Concerns were reiterated as to the importance of capacity building on BEPS issues. It was recommended that guidance should be drawn from the extensive experience not only of the OECD’s Task Force on Tax and Development but also of other organisations such as the IMF and the World Bank Group, as well as the experience of other developing countries. It was also suggested that the

165 See OECD Public Consultation, Transfer Pricing Comparability Data and Developing Countries (2014). Available on: www.oecd.org/ctp/transfer-pricing/transfer-pricing-comparability-data-­ developing-countries.pdf. 166 Four possible approaches were set out to address these concerns: expanding access to data sources for comparables, more effective use of data sources for comparables, approaches to identifying arm’s length prices without reliance on direct comparables and advance pricing agreements and mutual agreement proceedings. 167  See Parts 1 and 2 of A Report to G20 Development Working Group on the Impact of BEPS in Low Income Countries, published in July 2014 and August 2014 respectively. Available on: www.oecd.org/ ctp/tax-global/part-1-of-report-to-g20-dwg-on-the-impact-of-beps-in-low-income-countries.pdf and www.oecd.org/g20/topics/taxation/part-2-of-report-to-g20-dwg-on-the-impact-of-beps-in-lowincome-countries.pdf.

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OECD, IMF, UN, World Bank Group and regional organisations should consider ­developing practical toolkits to help developing countries implement key BEPS actions, without creating separate or alternative norms or standards. For the project to succeed, it was necessary to ensure that BEPS solutions were relevant to, and effective for, developing countries. At the same time, developing countries had to be fully engaged to ensure that the suggested solutions take into account the information and capacity gaps they frequently face. The OECD promised to strengthen its involvement with developing countries. Moreover, it was noted that a multilateral instrument, as envisaged by Action 15 of the BEPS Action Plan, might prove to be an important tool for developing countries that have a tax treaty network. G20 countries were urged to engage in dialogue with developing countries on the design and potential benefits of a multilateral instrument. Following this report, the OECD continued to seek ways to ensure developing countries were better integrated into the BEPS project. On 12 November 2014, the OECD published its strategy for deepening the engagement of developing countries.168 Guidance was given on how to strengthen their involvement in the decision-making process and bring them to the heart of the technical work. It was reiterated that capacity building to address BEPS issues was imperative. In the summary of proceedings of an Eurasian BEPS meeting held on 4–5 March 2015, participants welcomed the new OECD/G20 strategy to strengthen the involvement of developing countries into the BEPS project. This made the entire process more inclusive and provided a unique opportunity to enhance the dialogue.169 The BEPS project was welcomed as a means of updating the international standards to the economic realities of globalisation. However, concerns were expressed mostly about implementation and the transitional costs of BEPS measures, as well as the need for a coordinated approach to prevent double taxation. Notwithstanding the OECD’s attempts to be more inclusive in the BEPS project, there is still a general concern that the BEPS agenda prejudices developing countries and that their interests are not properly reflected in the Action Plan.170 One could argue that efforts to align the arm’s length principle to reflect value creation are there only to temporarily appease developing countries. These countries face substantial challenges especially as regards the implementation of transfer pricing regimes in their economies: the cost of commercial databases, the difficulties of hiring and retaining specialised auditors, as well as the lack of comparable data and other transitional costs.171 Some of the proposals in the discussion drafts, for example the proposals under the Risk and Re-characterisation D ­ iscussion Draft, 168 

Available on: www.oecd.org/tax/strategy-deepening-developing-country-engagement.pdf. See ‘OECD Releases Eurasian BEPS Meeting Summary’, 2015 WTD 47-15 (5 March 2015). Also see comments made by Pascal Saint-Amans at the Global Forum on Transfer Pricing meeting on 16-17 March 2015, where developing countries were welcomed as vital participants in the BEPS project. See report in Tax Analysts 2015, n 164 above. 170  Shee Boon Law, ‘Base Erosion and Profit Shifting—An Action Plan for Developing Countries’ (2013) 68 Bulletin for International Taxation 41–46. 171  See OECD Releases Eurasian BEPS Meeting Summary, n 169 above. 169 

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depend on the availability of experts with specialised knowledge of many i­ ndustry sectors and business models, which is an unrealistic expectation for many ­ ­developing countries. As noted by the BEPS Monitoring Group, ‘[e]ven the most developed OECD members struggle to match the resources of the private sector, as seen by the recent decision of the US IRS to pay $2m to consultants to help with its audit of Microsoft’.172 Furthermore, while procedurally the OECD appears to have integrated developing countries much more than in any previous initiative, the extent to which these countries have actually influenced the final product remains to be seen. The discussion drafts of the deliverables produced so far, as analysed in this and in previous chapters, suggest limited influence.173 Perhaps this can be attributed to the fact that the scope of the BEPS project itself is rather limited—it is (or supposed to be) about reform of existing rules. By contrast, as suggested by NGO representatives, for developing countries, more radical proposals might be appropriate such as taxation on a unitary basis or general application of the profit split method.174 Of course, adoption of such proposals by the OECD and universal implementation by countries is a near impossibility—hence why the gap between the demands of developing and developed countries is unlikely to be ever fully bridged. In any case, it has been argued that cooperation is not necessarily good and its consequences are not always desirable. International taxation has thus far been based on cooperation that serves OECD countries rather than all countries. Tsilly Dagan has referred to this as cartelistic cooperation.175 Her arguments seem to counter the conclusions of the BEPS initiative that a shift to cooperation is a prerequisite for the survival of the international tax regime. Whilst this may be to the benefit of OECD countries, it might not necessarily serve other countries such as the BRICS (ie Brazil, Russia, India, China and South Africa). Although these countries have a unique position of power in today’s global economy and this position grants them increasing influence and great potential, nevertheless, for the time being, BRICS countries face many limitations in transforming the international tax landscape. It might be best if these and other developing countries embrace 172  BEPS Monitoring Group, Summary of Evaluations of BEPS Action Plan Proposals. Available on: bepsmonitoringgroup.files.wordpress.com/2015/03/summary-march-2015.pdf. 173  As Sol Picciotto argued, while the OECD has had some engagement with developing countries on BEPS issues, it has not adopted their views, such as the inclusion of location-specific advantages as intangibles. See analysis in section 3.3 of Ch 3 of this volume. Although the OECD has tried to consult developing countries, the most it has been able to do is alert them to the issues. See David D Stewart, ‘Sol Picciotto—BEPS and the Developing World’ (2014) 76 Tax Notes International 1060 (22 December 2014). 174  See Tax Justice Network, Briefing on Base Erosion and Profit Shifting (BEPS) Implications for Developing Countries (February 2014). Available on: www.taxjustice.net/wp-content/uploads/2013/04/ TJN-Briefing-BEPS-for-Developing-Countries-Feb-2014-v2.pdf. 175  See Tsilly Dagan, ‘BRICS: Theoretical Framework and the Potential of Cooperation’ in Yariv Brauner and Pasquale Piston (eds), BRICS and the Emergence of International Tax Coordination (IBFD, 2015). The concept was developed in her previous work. See, eg Tsilly Dagan, The Costs of International Tax Cooperation, University of Michigan Law, Public Law Research Paper 13 (2002); Tsilly Dagan, ‘Just Harmonisation’ (2010) 42 University of British Columbia Law Review 331.

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the BEPS project and participate in the consultations, to try and ensure as far as possible that their concerns are taken into account. In general, in the current state of the international tax system, it is only through proper engagement in the BEPS discourse that some tangible benefits could accrue to developing countries and their interests and agenda promoted. Therefore, however cynical one is of the BEPS project, for developing countries there is something to be gained. If efforts to streamline the arm’s length principle with value creation do reach fruition, even partially, then this could have important implications for the tax base of developing countries. At the time of writing this book, the final versions of some of the BEPS proposals were not yet released. As already explained in the introduction to this book, this and the previous chapters on BEPS analyse material available up to 1 June 2015. There is an overview and a general critique of the proposals in the final chapter to this book. The next chapters examine the measures taken by the European Union to tackle international tax avoidance. It is noted that some of the EU measures share similarities with the BEPS proposals. The compatibility of some of the BEPS proposals with the general principles of EU law are also considered later on in this book.

5 International Tax Avoidance and European Union Law In order to understand the European Union’s response to aggressive tax planning and MNEs engaged in such tax planning, it is important to consider the background against which some of the relevant initiatives unfolded. Up until very recently, there was not much of an official policy on tax avoidance, let alone aggressive tax planning. In fact, most of the case law of the Court of Justice seemed to be devoted to the unravelling of domestic anti-abuse rules on the basis of incompatibility with the various fundamental freedoms under EU law. The first part of this chapter considers the judicial response to the concept of tax abuse, mainly by the Court of Justice. This is then juxtaposed with the European Commission’s initiatives and its Action Plan to Strengthen the Fight against Tax Fraud and Tax Evasion as a newly-formed policy on international tax avoidance. This chapter sets the background against which, in the next chapter, there is an analysis of the compatibility of the various items of the BEPS Action Plan with EU law.

5.1.  The Judicial Development of A Principle of Abuse of Tax Law For some time, it has been debated whether there is one coherent principle of abuse of EU law and, as a corollary, whether Member States are entitled or under an obligation to combat abusive tax practices. As discussed elsewhere, in the current state of the Court’s jurisprudence, it is difficult to conclude that the concept of tax abuse has been de-nationalised and that there is now an EU principle of tax abuse.1 Not only is the terminology inconsistent, with the Court using the

1  See ch 8 in Christiana HJI Panayi, European Union Corporate Tax Law (Cambridge University Press, 2013). Contrast with the position of Paolo Piantavigna, ‘Tax Abuse in European Union Law: A Theory’ (2011) 20 EC Tax Review 134 and Adolfo Martin Jimenez, ‘Towards a Homogeneous Theory of Abuse in EU (Direct) Tax Law’ (2012) 66 Bulletin for International Taxation 270.

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terms ‘abuse’, ‘evasion’, ‘avoidance’ and ‘fraud’ interchangeably in the tax case law but there are also linguistic discrepancies in the translations of the judgments.2 ­Furthermore, the various terms may have different meanings in different jurisdictions and/or their boundaries may be unclear.3 Overall, recent case law suggests that EU law does not provide a general principle of abuse of rights in the field of direct taxation. Whilst a principle of abuse of rights may be deduced from some cases in the area of VAT, it does not apply in a non-harmonised area. In Halifax,4 the Court of Justice first showed signs of accepting a free-standing principle of abuse of law in the VAT context.5 This case dealt with an aggressive and complex VAT planning scheme intended to locate the place of supply of services outside the EU. The UK tax authorities challenged this scheme. Eventually, a reference was made to the Court of Justice to interpret the rules of the Sixth VAT Directive on the place of supply of services. More importantly, the Court of Justice was also asked to determine whether there was a principle of abuse of rights disallowing such schemes. The Court of Justice decided that the transactions encompassed supplies of services for the purposes of the VAT legislation and therefore were subject to it. In any case, the application of Community legislation could ‘not be extended to cover abusive practices by economic operators, that is to say transactions carried out not in the context of normal commercial operations, but solely for the purpose of wrongfully obtaining advantages provided for by Community law’.6 In this context, an abusive practice occurs where first, the transaction results in a tax advantage which would be contrary to the purpose of the provisions formally applied, and secondly, the essential aim of the transaction was to obtain a tax advantage.7 To the Court of Justice, objective criteria and respect of legal certainty were essential.8 For the purposes of the second part of the test, the Court of Justice stated that, in determining the real substance and significance of the transactions, national courts could consider factors such as the purely artificial nature of those transactions and the legal, economic and/or personal links among

2  Opinion Statement of the CFE ECJ Task Force on the Concept of Abuse in European Law, based on the Judgments of the European Court of Justice Delivered in the Field of Tax Law (November 2007). 3  What is mainly disputed in different jurisdictions is whether or not a certain transaction constitutes legitimate tax planning or (illegitimate) tax avoidance. 4  Case C-255/02 Halifax plc, Leeds Permanent Development Services Ltd and County Wide Property Investments Ltd v Commissioners of Customs & Excise [2006] ECR I-1609. 5  In the non-tax context, the origins of such a principle are traced back to earlier cases and mainly Case C-110/99 Emsland-Stärke GmbH v Hauptzollamt Hamburg-Jonas [2000] ECR I-1569. See Rita de la Feria, ‘Prohibition of Abuse of (Community) Law: The Creation of a New General Principle of EC Law through Tax’ (2008) 45 Common Market Law Review 395, 408. 6  Halifax, n 4 above, para 69. 7  Ibid, paras 74–75. 8  Ibid, para 72.

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operators involved in the tax avoidance scheme.9 If an abusive practice was found to exist, then the transactions involved had to be redefined so as to re-establish the situation that ‘would have prevailed in the absence of transactions constituting that abusive practice’.10 Although the Halifax case was hailed as a ground-breaking decision for the purposes of VAT legislation, it was not entirely clear whether guidance could be derived from it for other areas such as direct tax law. Later cases seem to confirm the idea that the principle would only be relevant to VAT cases. In Part Service, another VAT case,11 the Halifax two-pronged test was applied and refined. The Court of Justice clarified that to find an abusive practice for the purposes of the Sixth VAT Directive it was enough when the accrual of a tax advantage was the principal aim of the transaction or the transactions in question, and not the sole aim pursued, to the exclusion of other economic objectives.12 This was for the national court to assess.13 Similarly, in Weald Leasing,14 the Court of Justice dealt with an asset-leasing transaction, the purpose of which was the deferment of the VAT liability through its spreading on rental payments. Here, the existence of the tax advantage was not enough. It had to be shown that this advantage was contrary to the purposes of the VAT legislation.15 The Court of Justice emphasised that a taxable person could not be criticised for choosing a leasing transaction which procured him the advantage of spreading the payment of his tax liability.16 A finding that there was an abusive practice was inferred from the object and effects of the impugned transactions, as well as their purpose.17 The fact that the undertaking did not usually engage in such transactions was irrelevant.18 If the transaction was abusive, then it had to be redefined so as to re-establish the situation that would have prevailed in the absence of the elements of those contractual terms which were abusive.19 Weald Leasing is important as the Court of Justice openly embraced the arm’s length principle as a means of delineating elements that could go towards establishing the abusive nature of a transaction.20 It also clarified that a finding of abuse does not nullify the transaction but paves the way for its re-characterisation. 9 

Ibid, para 81. Ibid, para 94. 11  Case C-425/06 Ministero dell’Economia e delle Finanze, formerly Ministero delle Finanze v Part Service Srl, company in liquidation, formerly Italservice Srl [2008] ECR I-897. 12  Ibid, para 45. 13  Ibid, para 62. 14  Case C-103/09 The Commissioners for Her Majesty’s Revenue and Customs v Weald Leasing Ltd [2010] ECR I-13589. 15  Ibid, para 33. 16  Ibid, para 34. 17  Ibid, para 44. 18  Ibid, para 45. 19  Ibid, para 53. 20  Also see para 50 in Case C-277/09 The Commissioners for Her Majesty’s Revenue & Customs v RBS Deutschland Holdings GmbH [2010] ECR I-13805, where the fact that the various transactions concerned took place between two parties which were legally unconnected was decisive. 10 

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More recently, in the Ocean Finance case21 the Court of Justice seems to have shifted away from the more objective element of the Halifax test.22 By focusing on the artificiality of the transaction, it gave emphasis to the more subjective second test. In Ocean Finance, it was stated that the consideration of economic and commercial realities was a fundamental criterion for the application of the common system of VAT. These may be more decisive than the contractual terms for identifying the recipient of a supply of services. This language is very reminiscent of the language used by the OECD in its Risk and Re-characterisation Discussion Draft, reviewed in Chapter three of this volume.23 In this case, Paul Newey, a UK loan broker supplied VAT-exempt broking services. At the same time, he received advertising services for the promotion of his business, which were subject to VAT in the UK. In consequence, the VAT paid for the advertising services was not recoverable. Mr Newey entered into complex arrangements24 with an offshore subsidiary to mitigate a substantial amount of irrecoverable input VAT. The UK tax authorities challenged this structure, arguing that the aim of going offshore was to avoid paying VAT on taxable advertising services. The essence of the questions referred was whether the contractual terms were to be considered as decisive in determining the supplier and recipient in a supply of services for VAT purposes. The Court of Justice found that contractual terms, although an important factor to be taken into consideration, were not decisive. Sometimes, contractual terms did not wholly reflect the economic and commercial reality of the ­transactions.25 ‘That is the case in particular if it becomes apparent that those contractual terms constitute a purely artificial arrangement which does not correspond with the economic and commercial reality of the transactions’.26 Referring to previous case law and to the objective of the Sixth VAT Direct, the Court of Justice recalled that ‘the effect of the principle that the abuse of rights is prohibited is to bar wholly artificial arrangements which do not reflect economic reality and are set up with the sole aim of obtaining a tax advantage’.27 Contractual terms could be disregarded if it became apparent that they did not reflect economic and commercial reality. This was for the referring court to ascertain.28 If indeed this was the case, then ‘those contractual terms would have to be redefined so as to re-establish the situation that would have prevailed in

21  Case C-653/11 HM Revenue & Customs v Paul Newey, trading under the business name Ocean Finance [2013] ECR I-409. 22  Ie whether the transaction resulted in a tax advantage which would be contrary to the purpose of the provisions formally applied. 23  See section 3.4.4 of this volume. 24  Paul Newey, n 21 above, paras 17–28. 25  Ibid, paras 43–44. 26  Ibid, para 45. 27  Ibid, para 46. 28  Ibid, para 49.

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the absence of the transactions constituting that abusive practice’.29 In this case, the Commissioners could legitimately regard Mr Newey as actually being the ­supplier of the loan broking services and the recipient of the supplies of advertising services at issue.30 This case seems to strengthen the position of the tax authorities in their fight against tax fraud and abusive practices. For businesses, it makes it imperative to have comprehensive and well-structured documentation reflecting the economic reality. Substance over form has become crucial. To an extent, the Court’s judgment seems to be aligned with recent trends whereby artificiality and other objective factors are the main ingredients of proposed anti-abuse rules, thus also catching unintentional mismatches and double non-taxation. However, it is not certain whether the Court is reverting to the Halifax sole purpose test, in which case, the onus of proof for the tax authorities would seem to be higher than the ‘one of the principal purposes’ test of later case law. If that is the case, then arguably, the amendment to the Parent-Subsidiary Directive discussed below, which relies on ‘one of the principal purposes’ test is more empowering for tax authorities—as an abuse of tax law test—than what seems to be provided for in the area of VAT.31 Apart from VAT cases, the idea of a general principle of abuse of tax law was explored in some cases under the Merger Directive.32 Although the Court’s statements in these cases suggested a free-standing principle of abuse of rights, in 3M Italia33 the Court of Justice rejected this view, concluding that a general principle of abuse of rights did not apply to unharmonised taxes. To the Court, it was clear that no general principle existed in EU law which might entail an obligation on the Member States to combat abusive practices in the field of direct taxation.34 To an extent, the Court’s judgment put to rest arguments that there is a general anti-avoidance rule—ie a GAAR—for the purposes of EU tax law;35 which renders the insertion of a GAAR in the Parent-Subsidiary Directive even more perplexing. Nevertheless, a finding of abuse of tax laws or tax avoidance is not completely irrelevant as far as the compatibility of national tax legislation in non-harmonised areas is concerned. Depending on the term used by Member States or the Court, the prevention of tax abuse or tax avoidance or tax evasion is often advanced as a justification for national measures restricting fundamental freedoms.

29 

Ibid, para 50. Ibid, para 51. 31  See also analysis in section 5.3.2 below. 32  See Case C-321/05 Hans Markus Kofoed v Skatteministeriet [2007] ECR I-5795, para 38 and Case C-126/10 Foggia—Sociedade Gestora de Participações Sociais SA v Secretário de Estado dos Assuntos ­Fiscais [2011] ECR I-10923. Cf the Court’s decision in Case C-352/08 Modehuis A Zwijnenburg BV v Staatssecretaris van Financiën [2010] ECR I-4303. See ch 7 in HJI Panayi (2013), n 1 above. 33  Case C-417/10 Ministero dell’Economia e delle Finanze, Agenzia delle Entrate v 3M Italia SpA [2012] ECR I-184. 34  Ibid, para 32. 35  See analysis in ch 8, HJI Panayi (2013), n 1 above. 30 

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Sometimes it is enough to justify the restriction but sometimes it is not. This is an essential point to grasp in assessing the compatibility of some of the BEPS deliverables, especially the pure anti-abuse measures, with EU law. The compatibility ­assessment should arguably be done in conjunction with the European Union’s official policy on aggressive tax planning, to avoid contradictory results. At the time of writing, this policy is still largely a work in progress. The various stages of development of this policy are described next.

5.2.  The EU Policy on Tax Abuse and Aggressive Tax Planning It is difficult to delineate the European Union’s policy in this area. As already mentioned, initially the emphasis was not so much on the prevention of international tax avoidance but rather on the prevention of overtly restrictive domestic antiabuse rules which hindered the single market. There was no discussion on double non-taxation36 or aggressive tax planning.

5.2.1.  Commission Communication on Anti-Abuse Measures The 2007 Commission Anti-Abuse Communication37 on the application of antiabuse measures placed emphasis on intentional tax abuse, though there was mention of adopting coordinating solutions in close cooperation with Member States so as to reduce potential mismatches resulting in inadvertent non-taxation. In this Communication, it was stated that the notion of ‘anti-abuse regulations’ covered numerous laws, measures and practices in Member States. This Communication called for a more targeted and better coordinated application of these rules. There had to be a just balance between the public interest in tackling abuse and the need to avoid restrictions on cross-border activities within the European Union. The Commission went on to reiterate the principles under the case law which had arisen at the time. The need to prevent tax avoidance or abuse38 could

36  See for example the IFA 2004 conference topic on double non-taxation for which there was no EU report. Similarly, there were very few references to EU law in the General Report. Double non-taxation was not an issue for the European Community at the time; rather measures to curb it were. See IFA Cahiers 2004—Vol 89a, ‘Double non-taxation’, General Report by Michael Lang. 37  Commission Communication of 10 December 2007 to the Council, the European Parliament and the European Economic and Social Committee entitled ‘The application of anti-abuse measures in the area of direct taxation—within the EU and in relation to third countries’ (COM(2007) 785 final) (henceforth, Commission Anti-Abuse Communication). 38  Rather confusingly, in many places, the Commission used the terms tax avoidance and abuse as if they were synonymous, as far the analysis was concerned.

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c­onstitute an overriding reason in the public interest capable of justifying a restriction on fundamental freedoms. The Commission added that the notion of tax avoidance is limited to ‘wholly artificial arrangements aimed at circumventing the application of the legislation of the [Member States] concerned’.39 In order to be lawful, national tax rules must be proportionate and serve the specific purpose of preventing wholly artificial arrangements. As in the case law, the Commission emphasised that the mere fact that a subsidiary was established in another Member State could not, of itself, be treated as giving rise to tax avoidance.40 Similarly, the fact that the activities carried out by a secondary establishment in another Member State could just as well be pursued by the taxpayer from within the territory of its home Member State did not warrant the conclusion that there was a wholly artificial arrangement.41 The objective of minimising one’s tax burden was in itself a valid commercial consideration as long as the arrangements entered into with a view to achieving it did not amount to artificial transfers of profits. In so far as taxpayers had not entered into abusive practices, Member States could not hinder the exercise of their freedoms simply because of lower levels of taxation in other Member States.42 The detection of a wholly artificial arrangement amounted in effect to a substance-over-form analysis.43 As far as proportionality was concerned, again, the Commission, echoing case law, noted that in order to ensure that genuine establishments and transactions were not unduly sanctioned it was imperative that where the existence of a purely artificial arrangement was alleged, the taxpayer was given the opportunity, without being subject to undue administrative constraints, to produce evidence of any commercial justification that there may have been for that arrangement. This would be determined on a case-by-case basis44 and would be subject to an independent judicial review. The Commission Anti-Abuse Communication also offered some guidance regarding adjustments; these should be limited to the extent that was attributable to the purely artificial arrangement. ‘With regard to intra-group transactions that means adherence to the arm’s length principle, i.e. the commercial terms as would have been agreed upon between unrelated

39 

Commission Anti-Abuse Communication, n 37 above, p 3. Ibid, p 3. 41  Ibid. 42  Ibid. Citing Case C-294/97 Eurowings Luftverkehrs AG v Finanzamt Dortmund-Unna [1999] ECR I-7447, para 44. Interestingly, at pp 3–4, the Commission stated that distortions to the location of business activities due to state aid that was incompatible with the EC Treaty and to harmful tax competition did not entitle Member States to take unilateral measures intended to counter their effects by limiting freedom of movement. Rather they need to be resolved at source through the appropriate judicial or political procedures. Citing Advocate General Léger in Case C-196/04 Cadbury Schweppes plc and Cadbury Schweppes Overseas Ltd v Commissioners of Inland Revenue [2006] ECR I-7995, paras 55–60. 43  Commission Anti-Abuse Communication, n 37 above, p 4. 44  Ibid, p 5. In addition, the Commission considered that the burden of proof should not lie solely on the side of the taxpayer and that account should be taken of the general compliance capacity of the taxpayer and of the type of arrangement in question. 40 

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­parties’.45 Member States were not prevented from imposing penalties on taxpayers who had made use of abusive schemes to avoid tax. Later on in the Communication, the Commission applied these conclusions in the context of CFC and thin ­capitalisation rules.46 The same conclusions applied as regards EEA States, except in situations where there was no adequate information exchange relationship with the relevant EEA State.47 As far as third countries were concerned, in the context of CFC and thin capitalisation rules, the Commission stated that the gravity of these rules ‘lies clearly within freedom of establishment’48 to the extent that they involve definite influence and control. Member States should therefore not be precluded from applying CFC and thin cap rules in relation to third countries. ‘Community law does not impose any particular requirements on the legitimacy of the application of such legislation to transactions outside the EU’.49 However, should the application of those rules not be confined to situations and transactions between companies in a corporate group (or otherwise related parties where one has definite influence over the other), they would need to comply with the free movement of capital. Although the emphasis of this Communication was on tax abuse and the compatibility of anti-abuse measures with EU law, there was recognition of the importance of such measures for Member States, in protecting their tax bases. The Commission identified the need for a general review of Member State anti-­ avoidance rules.50 It was important for Member States to improve the coordination of anti-abuse measures within Member States and in relation to third countries. Inter alia, Member States were encouraged to establish common definitions of the notions of abuse and purely artificial arrangements, to improve administrative cooperation to detect and neutralise fraudulent fiscal practices, to exchange best practices compatible with Community law and to reduce overlaps, which can result in unintended non-taxation. Unintentional non-taxation was also mentioned earlier on in the Commission Anti-Abuse Communication, where it was noted that Member States need ‘to be able to operate effective tax systems and prevent their tax bases from being unduly eroded because of inadvertent non-taxation’.51 As further on elaborated, lack of concerted interaction between Member State tax systems could result in unintended non-taxation and provide scope for abuse, thus undermining the

45 

Ibid. Ibid, pp 6–7. 47  Ibid, pp 5–6. 48  Ibid, p 8. 49  Ibid. 50  Ibid, pp 8–9. 51  Ibid, p 5. 46 

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f­ airness and ­balance of these systems.52 To an extent, this could be perceived as the ­precursor of some of the actions subsequently taken at EU level not only to deal with tax abuse but also double non-taxation and later on aggressive tax planning. The shift in the Commission’s priorities, while barely noticeable at the time of the 2007 Commission Anti-Abuse Communication, was clearly evident in subsequent years.

5.2.2.  From Double Taxation to Double Non-Taxation A Communication on double taxation was published on 11 November 2011.53 In this Communication, the Commission expressed its determination to address double taxation problems. It was acknowledged that in the current state of the law, in the absence of an EU initiative, Member States were not obliged to prevent juridical double taxation, since this phenomenon fell outside the scope of fundamental freedoms.54 Citing also Commission consultations produced the previous year,55 it was reiterated that EU taxpayers remained significantly concerned by double taxation issues and the double taxation problem was significant: on average more than 20 per cent of the reported cases were above €1 million for corporate taxpayers and more than 35 per cent were above €100,000 for individuals.56

52  Ibid, p 6. Specific examples of mismatches giving rise to non-taxation were discussed in p 6. ‘­Mismatches may arise, for example, in relation to the qualification of debt and equity. One [Member State] may consider a transaction to be an equity injection and thereby exempt the income derived from it (as profit distribution), whereas another [Member State] may consider the same transaction to be a loan and allow tax deductibility for the consequent payments (as interest). This may result in a deduction in one [Member State] without corresponding taxation in another [Member State]. The same is true of hybrid entities, i.e. entities which are regarded as corporate bodies by one [­Member State] and as transparent entities by another. This difference in qualification may lead to double exemptions or double deductions. Such problems are best tackled at source, by reducing the ­occurrence of mismatches. Failing that, it is desirable to improve administrative co-operation to detect situations in which such mismatches are exploited abusively. The Commission proposes to discuss these issues with [Member States] in more detail to examine what scope there is for possible coordinated solutions in this area’. 53  See Communication from the Commission to the European Parliament, the Council and the European Economic and Social Committee, Double Taxation in the Single Market, COM(2011) 712 final—henceforth, the Commission Double Taxation Communication. 54  Ibid, p 5. See also ch 5 in HJI Panayi (2013), n 1 above. 55  See Public Consultation Paper, Double Tax Conventions and the Internal Market: factual examples of double taxation cases with a follow-up questionnaires for experts, corporate and individuals. Also see the summary of the responses received available on: ec.europa.eu/taxation_customs/resources/­documents/ common/consultations/tax/summary_report_consultation_double_tax_conventions_en.pdf. Also see Public Consultation Paper, Consultation on possible approaches to tackling cross-border inheritance tax obstacles within the EU (2010) and Public Consultation Paper, Consultation on Taxation of cross border interest and royalty payments between associated companies (2010). Available on: ec.europa.eu/taxation_ customs/common/consultations/tax/2010_04_doubletax_en.htm; ec.europa.eu/taxation_customs/ common/consultations/tax/2010_06_inheritance_en.htm; ec.europa.eu/taxation_customs/common/ consultations/tax/2010_08_royalty_en.htm. 56  See Commission Double Taxation Communication, n 53 above, p 6.

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Existing instruments were insufficient to address many of the remaining double taxation situations.57 The Interest and Royalties Directive was limited in scope. Also, tax treaties did not cover all taxes relevant from an internal market perspective; nor did they provide for the removal of double taxation, especially in triangular or multilateral cases. Moreover, tax treaty provisions were not interpreted and implemented consistently by all Member States. The time needed to conclude mutual agreement procedures under either the Arbitration Convention or tax treaties was too long and these procedures often did not succeed in solving the problems submitted. As an immediate step, the Commission referred to its proposal for a Common Consolidated Corporate Tax Base (CCCTB)58 and the proposal for a recast of the Interest and Royalties Directive.59 In addition, the Commission expressed its willingness to adopt further measures, such as possible solutions to tackle crossborder inheritance tax obstacles as well as the double taxation of dividends paid to portfolio investors.60 Other suggestions were the creation of a forum on double taxation for purely EU tax matters, a proposal for a code of conduct on double taxation and the feasibility of an efficient dispute resolution mechanism. The Commission also expressed its concerns about double non-taxation and said that it was reviewing the situation with a view to proposing appropriate action.61 Indeed, shortly thereafter, the Commission issued a public consultation document on double non-taxation.62 The scope of the double non-taxation consultation only included cases of cross-border double non-taxation, ie cases where the tax rules of two countries combined led to non-taxation. It was limited to direct taxes, such as corporate income taxes, non-resident income taxes, capital gains taxes, withholding taxes, inheritance taxes and gift taxes. It was stated that double non-taxation had potentially harmful effects in terms of fairness of the tax systems and distortion of the internal market.63 The Commission noted that avoidance of double non-taxation had ‘an enhanced importance in the present Economic Crisis context’.64

57 

Ibid. Brussels, COM(2011) 121/4, 2011/0058 (CNS); SEC(2011) 316 final. This was accompanied by a detailed impact assessment. See Commission Staff Working Document Impact Assessment Accompanying document to the Proposal for a Council Directive on a Common Consolidated Corporate Tax Base (CCCTB), Brussels, 16 March 2011, SEC(2011) 315 final. Also see Commission Staff Working Paper, Summary of the impact assessment—Accompanying document to the proposal for a Council Directive on a Common Consolidated Corporate Tax Base (CCCTB), SEC(2011) 316 final. 59  Proposal for a Council Directive on a common system of taxation applicable to interest and royalty payments made between associated companies of different Member States, COM(2011) 714 final. 60  Commission Double Taxation Communication, n 53 above, p 11. 61  Ibid, p 8. 62  Staff working paper, The internal market: factual examples of double non-taxation cases: Consultation document (Brussels, TAXUD D1 D(2012)). 63  Ibid, p 4. 64  Ibid. 58 

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The Commission sought consultation on a number of situations leading to double non-taxation, pointing out that the list was not exhaustive.65 Interested parties were invited to submit their contributions by 30 May 2012. The Commission then published a summary of the responses received.66 Overall, it was noted that there were fewer contributions compared to previous consultations. While having full regard to the principle of subsidiarity, the Commission reiterated the need to establish more coherence between Member States’ individual positions in the international tax arena. ‘This requires a greater degree of coordination at EU level so as to ensure that the momentum towards a more open and constructive tax co-operation continues at a global level’.67 It was noted that the business community expressed concerns on the scope of the consultation. In fact, many of the contributors did not provide answers to the specific questions of the consultation document, instead they provided broader and more general comments on the issues raised. One general criticism was that the consultation was vague. There was no clear distinction between actual double non-taxation (eg due to mismatches of hybrid entities and hybrid instruments) and tax competition (low taxation). A definition of ‘double non-taxation’ was needed.68 It was stressed that direct taxation falls within the competence of the Member States’ sovereignty. Several contributors found that any measures against double non-taxation should be handled at Member State level, while others found some coordination appropriate (eg to avoid mismatches). Others argued that the issue of double non-taxation should not be addressed separately from that of double taxation, as the two were considered as two sides of the same coin.69 There was support for the CCCTB as a measure to deal with some of these issues. The double non-taxation issue which most contributors found least acceptable was double non-taxation due to mismatches of countries’ qualifications of hybrid entities and hybrid financial instruments. Several contributors also argued that application of tax treaties sometimes led to double non-taxation. This was an issue also to be considered in the future. It was overwhelmingly stressed that double taxation and double non-taxation were two sides of the same coin and should

65  The following 10 situations were considered: mismatches of entities, mismatches of financial instruments, application of double tax treaties leading to double non-taxation, transfer pricing and unilateral Advance Pricing Arrangements, transactions with associated enterprises in countries with no or extremely low taxation, debt financing of tax exempt income, different treatment of passive and active income, double tax treaties with third countries, availability of relevant information for detection of double non-taxation. 66 Commission, Summary report of the responses received on the public consultation on factual examples and possible ways to tackle double non-taxation cases (Brussels, 5 July 2012, TAXUD D1 D(2012)). Available on: ec.europa.eu/taxation_customs/resources/documents/common/consultations/ tax/double_non_tax/summary_report.pdf. 67  Ibid, p 2. 68  Ibid, p 3. 69  Ibid, p 3.

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both be addressed by the Commission. Furthermore, it was noted that measures against double non-taxation had an adverse impact on European economic competitiveness. Therefore, it was preferable to coordinate the EU’s initiatives with other initiatives at EU and international level that addressed similar aspects of double (non-) taxation.70 Furthermore, building on the positive experiences of the Joint Transfer ­Pricing Forum (JTPF), it was suggested to set up a Forum on double taxation for purely EU tax matters and perhaps to cover double non-taxation. The Commission revealed its intention to publish a Communication on good governance in the tax area in relation to tax havens and aggressive tax planning before the end of 2012. These were indeed published, under slightly different titles, in the context of a wider Action Plan to reinforce the fight against tax fraud and tax evasion.

5.2.3.  The EU Pre-Action Plan Communication Since 2012, the EU institutions are taking a much more active role in the fight against tax fraud and tax evasion. On 2 March 2012, the European Council called on the Council and the Commission to rapidly develop concrete ways to tackle this issue, including in relation to third countries and to report by June 2012. On 19 April of that same year, the European Parliament adopted a resolution echoing the urgent need for action in this area.71 Following this, on 27 June 2012, the Commission adopted a Communication on concrete ways to reinforce the fight against tax fraud and tax evasion including in relation to third countries.72 In this Communication, it was suggested that the problems posed by tax fraud and evasion must be tackled at three levels. First, tax collection within each Member State had to be improved. Secondly, there was a need to enhance cross-border cooperation between Member States’ tax administrations. Thirdly, it was important for the European Union to have a clear and coherent policy vis-à-vis third countries in order to promote its standards at international level and ensure a level playing field. The Communication outlined how tax compliance could be improved and fraud and evasion reduced, through a better use of existing instruments and the adoption of pending Commission proposals. It also identified areas where further legislative action or coordination would benefit the European Union and

70  At the time, it was the EU Code of Conduct Group’s reports and the (pre-BEPS) OECD report on Hybrid Mismatches. See OECD, Hybrid Mismatch Arrangements: Tax Policy and Compliance Issues (OECD, 2012). 71  European Parliament resolution of 19 April 2012 on the call for concrete ways to combat tax fraud and tax evasion (2012/2599(RSP)). 72  Communication from the Commission to the European Parliament and the Council on concrete ways to reinforce the fight against tax fraud and tax evasion including in relation to third countries, COM(2012) 351 final of 27 June 2012.

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Member States. It was suggested that such action should not only target fraudulent activity and tax evasion but also aggressive tax planning.73 As such, the term aggressive tax planning was formally introduced and described as follows: ‘Aggressive tax planning includes the use of artificial operations or structures and the exploitation of mismatches between tax systems with the effect of undermining Member States’ tax rules and exacerbating the loss of tax revenues’.74 The importance of tax policy for fiscal consolidation and growth was noted,75 as well as the fact that fair and ambitious fiscal consolidation was impaired by inefficient and ineffective tax collection mechanisms. For many Member States there were substantial problems of tax evasion often linked to poor administrative capacity.76 The Commission suggested amending and strengthening existing ­instruments.77 At the same time, it had to be ensured that established good governance principles in the tax area, such as transparency, exchange of information and fair tax competition, were promoted in a more consistent manner, not just within the European Union but with third countries as well.78 Coherence between EU policies was essential. Good governance principles in the tax area should continue to be included in all relevant EU-level agreements with third countries79 as well as promoted through development cooperation incentives as outlined in previous Communications.80 Furthermore, it was suggested that cooperation with other international organisations should be improved and synergies should be explored.81

73 

Ibid, p 3. Ibid. 75  This was recognised in the process of the European Semester (Commission Communication on the Annual Growth Survey 2012—COM(2011) 815 final of 25 November 2011—17229/11; Council conclusions of 16 February 2012 (6353/1/12 Rev.1)) and the Euro Plus Pact (Council conclusions of 16 February 2012 (6404/1/12 Rev.1)). See p 4 of the Commission Communication on concrete ways to reinforce the fight against tax fraud and tax evasion, n 72 above. 76  Ibid, p 4. 77  Eg the Savings Directive, the Mutual Assistance Directive on exchange of information. There was also discussion of the possible use of the Tax Identification Number, the Quick Reaction Mechanism on VAT fraud etc: ibid, pp 6–9. 78  Ibid, p 9. 79  Ibid, p 11. 80  Communication from the Commission to the European Parliament and the Council, Promoting Good Governance in Tax Matters, COM(2009) 201 final of 28.4.2009 and Communication from the Commission to the European Parliament and the Council, Tax and Development—Cooperating with Developing Countries on Promoting Good Governance in Tax Matters, COM(2010) 163 final of 21 April 2010. 81  Commission Communication on concrete ways to reinforce the fight against tax fraud and tax evasion, n 72 above, p 11. It was noted that the European Union participates actively in other international forums such as the OECD, the International Organisation for Tax Administration (IOTA), the Inter American Center of Tax Administrations (CIAT), the International Tax Dialogue (ITD), the International Tax Compact (ITC), and the African Tax Administration Forum (ATAF). 74 

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As far as tax havens were concerned, the Commission briefly reviewed the ongoing work of the OECD.82 It was recognised that important progress was made through the almost universal adoption of strong rules on information exchange and transparency following the successful re-launching of the OECD’s Global Forum on Transparency and Exchange of Information for Tax Purposes. One criticism raised was that the Forum did not consider the question of ‘fair tax competition’, a principle which the European Union upheld internally via the Code of Conduct for business taxation.83 ‘Promoting such a concept to third countries is relevant both for the OECD and the EU’.84 The Commission added that the burden of additional compliance costs due to uncoordinated actions by Member States to protect their tax bases against tax havens fell on all taxpayers. Such compliance costs would be reduced if there was a coordinated action. The Commission discussed possible policy responses. This was a precursor to the Commission’s detailed Action Plan to strengthen the fight against tax fraud and tax e­ vasion. This Action Plan would seek to set out concrete steps to enhance administrative cooperation and to support the development of the existing good governance policy, the wider issues of interaction with tax havens and of tackling aggressive tax planning. The Action Plan, accompanied by two recommendations, was released in December 2012. By that time, the concept of aggressive tax ­planning was beginning to be firmly established and concerns about it widely shared in the international tax community.

5.2.4. Action Plan to Strengthen the Fight Against Tax Fraud and Tax Evasion The Commission Communication on an Action Plan to strengthen the fight against tax fraud and tax evasion85 set out the parameters of the scope of action to be taken. In this Communication, the Commission presented the initiatives it had already taken or had already discussed in its previous Communication86 and new initiatives. The Action Plan contained practical actions which could deliver concrete results to all Member States.87 In a remarkably different tone than in

82 

Ibid, pp 11–12. of the ECOFIN Council meeting on 1 December 1997 concerning taxation policy ([1997] OJ C2/1 of 6 January 1998). 84  Commission Communication on concrete ways to reinforce the fight against tax fraud and tax evasion, n 72 above, p 12. 85  Communication from the Commission to the European Parliament and the Council, An Action Plan to strengthen the fight against tax fraud and tax evasion, COM(2012) 722 final of 6 December 2012. 86  Commission Communication on concrete ways to reinforce the fight against tax fraud and tax evasion, n 72 above. 87  Action Plan, n 85 above, p 3. 83  Conclusions

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earlier communications it was noted that, taking into account the freedoms awarded to Member States when operating in the internal market, businesses may structure arrangements with such jurisdictions via the Member State with the weakest response to these issues. ‘This does not only erode Member States’ tax bases but also endangers fair competitive conditions for business and, ultimately, distorts the operation of the internal market’.88 Two recommendations were mentioned in the Communication. These were the Recommendation on measures intended to encourage third countries to apply minimum standards of good governance in tax matters (henceforth, the Recommendation on Good Governance)89 and the Recommendation on Aggressive Tax Planning.90 The Recommendations were published separately at the same time as the Communication but their essence was summarised in the Communication. The Recommendation on Good Governance sought to provide Member States with a set of criteria to identify third countries that did not meet minimum ­standards of good governance in tax matters and a ‘toolbox’ of measures in regard to third countries according to whether they comply with those standards, or are committed to complying with them. As far as the Recommendation on Aggressive Tax Planning was concerned, the Commission referred to complex and artificial tax planning leading to the relocation of the tax base to other jurisdictions within or outside the European Union, as well as mismatches in national laws leading to double non-taxation and the exploitation of tax rates. The Commission also noted that aggressive tax planning could be considered contrary to the principles of Corporate Social Responsibility.91 Therefore, concrete steps were needed to address the ­problem.92 This was an interesting link to draw—one that is increasingly ­discussed, as shown in Chapter one of this volume. The Commission expressed its willingness to contribute to the work of international tax fora such as the OECD. Initiatives mentioned were, inter alia: the development of international standards to address the complexities of taxing electronic commerce; the creation of a Platform for Tax Good Governance; improvements in the area of harmful business taxation; promoting the Code of Conduct for business taxation in selected third countries; ensuring the Directives do not lead to double non-taxation; and continuing to develop standard forms for exchange of information in the field of taxation etc.93

88 

Ibid, p 5. Commission Recommendation of 6 December 2012 regarding measures intended to encourage third countries to apply minimum standards of good governance in tax matters (C (2012) 8805 final). 90  Commission Recommendation of 6 December 2012 on Aggressive Tax Planning (C (2012) 8806 final). 91 Communication on a renewed EU strategy 2011–14 for Corporate Social Responsibility— COM(2011) 681 final of 25 October 2011. 92  Action Plan, n 85 above, p 6. 93  Ibid, pp 7–8. 89 

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The remainder of the Communication set out specific measures to be taken in the short term,94 medium term95 and long term96 to tackle the problems mentioned. This was the Commission’s self-proclaimed ‘general contribution to the wider international debate on taxation and [which was] aimed at assisting the G20 and the G8 in its on-going work in this field’.97 In the Recommendation on Good Governance, the Commission reiterated the importance of setting out minimum standards of good governance in tax m ­ atters. This was a practical but essential first step in aligning the attitudes taken by ­Member States vis-a-vis jurisdictions not applying minimum standards. It was stipulated that a third country would only be complying with minimum standards of good governance in tax matters where it had adopted legal, regulatory and administrative measures intended to comply with the standards of transparency and exchange of information,98 where it effectively applied those measures and did not operate harmful tax measures in the area of business taxation.99 Tax measures which provided for a significantly lower effective level of taxation, including zero taxation, were to be regarded as potentially harmful.100 Such a level of taxation could operate by virtue of the nominal tax rate, the tax base or any other relevant factor.

94  This would include, inter alia, the revision of the Parent-Subsidiary Directive and the anti-abuse provisions of the other Directives, promoting the standard of automatic exchange of information in international fora and the EU IT tools, a European Taxpayer’s Code, reinforcing cooperation with other law enforcement bodies, promoting the use of simultaneous controls and the presence of foreign officials for audits, obtaining an authorisation from Council to start negotiations with third countries for bilateral agreements on administrative cooperation in the field of VAT etc: ibid, pp 9–11. 95  This would include the development of a computerised format for automatic exchange of information on income from employment, directors’ fees, life insurance products, pensions and on ownership of and income from immovable property, pursuant to Art 8(1) of the Mutual Assistance Directive 2011/16/EU, the use of an EU Tax Identification Number (TIN), the development of guidelines for tracing money flows, extending EUROFISC (a system of rapid exchange of information on cases of fraud in the VAT area) to direct taxation, creating a one-stop-shop approach in all Member States, developing motivational incentives including voluntary disclosure programmes, a tax web portal, an EU Standard Audit File for Tax etc: ibid, pp 11–14. 96  This would include a methodology for joint audits by dedicated teams of trained auditors, the development of mutual direct access to national databases, a single legal instrument for administrative cooperation for all taxes: ibid, pp 14–15. 97  Ibid, p 15. 98  These were set out in the Annex of the Recommendation on Good Governance, n 89 above, p 8. 99  Ibid, pp 4–5. 100 When assessing whether such measures are harmful, account should be taken of inter alia: (a) whether advantages are accorded only to non-residents or in respect of transactions carried out with non-residents, or (b) whether advantages are ring-fenced from the domestic market, so they do not affect the national tax base, or (c) whether advantages are granted even without any real economic activity and substantial economic presence within the third country offering such tax advantages, or (d) whether the rules for profit determination in respect of activities within a multinational group of companies departs from internationally accepted principles, notably the rules agreed upon within the Organisation for Economic Co-operation and Development, or (e) whether the tax measures lack transparency, including where legal provisions are relaxed at administrative level in a non-transparent way. In applying these criteria, the Recommendation urged Member States to take account of the conclusions reached by the Code of Conduct Group on Business Taxation on this issue: ibid, p 5.

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A number of measures would be taken vis-à-vis third countries, with a view to encouraging those countries to comply with those standards. It was recommended that Member States should publish blacklists of third countries not complying with the minimum standards set out above.101 Furthermore, Member States that had already adopted national blacklists should include in such lists third countries not complying with these minimum standards. Member States were encouraged to renegotiate, suspend or terminate tax treaties with non-compliant third countries, as well as initiate bilateral negotiations for tax treaties with compliant third countries. Member States should consider offering closer cooperation and assistance to third countries, especially developing ones, which were committed to complying with the minimum standards. Such closer cooperation would assist those third countries in their fight against tax evasion and aggressive tax planning.102 In the Recommendation on Aggressive Tax Planning,103 aggressive tax planning was described as consisting in the taking advantage of the technicalities of a tax system or of mismatches between two or more tax systems for the purpose of reducing tax liability. It could take a multitude of forms. Its consequences included double deductions and double non-taxation.104 It was emphasised that, with a view to moving to a better functioning of the internal market, it was necessary to encourage all Member States to take the same general approach towards aggressive tax planning.105 Situations leading to double non-taxation could ‘lead to artificial capital flows and movements of taxpayers within the internal market and thus harm its proper functioning as well as erode Member States’ tax bases’.106 Member States were, inter alia, urged to introduce a subject-to-tax requirement both in their unilateral double tax relief rules and in their bilateral tax treaties with other EU Member States and with third countries Also, Member States were encouraged to incorporate GAARs in their national legislation.107 The following wording was suggested: An artificial arrangement or an artificial series of arrangements which has been put into place for the essential purpose of avoiding taxation and leads to a tax benefit shall be ignored. National authorities shall treat these arrangements for tax purposes by reference to their economic substance.

101 

Ibid. Ibid, p 6. ‘To this end, they could second tax experts to such countries for a limited period of time. When judging third countries’ commitment to complying with those minimum standards, Member States should take into account all concrete indications to this effect, in particular steps towards compliance already taken by the third country concerned’. See para 6.1. 103  Recommendation on Aggressive Tax Planning, n 90 above. See also definition of term in Commission Communication on concrete ways to reinforce the fight against tax fraud and tax evasion, n 72 above, discussed in section 5.2.3. 104  Recommendation on Aggressive Tax Planning, n 90 above, p 2. 105  Ibid. 106  Ibid. 107  Ibid, p 4. 102 

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It was explained in the Recommendation that an ‘arrangement’ meant any trans­ action, scheme, action, operation, agreement, grant, understanding, promise, undertaking or event. An arrangement could comprise more than one step or part. An arrangement was considered artificial where it lacked commercial substance.108 The Commission emphasised the risk for countries seeking to tackle the problem alone—the companies would simply relocate. An EU-wide response was needed to close loopholes and ensure that no country lost out financially for addressing the problem. The Commission was committed to monitoring the implementation of these recommendations and putting pressure on countries whose progress was slow. It is undeniable that the concept of aggressive tax planning, as developed through these Commission initiatives goes beyond the EU concept of abuse d ­ iscussed in section 5.1 above. In fact, some of the Commission’s recommendations such as the GAAR run contrary to the Court of Justice’s refusal to a­ cknowledge, in 3M ­Italia,109 the existence of a general principle of abuse of rights which would impose an obligation on the Member States to combat abusive practices in the field of direct taxation. Not only is such a measure now recommended—albeit in a technically non-binding manner—but the scope of abusive practices is expanded to cover legal gaps or mismatches leading to double non-taxation110 and harmful tax regimes. Notwithstanding the questionable legality of some of these recommendations, as time goes by, they are increasingly seen as irreversible, especially due to the similarities they share with the BEPS project which, in principle and as an idea, enjoys almost universal support. The question of compatibility of some of the Commission’s Action Plan proposals with EU law will further be addressed when considering the compatibility of the BEPS deliverables in Chapter six.

108  Ibid, pp 4–5. In determining whether the arrangement or series of arrangements was artificial, national authorities were invited to consider whether they involved one or more of the following situations: (a) the legal characterisation of the individual steps which an arrangement consisted of was inconsistent with the legal substance of the arrangement as a whole; (b) the arrangement or series of arrangements was carried out in a manner which would not ordinarily be employed in what was expected to be a reasonable business conduct; (c) the arrangement or series of arrangements included elements which had the effect of offsetting or cancelling each other; (d) transactions were circular in nature; (e) the arrangement or series of arrangements resulted in a significant tax benefit but this was not reflected in the business risks undertaken by the taxpayer or its cash flows; (f) the expected pre-tax profit was insignificant in comparison to the amount of the expected tax benefit. The purpose of an arrangement or series of arrangements consisted in avoiding taxation where, regardless of any subjective intentions of the taxpayer, it defeated the object, spirit and purpose of the tax provisions that would otherwise apply. It was useful to consider whether one or more of the following situations occurred: an amount was not included in the tax base; the taxpayer benefitted from a deduction; a loss for tax purposes was incurred; no withholding tax was due; foreign tax was offset. 109  Case C-417/10 3M Italia, n 33 above. 110  See Ana Paula Dourado, ‘Aggressive Tax Planning in EU Law and in the Light of BEPS: The EC Recommendation on Aggressive Tax Planning and BEPS Actions 2 and 6’ (2015) 43 Intertax 42–57.

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5.3.  The Aftermath of the Action Plan 5.3.1.  Improving Standards and Soft Law Following the publication of the Action Plan, the Commission has moved forward with several of the recommendations outlined. On 25 February 2013, the Commission launched two consultations: one on the European Taxpayer’s Code111 and one on the European Taxpayer Identification Number (the EU TIN).112 In the first consultation, the Commission proposed to develop a European Taxpayer’s Code which would embed a core but comprehensive set of common tax principles and taxpayers’ rights and obligations. Member States would then be in a position to establish or adapt their own codes by reference to these common and generally agreed standards. As far as cross-border operations were concerned, a European Taxpayer’s Code might not only lead to improved access to the internal market but could also help raise the overall standards of tax administration.113 Through its questionnaire, the Commission assessed the situation in Member States and examined existing experience with national taxpayer’s codes or similar instruments.114 In the second consultation on the EU TIN, it was noted that the absence of a common approach to the identification of taxpayers impaired the efficiency of administrative cooperation and (automatic) exchange of information in ­particular. Although almost all Member States used some form of national TIN, these were built according to national rules which differed considerably among countries. These differences made it difficult to correctly identify, register and report foreign TINs. The introduction of an EU TIN could resolve these difficulties and facilitate the proper identification of taxpayers engaged in cross-border operations. A unique EU TIN would maintain rather than replace the existing national TINs. As far as the design of an EU TIN, the Commission put forward a number of questions for consultation.115 On 23 April 2013, the Commission launched the Platform for Tax Good Governance, to discuss best practices in the fight against tax evasion, tax avoidance and

111  Consultation Paper—A European Taxpayer’s Code—Brussels, 25 February 2013 (TAXUD.D. 2.002 (2013) 276169). See Luca Cerioni, ‘The Possible Introduction of a European Taxpayer Code: Objective and Potential Alternatives’ (2014) 54 European Taxation 392-403. 112  Consultation Paper—Use of An EU Tax Identification Number—Brussels, 25 February 2013 (TAXUD.D.2.002 (2013) 276134). 113  Consultation Paper—A European Taxpayer’s Code, n 111 above, p 3. 114 For the questions and the summary report of the contributions, see Summary Report on the outcome of the public consultation from DG TAXUD—A European Taxpayer’s Code, Brussels, 12 ­September 2013, (TAXUD.D.2 (Ares 2013) 3252439). 115  See ec.europa.eu/taxation_customs/common/consultations/tax/2013_eutin_en.htm.

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tax havens.116 This platform would monitor Member States’ progress in tackling aggressive tax planning and clamping down on tax havens, in line with the aforementioned Recommendations. The Commission’s work on good governance was discussed in Chapter one in reviewing international initiatives on the topic.117 In its plenary session in May, 2013, the European Parliament approved its ‘Report on Fight against Tax Fraud, Tax Evasion and Tax Havens’.118 Many issues were raised in this Report. The European Parliament emphasised that the European Union should take the leading role in discussions on the fight against tax fraud, tax avoidance and tax havens in the OECD, the Global Forum on Transparency and Exchange of Information for Tax Purposes, the G20, the G8 and other relevant multinational fora. The importance of international cooperation in this fight was raised, as well as the need to persuade non-EU countries to build up and improve the efficacy of their respective tax collection systems by subscribing to the principles of transparency, automatic exchange of information and abolition of harmful tax measures, and to assist them in doing so.119

The European Parliament also welcomed the Foreign Account Tax Compliance Act (FATCA) as a first step towards an automatic exchange of information between the European Union and the US to fight cross-border tax fraud and tax evasion, criticising the fact that a bilateral/intergovernmental approach had been taken in the negotiations with the US rather than a common EU negotiating position.120 It also criticised the lack of full reciprocity in the exchange of information.121 The European Parliament called on Member States, as a matter of priority, to close the loopholes of the Savings Directive and welcomed the international discussions on the updating of the OECD guidelines on transfer pricing122 and the measures suggested in the Action Plan.123 The European Parliament called for a common EU approach towards tax havens but also asked the Commission to adopt a clear definition and a common set of criteria to identify tax havens.124 A public European blacklist of tax havens was necessary.125 There is certainly a lot of focus on transparency now. On 9 April 2013, five EU Member States (Germany, France, Spain, Italy and the UK) announced their

116  Commission Decision of 23 April 2013 on setting up a Commission Expert Group to be known as the Platform for Tax Good Governance, Aggressive Tax Planning and Double Taxation, Brussels, 23 April 2013 (C(2013) 2236 final). 117  See Ch 1, section 1.3 of this volume. 118  Report on Fight against Tax Fraud, Tax Evasion and Tax Havens (2013/2060(INI)), C ­ ommittee on Economic and Monetary Affairs, 2.5.2013. Available on: www.europarl.europa.eu/sides/getDoc. do?pubRef=-//EP//TEXT+REPORT+A7-2013-0162+0+DOC+XML+V0//EN. 119  Ibid, para 8. 120  Ibid, para 15. 121  Ibid. 122  Ibid, paras 46–47. 123  Ibid, paras 48–63, 67–75. 124  Ibid, paras 64–65. 125  Ibid, para 66.

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intention to co-operate on a pilot multilateral exchange facility. This would be based on the Model inter-governmental agreement for the implementation of FATCA. Through this, they would exchange the same type of information among themselves as they would exchange with the US under FATCA. Arguably, with the advent of the OECD’s Common Reporting Standard and with the amendments to the Mutual Assistance Directive 2011/16/EU discussed in 5.3.2, this arrangement is likely to be obsolete.126 In June 2013, the new Accounting Directive127 was enacted which introduced an obligation for large extractive and logging companies to report country-by-­country the payments made to governments, and also on a project-basis. The obligation to publish the accounts is for tax years beginning on or after 1 ­January, 2016. There are several exemptions for small and medium-sized enterprises.128 Increased transparency is also manifest in the Extractive Industries ­Transparency ­Initiative.129 ­Furthermore, the Revised Capital Requirements D ­ irective130 aims to improve transparency in the activities of banks and investment funds in different countries, particularly ­regarding profits, taxes and subsidies in different jurisdictions.131 More recently, there is a move towards cracking down on anonymous shell companies. On 12 January 2015, the Council issued a proposal designed to combat money laundering and terrorist financing.132 This proposal revised the fourth ­anti-money laundering directive to include a specific reference to tax crimes, as well as require Member States to store beneficial ownership information in central registers which would be accessible to the public. Legal professional privilege would be preserved.133 To access a register, a person would in any event have to d ­ emonstrate a ‘legitimate interest’ in suspected money laundering, terrorist 126  See OECD report on Standard for Automatic Exchange of Financial Account Information in Tax Matters and model agreement. Available on: www.oecd.org/ctp/exchange-of-tax-information/ automatic-exchange-financial-account-information-common-reporting-standard.pdf. 127  Directive 2013/34/EU of the European Parliament and of the Council of 26 June 2013 on the annual financial statements, consolidated financial statements and related reports of certain types of undertakings, amending Directive 2006/43/EC of the European Parliament and of the Council and repealing Council Directives 78/660/EEC and 83/349/EEC. 128  See Arts 30–32 of Directive 2013/34/EU. 129  For more information, see: eiti.org/. 130  Directive 2013/36/EU of the European Parliament and of the Council of 26 June 2013 on access to the activity of credit institutions and the prudential supervision of credit institutions and investment firms, amending Directive 2002/87/EC and repealing Directives 2006/48/EC and 2006/49/EC. 131 For commentary, see Rudolf Reibel, ‘Tax Transparency—How to Make it Work’ (2015) 55 ­European Taxation 209–12. 132  See Proposal for a Directive of the European Parliament and of the Council on the prevention of the use of the financial system for the purpose of money laundering and terrorist financing. See release on 12 January 2015, available on: data.consilium.europa.eu/doc/document/ST-5116-2015-ADD-2/en/ pdf. 133 See ibid, para 7 of preamble: ‘There should, however, be exemptions from any obligation to report information obtained either before, during or after judicial proceedings, or in the course of ascertaining the legal position of a client. Thus, legal advice should remain subject to the obligation of professional secrecy unless the legal counsellor is taking part in money laundering or terrorist financing, the legal advice is provided for money laundering or terrorist financing purposes or the lawyer knows that the client is seeking legal advice for money laundering or terrorist financing purposes’.

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­ nancing and in ‘predicate’ offences that might help to finance them, such as fi ­corruption, tax crimes and fraud. The persons who are able to demonstrate a legitimate interest should have access to information on the nature and extent of the beneficial interest held.134 The European Parliament and Council agreed on this proposal on 27 January 2015.135 On 20 April 2015 the Council approved the revision to the fourth anti-moneylaundering directive, including a requirement for all Member States to create central registers of beneficial ownership information for companies, other legal entities, and trusts incorporated in their respective territories.136 Member States must ensure that the registers are available to competent authorities, financial intelligence units, and ‘obliged entities’, such as banks conducting due diligence tasks. A person must show a legitimate interest in alleged money laundering, terrorist financing, and predicate offences such as tax crimes to be able to access the beneficial ownership details.137 For trusts, central beneficial ownership ­information registers will be used when the trust generates tax consequences. It is up to the discretion of Member States to decide whether to make their beneficial ownership registers public.138 More instruments are likely to follow. On 7 May 2015, the European Parliament Legal Affairs committee approved the Shareholders’ Rights Directive,139 a draft law that would require, inter alia, large undertakings and public-interest entities to publish country-by-country information on profits or losses before tax, taxes on profits or losses and public subsidies received. The draft law aims to improve transparency and foster shareholders’ commitment to companies which should in turn improve their competitiveness and sustainability.140

5.3.2.  Amendments to Direct Tax Directives Following the momentum created by the OECD/G20 BEPS Action Plan and the EU Action Plan, the Commission seized on the opportunity to amend several 134 See

ibid, para 11 of preamble. See 2015 WTD 18-14 (27 January 2015). Position of the Council at first reading with a view to the adoption of a Directive of the ­European Parliament and of the Council on the prevention of the use of the financial system for the purposes of money laundering or terrorist financing, amending Regulation (EU) No 648/2012 of the European Parliament and of the Council, and repealing Directive 2005/60/EC of the European Parliament and of the Council and Commission Directive 2006/70/EC, Brussels, 8 April 2015 (OR. en). Also see regulation, available on: 2015 WTD 76-20. For commentary, see Stephanie Soong Johnston, ‘EU Council Approves Beneficial Ownership Register Rules’ 2015 WTD 76-1 (21 April 2015). 137  The details to be accessed are name, month and year of birth, nationality, country of residence, and nature and approximate extent of held beneficial interest. 138  See Draft Statement of the Council’s Reasons, Brussels, 27 March 2015, available on: 2015 WTD 76-22. 139  For a background to the Commission’s initiatives to amend the Shareholders’ Rights Directive 2007/36/EC, see: ec.europa.eu/internal_market/company/shareholders/indexa_en.htm. 140  See Stephanie Soong Johnston, ‘EU Parliamentary Committee Backs CbC Reporting Measure’, 2015 WTD 89-1 (8 May 2015). 135 

136  See

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direct tax directives.141 Some of the proposed amendments, such as those to the Savings Directive,142 were long overdue. On 25 November 2013, the Commission made a proposal to amend the ParentSubsidiary Directive to tackle hybrid loans and mismatches.143 The proposal also required Member States to adopt a common general anti-abuse clause to prevent them from extending the benefits of the directive to arrangements that did not reflect economic reality. This would replace the existing anti-abuse provision found in Article 1(2) of the Directive. At the ECOFIN meeting on 6 May 2014 there was no agreement by Member States. Regarding the hybrid loans aspect of the proposal, there was broad agreement but Sweden requested further assurance on certain technical aspects. The Member States also did not agree with the proposed general anti-abuse clause. There were concerns that the formulation was too broad and could lead to different interpretations in different Member States, creating uncertainty for businesses. Discussions on the proposed amendments continued. At the ECOFIN meeting on 20 June 2014,144 Member States finally reached an agreement but only on the hybrid element of the proposal. Article 4(1)(a) of the Directive would be amended to provide that where a parent company, by virtue of its association with its subsidiary, receives distributed profits, the Member State of the parent company shall refrain from taxing such profits to the extent that such profits are not deductible by the subsidiary of the parent company. It was confirmed that this provision would be applicable in situations of double nontaxation resulting from mismatches in the tax treatment of profit distributions between Member States which generate unintended tax benefits. Member States would have until 31 December 2015 to transpose the amendment into national law. There was no agreement on the common anti-abuse provision—the Council agreed to split it from the broader proposal in order to allow early adoption of the new rule on hybrid loans. On 9 December 2014, it was announced that the Council finally approved the general anti-abuse provision which would replace the existing anti-abuse provision. Broadly, this provision would allow Member States not to grant the benefits of the Directive to an arrangement or a series of arrangements that, having been put into place for the main purpose or one of the main purposes of obtaining a tax advantage which defeats the

141  Measures have also been taken in the VAT field, where new instruments were introduced to better fight VAT fraud, eg the Quick Reaction Mechanism and the Reverse Charge Mechanism. Also see Commission Proposal for a Council Directive amending Directive 2006/112/EC on the common system of value added tax as regards a standard VAT return, COM(2013) 721 of 23.10.13. See also the Implementation Plan (SWD/2013/ 428), the Impact Assessment (SWD/2013/427) and its summary (SWD/2013/426). These measures and proposals are not considered further in this book. 142  See ch 2 in HJI Panayi (2013), n 1 above. 143  See IP/13/1149. 144 See announcement available on: www.consilium.europa.eu/uedocs/cms_data/docs/pressdata/ en/ecofin/143274.pdf.

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object or purpose of this Directive, are not genuine having regard to all relevant facts and circumstances.

An arrangement could comprise more than one step or part—ie it can be a series of arrangements. Also an arrangement or a series of arrangements would be regarded as not genuine to the extent that it was not put into place for valid commercial reasons which reflect economic reality. Member States were entitled to continue applying their domestic or agreement-based provisions required for the prevention of tax evasion, tax fraud or abuse.145 The Commission welcomed this breakthrough agreement. As Commissioner Moscovici said, ‘[t]he agreement on the anti-abuse provisions of the ParentSubsidiary­Directive ensures a level-playing field for honest businesses in the EU’s Single Market and it closes down loopholes that could be exploited for aggressive tax planning’.146 Arguably, there are a few issues with these amendments. First, the hybrid loan aspect of the proposal raises similar concerns to the linking rules of Action 2 of the Action Plan, because of the mechanical nature of the rule and its expansive scope beyond wholly artificial arrangements. The compatibility of the BEPS linking rules is discussed in greater detail in the next chapter. There are, however, differences between the two anti-hybrid rules which ought to be pointed out. It would seem that the Parent-Subsidiary Directive amendment allows the Member State of residence of the recipient not to exempt the profits received—it does not impose an obligation to do so.147 Furthermore, there is no obligation on the Member State of source (ie the state of residence of the payor of profit distributions) to act in a certain way. Of course that Member State can use the common anti-abuse provision to take further punitive action. But the fact remains that it is within the discretion of either Member State to take any action at all. If some Member States exercise this discretion and others not, then it can lead to jurisdiction shopping. The same result would ensue if Member States in principle set out to enforce this provision but in practice interpret it very laxly.

145  Art 1(2) would be replaced by the following: ‘2. Member States shall not grant the benefits of this Directive to an arrangement or a series of arrangements that, having been put into place for the main purpose or one of the main purposes of obtaining a tax advantage which defeats the object or purpose of this Directive, are not genuine having regard to all relevant facts and circumstances. An arrangement may comprise more than one step or part. 3. For the purposes of paragraph 2, an arrangement or a series of arrangements shall be regarded as not genuine to the extent that they are not put into place for valid commercial reasons which reflect economic reality. 4. This Directive shall not preclude the application of domestic or agreement-based provisions required for the prevention of tax evasion, tax fraud or abuse’. See No doc: 16435/14 FISC 221 ECOFIN 1157. For commentary, see Luc De Broe, ‘At Last, Some Output on the Fight against Double Non-Taxation’ (2014) 23 EC Tax Review 310–12. 146 See STATEMENT/14/2501, available on the Commission’s website: europa.eu/rapid/pressrelease_STATEMENT-14-2501_en.htm. 147  For a contrary view, see Evgenia Kokolia and Evgenia Chatziioakeimidou, ‘BEPS Impact on EU Law: Hybrid Payments and Abusive Tax Behaviour’ (2015) 55 European Taxation 149–56; Filip Debelva and Joris Luts, ‘The General Anti-Abuse Rule of the Parent-Subsidiary Directive’ (2015) 55 European Taxation 223.

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By contrast, the rules devised under Action 2 of the BEPS Action Plan rely on action which is required to be taken by either jurisdiction in which the mismatch arises. The aim is for the mismatch to be neutralised by either jurisdiction. As a result of the primary and defensive rules which apply automatically and in a hierarchical manner, there is an obligation on either jurisdiction to take action. The amendment in the Parent-subsidiary Directive relies on unilateral discretionary action, whereas the linking rules under Action 2 rely (or will aim to rely) on bilateral obligatory action. Notwithstanding these differences, it would seem that the same analysis as to compatibility with EU law applies. The fact that a measure is at the discretion of a Member State does not cure any potential incompatibility with EU law. There is a further issue with the new anti-abuse rule of the Parent-Subsidiary Directive. The new rule incorporates a main purpose test, akin to that of Action 6 of the BEPS Action Plan. The compatibility of such tests with EU law is considered in the following chapter. However, as has already been pointed out,148 even if this clause is compatible with the principles set out by the Court of Justice in the ­Halifax line of cases,149 unlike VAT, this is an area of law remaining largely unharmonised. Therefore, where the main rules are not themselves harmonised, it is rather odd to have harmonisation of anti-abuse rules—ie the exception to the rules.150 As a result of the impetus, the Savings Directive was also finally adopted. Although a proposal to amend the Savings Directive had been pending since 2008,151 up until recently there was no consensus to adopt it.152 On 24 March 2014, the EU Council of Ministers finally adopted the revised version of the Savings ­Directive.153 Changes were made to close existing loopholes and better prevent tax evasion. Inter alia, a look-through approach based on ‘customer due diligence’ was implemented which would have prevented individuals from circumventing the Directive by using an interposed legal person (eg foundation) or arrangements (eg trust) situated in a non-EU country which did not ensure effective taxation.

148 

See discussion in section 5.2.4 above. See analysis in section 5.1 above. As Hans van den Hurk noted, ‘[a]s the Member States are unwilling to agree on harmonization of the rules, harmonisation of the exception to such rules is unlikely to be accepted’. See Hans van den Hurk, ‘Proposed Amended Parent-Subsidiary Directive Reveals the European Commission’s Lack of Vision’ (2014) 9 Bulletin for International Taxation 488, 493. 151  Proposal for Council Directive amending Directive 2003/48/EC on taxation of savings income in the form of interest payments: COM(2008) 727 final. This proposal was again discussed in the ECOFIN Council on 14–15 February 2011. See also Council of the European Union, 6514/11, Provisional Version, PR CO 6, 3067th Council meeting, ECOFIN, Brussels, 15 February 2011. Reported at 2011 WTD 33-16. 152  Notwithstanding Member States’ reluctance to amend the Savings Directive, the Commission continued with its mandate to re-negotiate stronger savings tax agreements with Switzerland, Andorra, Monaco, San Marino and Liechtenstein. The main purpose of re-negotiating these agreements was to ensure the continued equivalence of the measures applied by these countries with those applied internally within the European Union. See MEMO/12/353. 153  [2014] OJ L155/50 of 15 April 2014. 149 

150 

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The provisions of the Savings Directive were also refined to ensure that individuals would not circumvent the Directive by using an interposed legal person situated in an EU Member State. National rules transposing the revised Savings Directive should be adopted by Member States by January 2016.154 Ironically, just when the amendments to the Savings Directive have finally been approved, the whole Directive is likely to be repealed in the near future. This is because of the all-encompassing changes to the Mutual Assistance Directive 2011/16/EU which Member States agreed to at the ECOFIN meeting in October 2014. In this important meeting, Member States agreed on a Commission proposal to apply the widest possible scope of automatic exchange of information within the European Union, to mirror the global standard of automatic information exchange agreed by the G20.155 It was agreed that from 2017, Member State tax authorities would automatically exchange information with each other on most categories of income and capital held by private individuals and certain entities. Austria was to be given an additional year to apply the new rules, so as to have sufficient time to make the necessary technical adaptations. The revised Mutual Assistance Directive would cover a wide scope of income and capital—including most of what was already covered by the revised Savings Directive. In order to have just one standard of automatic information exchange and to avoid legislative overlaps, the Commission recommended the repeal of the Savings Directive to ensure that no loopholes are created or left for tax evaders. In December 2014, the newly-appointed EU Tax Commissioner Pierre Moscovici announced that the Commission would unveil a directive on the automatic exchange of information on tax rulings in the first quarter of 2015 and would examine additional anti-avoidance proposals.156 Automatic exchange of tax rulings was, inter alia, one of the proposals that the OECD made in the context of Action 5 of the BEPS project,157 as discussed in Chapter two of this volume.158 In February 2015 the Commission announced that it would soon present a Tax Transparency Package, including a legislative proposal for the automatic exchange of information on tax rulings159 and a proposal for a Common Consolidated Corporate Tax Base (CCCTB).160 This would set a foundation for a fairer and more transparent approach to taxation in the European Union. The Tax Transparency Package was to be based on the Commission’s commitment in its Work 154 See ec.europa.eu/taxation_customs/taxation/personal_tax/savings_tax/revised_directive/ index_en.htm. 155  See n 126 above. 156  Stephanie Soong Johnston, ‘EU to Unveil Directive for Tax Rulings Info Exchange in Early 2015’, 2014 WTD 232-1 (3 December 2014). 157  See OECD, Countering Harmful Tax Practices More Effectively, Taking into Account Transparency and Substance—Action 5: 2014 Deliverable. 158  See analysis of Action 5, in Ch 2, section 2.7. 159 See Press Release on 18 February 2015, IP/15/4436 available on: europa.eu/rapid/pressrelease_IP-15-4436_en.htm. 160  Teri Sprackland, ‘Now Is the Time for Action on Transparency, EU Tax Commissioner Says’, 2015 WTD 37-4 (25 February 2015).

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Programme in December 2014 to clamp down on tax evasion and tax avoidance and to ensure that taxes are paid in the country where profits were generated.161 Indeed, not long after that announcement, the Commission released its tax transparency package, which is discussed in greater detail below.

5.4.  The Tax Transparency Package On 18 March 2015, the Commission presented its Tax Transparency Package— the latest initiative of its ambitious agenda to tackle corporate tax avoidance and harmful tax competition in the European Union. A key element was the proposal to introduce the automatic exchange of information between Member States on their tax r­ulings. The problem with tax rulings was that Member States shared very little information with one another about their tax rulings and it was at their ­discretion to decide whether a tax ruling might be relevant to another EU Member State. As a result, Member States were often unaware of cross-border tax rulings issued elsewhere in the European Union which might impact their own tax bases. This lack of transparency was exploited by certain companies in order to artificially reduce their tax contribution. As noted in the Commission Communication on tax transparency,162 tax rulings which result in a low level of taxation in one Member State may entice companies to artificially shift profits to that jurisdiction. ‘Not only can this lead to serious tax base erosion for other Member States, but it can further incentivise aggressive tax planning and corporate tax avoidance’.163 Under the existing Mutual Assistance Directive 2011/16/EU, information on tax rulings can be exchanged on a spontaneous basis under certain circumstances.164 The Member State granting the tax ruling is, however, the only one to decide whether, and for whom, this information may be relevant. Moreover,

161  See Press Release on 16 December 2014, IP/14/2703 available on: europa.eu/rapid/press-release_ IP-14-2703_en.htm. Among the 23 initiatives see the initiative entitled ‘A Fairer Approach to Taxation’ which sets out the following: An Action Plan on efforts to combat tax evasion and tax fraud, including measures at EU level in order to move to a system on the basis of which the country where profits are generated is also the country of taxation; including automatic exchange of information on tax rulings and stabilising corporate tax bases. 162  Communication from the Commission to the European Parliament and the Council on tax transparency to fight tax evasion and avoidance, COM(2015) 136 final (Brussels, 18 March 2015), p 4. 163  Ibid. 164  For example, if the country has grounds for assuming that there may be loss of taxation in another Member State and this information would be foreseeably relevant for the enforcement of the income tax law of that other Member State, or if a person liable to tax obtains a reduction in, or an exemption from, tax in one Member State which would give rise to an increase in tax or to liability to tax in the other Member State, or if the competent authority of a Member State has grounds for supposing that a saving of tax may result from artificial transfers of profits within groups of enterprises etc. See Art 9(1) of existing Mutual Assistance Directive 2011/16/EU, which sets out the scope and conditions of spontaneous exchange of information.

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it can refuse to spontaneously exchange information on the basis of its commercial secrecy laws or public policy. To address this situation, the Commission proposed new provisions on exchange of tax rulings to be built into the existing legislative framework for information exchange, through amendments to the Mutual Assistance Directive.165 This would enable the rapid implementation of automatic exchange of information on tax rulings, as the procedures and processes to do so were already in place. This is not the first time that automatic exchange of tax rulings was considered within the European Union. During 2012, the Code of Conduct Group for Business Taxation had reviewed developments in Member States’ procedures regarding tax rulings. The Group had identified the types of cross-border rulings on which information should be exchanged spontaneously, and recommended the development of a Model Instruction that could be used by Member States for internal application.166 Obviously, the scope of the Commission’s proposal under the Tax Transparency Package is much more empowering than this. When the Commission’s proposal is adopted, Member States would be required to automatically exchange information on their tax rulings. Every three months, national tax authorities would have to send a short report to all other Member States on all cross-border tax rulings and advance pricing agreements167 that they have issued after the date of entry into force of the suggested Directive, including those which were issued during the last 10 years but remain valid on 1 January 2016. Member States would then be able to ask for more detailed information on a particular ruling. The exchange of information is expected to be carried out using a standard form that will be produced by the Commission. The Commission will develop a database where information may be recorded and centralised for other Member States to detect certain abusive tax practices by companies and take the necessary

165  See Proposal for a Council Directive amending Directive 2011/16/EU as regards mandatory automatic exchange of information in the field of taxation, SWD(2015) 60 final, COM(2015) 135 final, 2015/0068 (CNS) Brussels, 18 March 2015. The proposed Directive would also update the rules in the existing Directive concerning the provision of feedback, the practical arrangements for information exchange and the evaluation of administrative cooperation so as to extend them to the automatic information exchange on advance cross-border rulings and advance pricing arrangements. 166  See Document 10903/12 FISC 77, mentioned in the proposal, p 3. 167  Under para 5 of the proposed Art 8a of the Directive (Scope and conditions of mandatory automatic exchange of information on advance cross-border rulings and advance pricing arrangements) the information to be communicated shall, as a minimum, include the following: (a) the identification of the taxpayer and where appropriate the group of companies to which it belongs; (b) the content of the advance cross-border ruling or advance pricing arrangement, including a description of the relevant business activities or transactions or series of transactions; (c) the description of the set of criteria used for the determination of the transfer pricing or transfer price itself in the case of an advance pricing arrangement; (d) the identification of the other Member States likely to be directly or indirectly concerned by the advance cross-border ruling or advance pricing arrangement; (e) the identification of any person, other than a natural person, in the other Member States likely to be directly or indirectly affected by the advance cross-border ruling or advance pricing arrangement.

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action in response.168 After the initial exchange, a Member State may request more details or the full text of the document if it can demonstrate that the information is foreseeably relevant. The concepts of advance tax ruling and advance pricing agreement are broadly defined to ensure there are no divergent interpretations which could enable Member States to circumvent their obligations.169 Tax rulings and advance pricing agreements that cover purely domestic transactions or cross-border rulings that exclusively concern the tax affairs of natural persons are outside the scope of the proposal. It should be noted that the cross-border element does not seem to be restricted to EU Member States. To an extent, whether or not a transaction is a cross-border one does not appear to be well-defined.170 The Mutual Assistance Directive provides for a general limitation, according to which the provision of information may be refused by Member States where it would lead to the disclosure of a commercial, industrial or professional secret, or of a commercial process, or of information the disclosure of which would be contrary to public policy.171 Under the proposal, this limitation would not apply with respect to the exchange of information on advance tax rulings and advance pricing agreements.172 The Commission considers that such interests would be adequately protected under EU law and that the limited nature of the information that is required to be shared with all Member States should ensure sufficient protection of those commercial interests. In its Communication accompanying the proposals of the Tax Transparency Package, the Commission argued that this initiative would encourage healthier tax competition, as tax authorities would be less likely to offer selective tax treatment to companies if this was open to scrutiny by their peers.173 Moreover, the automatic exchange of information on tax rulings would enable Member States to detect c­ ertain abusive tax practices by companies and take the necessary action in response. In the Communication, the Commission also repeated its proposal to repeal the Savings Directive, as this text had since been overtaken by more ambitious EU legislation, which required the widest scope of automatic information exchange on financial accounts, including savings-related income. Repealing the Savings Directive would also create a streamlined framework in this context and prevent any legal uncertainty or extra administration for tax authorities and businesses. 168  See para 6 of proposed Art 8a which enables the possible creation by the Commission of a secure central directory concerning information communicated in the framework of this proposal. 169  See proposed paras 14–15 of Art 3. 170  See amendment to Art 3 of the existing Directive—insertions of paras 14–15. Cross-border transaction is defined as follows: ‘[t]he cross-border transaction may involve, but is not restricted to, the making of investments, the provision of goods, services, finance or the use of tangible or intangible assets and does not have to directly involve the person receiving the advance cross-border ruling’. 171  See Art 17(4) of the existing Directive. 172  See proposed Art 8a(9). Also see preamble, para 5. 173  Communication from the Commission to the European Parliament and the Council on tax transparency to fight tax evasion and avoidance, COM(2015) 136 final (Brussels, 18 March 2015), p 4.

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The Commission outlined a number of other initiatives to advance the tax transparency agenda in the European Union. New transparency requirements for multinationals would be assessed, such as the public disclosure of certain tax information by multinationals. The Commission would consider the benefits, costs and necessary safeguards in terms of data protection, protection of business secrets, etc. It would also examine how it would affect international competitiveness. Impact assessment work would be launched to analyse the various possible options. The OECD’s BEPS work on transparency requirements would also need to be considered, as well as the costs and benefits of transposing such rules into European Union law.174 Also, the Code of Conduct on Business Taxation was to be reviewed. It was noted that over the past years, the Code had become less effective in addressing harmful tax regimes as its criteria did not take into account more sophisticated corporate tax avoidance schemes. The Commission would therefore work with Member States to review the Code of Conduct as well as the mandate of the Code of Conduct Group in order to make it more effective in ensuring fair and transparent tax competition within the European Union.175 Further work would also be undertaken towards the better quantification of the tax gap.176 The Commission, along with Eurostat, would work with Member States to see how a reliable estimate of the level of tax evasion and avoidance can be reached. The Commission would also continue to promote greater transparency internationally, furthering the OECD’s efforts through its BEPS project. As a follow-up, two legislative proposals would be submitted to the European Parliament for consultation and to the Council for adoption. It was hoped that Member States would agree on the proposal for automatic exchange of tax rulings by the end of 2015, so that it can enter into force on 1 January 2016. It was also announced that before the summer, there would also be an Action Plan on Corporate Taxation. This second Action Plan would focus on measures to make corporate taxation fairer and more efficient within the single market. The re-launch of the CCCTB would also be considered as well as ideas for integrating some of the BEPS proposals at EU level. The EU’s Tax Transparency package has been hailed as revolutionary by Commissioner for Taxation Pierre Moscovici, but also by the OECD Secretary-General Angel Gurria, who urged Member States to resist aggressive lobbying to weaken the legislation.177 At a joint hearing by members of the Special Tax Rulings Committee and the Economic and Monetary Affairs committees of the European

174 

Ibid, p 5. Ibid, p 6. 176  Ibid, p 6. It was explained that the tax gap is the difference between tax that is due and the amount actually collected by national authorities. Tax evasion and avoidance were not the only contributors to the tax gap—administrative errors and bankruptcies also played a role. 177 Stephanie Soong Johnston, ‘OECD Chief Hails EU Tax Transparency Package as “Revolu­ tionary”’, 2015 WTD 62-1 (1 April 2015). 175 

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­ arliament, Moscovici repeated calls for measures ensuring tax fairness in the P European Union.178 He called for a single market for taxation. The European Union has certainly been living up to its pledge of tackling tax evasion and aggressive tax planning. Whether the measures on enhanced transparency will improve Member States’ capacity to address harmful tax practices and profit shifting beyond EU borders, without having a detrimental impact on the international competitiveness of EU companies, remains to be seen. There is obviously an appetite within the European Union to tighten corporate tax rules against aggressive tax planning. Various groups and working parties have been examining specific topics which are also on the BEPS agenda. They are examined next.

5.5.  The Group on Digital Economy In October 2013, a High-Level Expert Group on Taxation of the Digital Economy (henceforth, the Group on Digital Economy) was appointed to examine taxation issues linked to the digital economy, looking at both indirect taxes such as VAT and direct corporate taxation.179 The Group was asked to identify key problems and solutions, as well as improvements in the current way of taxing the digital economy in the European Union, in order to enable the Commission to develop an appropriate tax framework. In a report published on 28 May 2014, the EU Digital Economy Report,180 the Group on Digital Economy reached a number of important conclusions. First, it noted that special rules for the digital economy were not needed. Rather, the general rules should be applied or adapted so that digital companies were treated in the same way as others. The role of digitisation in lowering the costs for small and medium-sized enterprises to access the internal market was considered. The importance of having simple and predictable rules to promote increased growth was emphasised. [A] well-coordinated tax system, simple to comply with and to administer and inspired by best practices becomes a necessary condition for digital technology to realise its Single Market potential. Tax barriers for small and medium sized enterprises (SME) operating in the Single Market should be removed.181

178  See comments made at Special Tax Rulings Committee and the Economic and Monetary Affairs Committees. Available on: www.europarl.europa.eu/news/en/news-room/content/20150330IPR39428/ html/Moscovici-Corporate-profits-should-be-taxed-where-value-is-created. 179  The Group included seven representatives from business and academia. The first meeting of the group took place on 12 December 2013 and it was mandated to report back to the Commission in the first half of 2014. 180  Report of the Commission Expert Group on Taxation of the Digital Economy, 28 May 2014, p 5. Available on: ec.europa.eu/taxation_customs/resources/documents/taxation/gen_info/good_ governance_­matters/digital/report_digital_economy.pdf. 181  Ibid, p 5.

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The Group on Digital Economy expressed a firm belief ‘that the digital economy offers great opportunities for Europe including solutions and opportunities to radically simplify tax administration and collection’.182 However, it also posed new challenges to which the tax systems needed to adapt.183 The Group on Digital Economy recognised that the increased mobility associated with digital technologies exacerbated challenges faced by the existing tax systems. In the substantive part of the report, it was reiterated that the high-profile cases that led to the BEPS agenda concerned digital companies. ‘There is a perception, supported by some of the publically available data, that BEPS is especially prevalent in the digital economy’.184 The Group on Digital Economy endorsed the work of the OECD/G20 on BEPS and emphasised that it was in the best interests of the European Union for Member States to speak with one voice in the project and to have common positions.185 At the same time, there was a tacit recognition of the limitations of the BEPS project: how it was bound by its mandate and timeline; and how it took the existing international rules as a given. By contrast to the OECD’s deliverables on Action 1 which made no ­recommendations,186 here there was general consensus on the destination ­principle—ie t­ axation at the place of consumption. This would apply to all goods and services. The Group on Digital Economy suggested that the EU Mini One Stop Shop (MOSS) which covers business-to-consumer sales of telecommunications, television/radio broadcasting and electronic services should be expanded into a broad One Stop Shop (OSS) to cover all business-to-consumer transactions. Under the MOSS, from 1 January 2015, businesses are able to register and pay VAT for the supply of these services to non-taxable persons in their country of residence. Rather than registering in each Member State of consumption, businesses would account for VAT via a web portal of one Member State only.187 It appears 182 

Ibid, p 11. Ibid. 184  Ibid, p 24. Reference was made to the US Senate’s Permanent Subcommittee on Investigations hearing on ‘Offshore Profit Shifting and the US Tax Code—Part 2 (Apple Inc)’: ibid, p 24, fn 27. The report contained, in Annexes 2A and 2B, an overview of the corporation tax charge in relation to the income and sales for a sample of the largest digital and non-digital US companies. 185  EU Digital Economy Report, n 180 above, p 41. 186  See Ch 2, section 2.3 of this volume. 187  See ‘Guide to the VAT Mini One Stop Shop’, published by the Commission on 23 October 2013, available on: ec.europa.eu/taxation_customs/resources/documents/taxation/vat/how_vat_works/­ telecom/one-stop-shop-guidelines_en.pdf. This scheme is optional and it is a simplification measure following the change to the VAT place of supply rules, in that the supply takes place in the M ­ ember State of the customer and not the Member State of the supplier. MOSS mirrors the scheme in place until 2015 for supplies of electronically supplied services to non-taxable persons by suppliers not established in the EU. There is no registration threshold. This has been criticised and is likely to change. For commentary, see Paolo Centore and Maria Teresa Sutich, ‘Taxation and Digital Economy: Europe is Ready’ (2014) Intertax 784–87; Matthew Dubin, ‘The EU Digital Service VAT Change and the Potential Effects on Suppliers and their Customers’ (2015) 78 Tax Notes International 535 (9 Feb 2015); Patrick Wille, ‘New Rules from 2015 Onwards for Telecommunications, Radio and Television Broadcasting, and Electronically Supplied Services’ (2015) 26 International VAT Monitor 6–8; Marie Lamensch, ‘The 2015 Rules for Electronically Supplied Services—Compliance Issues’ (2015) 26 International VAT Monitor 11–16; Rick Minor, ‘The EU’s Emerging Digital Single Market’ (2015) 78 Tax Notes International 599 (18 May 2015). 183 

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that the Group on Digital Economy views the successful introduction of MOSS as a precursor to the adoption of OSS.188 Furthermore, it was argued that there was no need for a new concept of digital taxable presence which would trigger taxable nexus on the collection of data over the internet, the processing and monetising of such data, ‘even if this was considered reasonable from the viewpoint of an appropriate international allocation of profits’.189 The Group on Digital Economy considered this option extensively and concluded that there was no convincing argument why the collection of data via electronic means in a country should in itself create a taxable presence in that country. It was recommended that deficiencies in the interpretation and application of the existing nexus provisions should be addressed under the BEPS project which was endorsed and the VAT system. ‘Revenue concerns of the country where digital services and products are consumed should be adequately addressed via the VAT system’.190 As far as reviewing the PE concept was concerned, such review was justified and necessary given the business models applied in the digital economy.191 The Group on Digital Economy suggested that the review should focus on two elements in the existing PE definition; first, remote contracting and the distinction between dependent agent and commissionaire and secondly, the definition of the ‘­preparatory or auxiliary activities’ exemption. As long-term policy options, it was recommended that the European Union should consider a fundamental review of international corporation tax mechanisms, including a consideration of both the allocation of the right to tax and the most appropriate base for corporation tax.192 The emphasis was on issues related to the taxation of MNEs where problems of identifying value creation were exacerbated. The digitalisation and transformation of the economy suggests that IP whose value is created within highly integrated groups will be more and more the rule. It is therefore appropriate to raise the question how long transfer pricing rules based on the arm’s length principle can be relied upon to give an objective outcome that is not susceptible to manipulation.193

One option was the CCCTB. The Group on Digital Economy also thought that given the pace of technological development and the need to avoid creating barriers to trade, more radical changes to the corporation tax system were needed. Another suggestion was a destination-based corporation tax. This would be similar to a VAT but exports would be zero-rated and imports would be taxed. Wages

188  See David D Stewart, ‘Digital Economy Raises Need for Simplified Tax Regimes, EU Report Says’ 2014 WTD 103-2 (29 May 2014). Also see Rick Minor, ‘A Practical Perspective on the EU Digital Economy Expert Group’s Proposals for VAT on Electronic Services’, 2014 WTD 106-5 (3 June 2014). 189  EU Digital Economy Report, n 180 above, p 47. 190  Ibid. 191  Ibid, p 48. 192  Ibid, p 41. 193  Ibid, p 49.

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would be deductible and the tax would continue to be levied on an accounting basis.194 In the meantime, it was recommended that partial changes to the e­ xisting system such as those mentioned above would help avoid additional layers of complexity. Given that the CCCTB has resurfaced in the Commission’s Tax Transparency Package, this may accelerate the implementation of some of the Group’s long-term options. Furthermore, a successful implementation of the MOSS may facilitate the application of the destination principle in this area. As such, the EU ‘solution’ could prove to be a precursor to an internationally-accepted solution for the ­purposes of Action 1 of the BEPS project too.195 Recently, on 6 May 2015, the Commission announced a strategy for a digital single market throughout the European Union, which includes plans to introduce legislation extending MOSS to cross-border remote sales of tangible goods.196 A set of t­argeted actions are to be delivered by the end of next year and will be built on three pillars: namely, better access for consumers and businesses to digital goods and services across Europe; creating the right conditions and a level playing field for digital networks and innovative services to flourish; and maximising the growth potential of the digital economy.

5.6.  The Code of Conduct Group on Business Taxation The Code of Conduct Group (Business Taxation) has also been instrumental in the design of standards and the development of measures to tackle harmful tax competition and international tax avoidance. The Code of Conduct Group was 194  Ibid, p 50. This proposal is broadly based on Michael Devereux and Alan Auerbach’s research on a d ­ estination-based cash flow tax. See A Auerbach and MP Devereux, Consumption and Cash-Flow Taxes in an International Setting (2012) Oxford University Centre for Business Taxation Working Paper Series, WP 12/14. Also see Michael Devereux and Rita de la Feria, Designing and implementing a ­destination-based corporate tax (2014) Oxford University Centre for Business Taxation, WP 14/07. The proposal has been criticised in that, inter alia, it would lead to a significant shift of revenue between small countries and countries with a strong export business to bigger markets and countries with small export businesses. See Björn Westberg, ‘Taxation of the Digital Economy—An EU Perspective’ (2014) 54 European Taxation 541–44. 195  For more concrete proposals, see report recently published by the French government agency France Stratégie on taxation in the digital economy. A number of recommendations are set out based on theoretical models regarding network rents, two-sided markets, privacy protection, and fiscal competition among countries. See Taxation and the digital economy: A survey of theoretical models—Final report, published on 26 February 2015. The report is available on Tax Analysts, 2015 WTD 49-18 (26 February 2015). 196  See Commission Communication, A Digital Single Market Strategy for Europe, COM(2015) 192 final (Brussels, 6 May 2015). Also see Commission Staff Working Document, A Digital Single Market Strategy for Europe—Analysis and Evidence Accompanying the document Communication from the Commission to the European Parliament, the Council, the European Economic and Social Committee and the Committee of the Regions A Digital Single Market Strategy for Europe, SWD(2015) 100 final (Brussels, 6 May 2015). For commentary, see William Hoke, ‘EU to Propose Extending MOSS to Remote Sales of Tangible Goods’, 2015 WTD 89-2 (8 May 2015).

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established in 1998197 under the chairmanship of UK Paymaster General Dawn Primarolo, to assess the tax measures that may fall within the scope of the Code of Conduct on Business Taxation.198 Member States could also report harmful tax measures in other Member States.199 Although technically the Code of Conduct Group has no binding powers, its ­decisions have great political force and cannot be easily ignored. The ­decision-making process of the Code of Conduct Group is not based on unanimity and has been described as being far from transparent.200 As noted in a recent report, the Group should maintain to aim at a (broad) consensus to reflect the positions of the Member States in the Group in its reports to ECOFIN, to avoid losing the effectiveness of the Group, while respecting the principle of unanimity as laid down in the Council conclusions of 9 March 1998 concerning the establishment of the Code Group. In the case broad consensus cannot be reached, the Group’s reports can express the various views mentioned.201

Initially, the Code of Conduct Group’s main focus was to examine potentially harmful tax measures in Member States in the context of the Code of Conduct on Business Taxation.202 The Code of Conduct required Member States to amend existing tax measures or practices that constituted harmful tax competition (rollback) and to refrain from introducing any such measures in the future (standstill). It identified as harmful, tax measures of a legislative, regulatory and ­administrative nature, which had, or might have a significant impact on the location of business in the Union203 and which departed from the benchmark system—ie which

197  Resolution of the Council and the Representatives of the Governments of the Member States, meeting within the Council of 1 December 1997 on a code of conduct for business taxation, [1998] OJ 06.01.1998. 198  Code of Conduct for Business Taxation, [1998] OJ C2 of 6 January 1998. For further analysis, see, inter alia, Hans Gribnau, ‘The Code of Conduct for Business Taxation: An Evaluation of an EU Soft-Law Instrument’ in Dennis Weber et al, Traditional and Alternative Routes to European Tax Integration (IBFD, 2010); William Bratton and Joseph McCahery, ‘Tax Coordination and Tax Competition in the European Union: Evaluating the Code of Conduct on Business Taxation’ (2001) 38 Common Market Law Review 677. On the work of the Code of Conduct Group in this area, which is subject to a high level of confidentiality, see Martijn Nouwen, ‘The Gathering Momentum of International and Supranational Action against Aggressive Tax Planning and Harmful Tax Competition: The State of Play of Recent Work of the OECD and European Union’ (2013) 53 European Taxation 491, at 499 et seq. Also see Carlo Pinto, Tax Competition and EU Law (Kluwer, 2003) 209, 217–19. 199  As Gribnau notes, this ‘informer’ provision was a great success as Member States put more than 175 measures on the list. See Hans Gribnau (2010), n 198 above, p 69. 200  Joris Luts, ‘Compatibility of IP Box Regimes with EU State Aid Rules and Code of Conduct’ (2014) 23 EC Tax Review 258–83, 276. Also see Code of Conduct Group (Business Taxation) Draft Council Conclusions (Work Packages) 26 November 2008, SN 16410/08, 5–6. 201  Report from the EU Code of Conduct Group (Business Taxation) to the ECOFIN Council of 4 December 2012, para 4. 202  See ch 2 in HJI Panayi (2013), n 1 above. 203  Code of Conduct, n 198 above, para A(1).

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­ rovided for a significantly lower effective level of taxation than the general level p of taxation in the Member State concerned.204 The first report of the Code of Conduct Group, also known as the Primarolo Report, was approved by the ECOFIN Council in Vienna on 1 December 1998. This report listed 66 preferential tax measures that had been found to be harmful. The Primarolo Report also listed six categories of harmful tax measures relating to insurance practices, financial services, transfer pricing, holding company regimes, exempt and offshore entities and miscellaneous measures. Interim draft reports had been published in 1998. Since 1999, numerous harmful tax measures in the legislation of Member States and associated or dependent territories have been revised or are being dismantled. As part of its regular work, the Code of Conduct Group monitors the standstill and rollback of harmful tax measures as agreed under the Code of Conduct.205 In the context of anti-abuse assessments, the Group has expanded the scope of its work to include hybrid entity and hybrid PE mismatches, patent boxes, double non-taxation, administrative practices, links to third countries and more. In 2009, a Subgroup of the Code of Conduct Group had begun work on a general framework for hybrid mismatch rules that would apply to intra-EU mismatch arrangements involving hybrid entities. The work of the Subgroup had provided valuable guidance on a coordinated approach to addressing hybrid mismatch arrangements. In a 2010 report to the ECOFIN Council206 the Code of Conduct Group (Business Taxation) agreed that participation exemptions should not lead to the exemption of payments that were treated as tax deductible by the country of the payer. In its 2012 Action Plan, the Commission called on the Group to provide rapid solutions to mismatches. Eventually, there was a proposal to amend the Parent–Subsidiary Directive, as discussed in section 5.3.2 above. It was reported at the June 2014 ECOFIN meeting207 that the Subgroup had produced a proposal for draft guidance on intra-EU hybrid entity mismatches. The Group was to continue its work for draft guidance on hybrid PEs. On 9 December 2014 the Code of Conduct Group again reported to ECOFIN as regards its work on guidance for hybrid entity mismatches. It has been reported that the guidance

204  Ibid, para B(1). The Code of Conduct on Business Taxation had set out some criteria for identifying potentially harmful measures, such as ring-fencing of a beneficial tax regime in favour of non-residents, significantly lower effective levels of taxation, lack of transparency, the conferral of tax advantages in the absence of any real economic activity or the deviation from internationally accepted rules on profit determination for companies in a multinational group: ibid. 205  Ibid. For a useful overview of the exercise of this function of the Group, see Vinod Kalloe, ‘­Corporate Tax Treatment of Interest: EU State Aid and the EU Code of Conduct as a Means of Combating Harmful Tax Competition’ (2011) 51 European Taxation 504–14. 206  Council Doc 16766/10 (7 December 2010). See also previous Code of Conduct Group Progress Report of 25 May 2010, doc 10033/10, para 31. 207  See Doc 11227/14 FISC 102 ECOFIN 701 (Brussels, 23 June 2014), p 14. Available on: register. consilium.europa.eu/doc/srv?l=EN&f=ST%2011227%202014%20INIT.

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focuses on two mismatch situations involving hybrid entities: one where a double deduction or other relief is given in two Member States for the same payment, and the other where a deduction or relief is given in one Member State without a corresponding receipt in another country. The solution put forward is for both Member States to treat the entity as non-transparent in the first situation, and as transparent in the second situation.208 This solution seems to require joint action by two Member States, as with the BEPS linking rules under Action 2. It is not a unilateral solution, or a unilateral solution in a multilateral instrument, as with the Parent-Subsidiary Directive.209 The Code of Conduct Group has also been mandated to review the third criterion (economic substance) of the Code of Conduct on Business Taxation in the context of patent box regimes. On 10 December 2013 the Group was asked by ECOFIN to assess all patent boxes in the European Union, taking into account international developments. On 9 December 2014 the Code of Conduct Group reported to ECOFIN, announcing that it had come to an agreement on the interpretation of economic substance in this context. The Code of Conduct Group endorsed the modified nexus approach,210 with a reservation from the Netherlands.211 Overall, it was concluded that the patent box regimes in the European Union were not compatible with the nexus approach and should be amended. It is interesting to note that the adoption of the modified nexus approach also suggests that henceforth, under patent box regimes there should be no ­conferral of tax benefits for intangibles developed in other Member States. This change was aimed at curbing (mainly but not only) the UK patent box regime, pursuant which benefits were broadly given irrespective of where the qualifying IP was developed.212 Under the UK patent box, companies could apply a lower rate of corporation tax (of 10 per cent) to profits earned from its patented inventions. A company could benefit from the patent box if it owned or exclusively licensed-in patents granted by the UK Intellectual Property Office, the European Patent Office

208 See KPMG Euro Tax Flash, Issue 243, 16 December 2014, available on: www.kpmg.com/Global/ en/services/Tax/regional-tax-centers/european-union-tax-centre/Documents/eu-tax-flash/etf-243. pdf. 209  See analysis in sections 5.3.2. and 6.2. 210  See Stephanie Soong Johnston, ‘EU Clarifies Position on Patent Box Inquiry’, 2015 WTD 25-2 (6 February 2015). Also see William Hoke, ‘European Commission Expands State Aid Inquiries’, 2014 WTD 243-2 (18 December 2014). 211  The Netherlands appeared to disagree with the limitation on the scope of the assets that would qualify for preferential treatment. For the Netherlands it was important that IP regimes were not limited to patents, but could also cover other innovations derived from R&D, provided that such activities had been certified by a competent government authority (not being the tax authorities), so that the linkage between R&D, IP-assets and profits (tracking and tracing) could be ensured. See reservation to be inserted to Council conclusions in the minutes of the ECOFIN Council on 9 December 2014 (Doc: 16846/14 FISC 233 ECOFIN 1196 (11 December 2014), para 2. 212  On an early discussion on this topic, see Kate Alexander, ‘Analysis—UK patent box: fair competition or a harmful tax practice?’, Tax Journal, Issue 1192, 11 (8 November 2013); Carmen Aquerreta, ‘The adviser Q&A: Is the UK’s patent box “harmful”?’, Tax Journal, Issue 1191, 9 (1 November 2013).

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and several EEA countries.213 Therefore, benefits were given even if the qualifying IP was developed outside of the UK. Germany had raised objections to IP boxes and specifically objected to the UK patent box, as the number of patents obtained in the UK by German-based companies had significantly increased since the UK regime was introduced in 2011.214 Germany had requested that the regime be investigated under the EU’s Code of Conduct on Business Taxation. The Commission seemed to share the belief that the UK’s patent box regime was in breach of the Code of Conduct.215 Germany favoured the introduction of a test limiting benefits by reference to the proportion of total R&D expenditures that a claimant company incurred.216 This was seen as a proxy for the amount of relevant substance a claimant had. The UK had previously rejected this approach, arguing that transfer pricing rules should instead be applied to ensure that company profits properly reflect the degree of substance in the company.217 There was also another, very important ground. Arguably, the UK position was mandated under EU law and more specifically under the fundamental freedoms of the Treaty on the Functioning of the European Union (TEFU). As shown in the next chapter, in the analysis of the compatibility of the modified nexus approach with EU law, the Court of Justice has held in the past that Member States cannot impose restrictions with respect to the location of the R&D activities giving rise to the qualifying asset.218 This leads to the incredulous situation whereby ‘a domestic (tax) legislator, by aligning his IP box regime with the fundamental freedoms of the TFEU, could fall foul of a “soft law” instrument such as the Code’.219 It is rather unfortunate that the Code

213  The EEA countries listed were the following: Austria, Bulgaria, the Czech Republic, Denmark, Estonia, Finland, Germany, Hungary, Poland, Portugal, Romania, Slovakia and Sweden. See HMRC guidance available on: www.gov.uk/corporation-tax-the-patent-box. 214  See Mindy Herzfeld, ‘Political Developments in BEPS and the EU’ (2014) 76 Tax Notes International 653 (Nov 24, 2014). For an overview, see Fabian Mang, ‘The (In)Compatibility of IP Box Regimes with EU Law, the Code of Conduct and the BEPS Initiatives’ (2015) 55 European Taxation 78–87; Antonio Carlos dos Santos, ‘What is Substantial Economic Activity for Tax Purposes in the Context of the European Union and the OECD Initiatives against Harmful Tax Competition?’(2015) 24 EC Tax Review 166–75. 215  In a report prepared ahead of the 22 October 2013 meeting of the Code of Conduct Group, the Commission argued that the UK rules were in breach of two of the criteria of the Code of Conduct on Business Taxation. First, there was a significantly lower level of taxation on patent related income and secondly, the tax advantages were conferred notwithstanding the lack of real economic activity and substantial economic presence within the Member State. At an ECOFIN meeting on 10 ­December 2013, a decision on the UK patent box was postponed. Instead, as explained in the main text above, ECOFIN invited the Code of Conduct Group to assess all EU patent boxes by the end of 2014, also against the background of international developments. For commentary, see David D Stewart, ‘European Commission Finds UK Patent Box in Violation of Code of Conduct’, 2013 WTD 202-1 (18 ­October, 2013). 216  See Jonathan Bridges, ‘The Q&A: The UK/German proposal for preferential IP regimes’, Tax Journal, Issue 1240, p 8 (21 November 2014). 217  Ibid. 218  See Case C-254/97 Baxter and Case C-39/04 Laboratoires Fournier, discussed in Ch 6, section 6.5 below. 219  Joris Luts (2014), n 200 above, 280.

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of Conduct Group had not considered this perspective. The point is revisited in the next chapter. It should be noted that patent box regimes may also fall foul of the state aid prohibition. Although in 2008 the Commission approved the Spanish patent box regime as not being selective, it is now rethinking its position.220 This was made clear in a press release in March 2014, at the beginning of an investigation in the ­Luxembourg tax practices.221 The reason for the rethink was that since 2008, the Commission ‘had received indications that special tax regimes seem to mainly benefit highly mobile businesses and do not trigger significant additional research and development activity’.222 Therefore, the Commission began to gather information to assess whether the regimes grant a selective advantage to a particular group of companies, in breach of EU state aid rules. The Commission asked in total 10 Member States with patent box regimes to give information on these regimes but no formal investigation was launched.223 Following the December 2014 ECOFIN meeting, it was thought—though not officially confirmed—that the Commission would not be pursuing state aid investigations (or would not be pursuing any case aggressively), pending ongoing discussions at the level of the Code of Conduct Group and the OECD on this topic. Although a political compromise seems to be preferred, the Commission has not, however, excluded the possibility of taking action itself.224 Overall, these are the main developments that have taken place at the time of writing. As commented above, the European Union has placed a lot of emphasis on tackling tax evasion and aggressive tax planning. The Commission has seized on this unique political momentum and many legislative proposals or amendments that had been lurking for some time have now been fast-tracked at Council level. However, some of the measures that have been adopted, or aspects of them, may be incompatible with EU law. This point was made throughout the chapter. There are similar concerns as regards the compatibility of some of the BEPS ­deliverables with EU law. These concerns are examined in greater detail in the next chapter.

220  Under the Spanish patent box regime notified to the Commission in August 2007, a corporate tax credit of 50% was to be given for revenues stemming from patents, designs, models, plans, secret formulas and processes. The tax credit was open to all companies, irrespective of their size or sector and there was no restriction concerning the location of the eligible activities. The public administration would have no discretion in applying the measure as the criteria were considered to be objective and defined ex-ante in the implementing regulation. The Commission concluded that the tax credit was within the logic of the Spanish tax system and that it would provide an incentive for companies to invest in R&D. See IP/08/216, dated 13 February 2008, available on: europa.eu/rapid/ press-release_IP-08-216_en.htm. 221  See IP/14/309, dated 24 March 2014. Available on: europa.eu/rapid/press-release_IP-14-309_ en.htm. 222  Ibid, pp 1–2. 223  Also see Lee A Sheppard, ‘Are EU Patent Boxes State Aid?’ (2015) 77 Tax Notes International 383 (2 February 2015). 224  See comments of Commission’s spokesman, reported by Stephanie Soong Johnston, ‘EU ­Clarifies Position on Patent Box Inquiry’, 2015 WTD 25-2 (6 February 2015).

6 The Compatibility of the BEPS Proposals with European Union Law This chapter examines the compatibility of some of the proposals produced under the BEPS deliverables with EU law. Where relevant, there is also a review of the compatibility of the recent EU measures taken to address aggressive tax planning. The analysis is made on the basis of several themes that arise from the BEPS deliverables. At the time of writing this book, the ambitious timeline for the delivery of the BEPS Action Plan had not yet expired. This chapter will proceed on the basis of what is already publicly available as of 1 June 2015.

6.1.  Rules on the Determination and/or Allocation of Taxing Rights: BEPS Actions 1, 7–10 The proposals made under Action items 1 and 7 to 10 largely represent rules on the determination and/or allocation of taxing rights. Such rules technically fall within the exclusive competences of Member States. As far as determination of taxing rights is concerned, the European Union cannot interfere in the tests that a Member State uses to exercise source taxation or taxation on the basis of residence (ie when taxing rights are to be triggered). For example, the European Union cannot interfere in the tests that a Member State uses to determine whether a permanent establishment arises in that Member State (source state jurisdiction), or when a company or an individual is tax resident (residence state jurisdiction). These fall within the exclusive competence of Member States. Technically, a Member State can determine that, notwithstanding insufficient presence for the purposes of Action 5 of the OECD Model, a permanent establishment would exist if a non-resident person is carrying on an ­activity in that Member State by supplying goods and services to resident customers.1

1  See, for example, one of the triggers of the UK’s Diverted Profits Tax, discussed in Ch 9 of this volume.

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Or, a Member State can determine that a company is tax resident if it is managed and controlled in that Member State even if it is incorporated in another jurisdiction.2 Similarly, the European Union cannot interfere with how a Member State exercises its ­taxing rights vis-à-vis other countries. From a residence-state perspective, a Member State may, for example, choose to tax a resident on a worldwide basis or on a citizenship basis or on a territorial basis. It may choose to tax income earned abroad by its resident employees or not. It may choose to tax a resident on the capital gains made abroad or not. It may choose to tax the pensions of resident individuals, irrespective of where those pensions arise and/or where the place of employment was. From a source-state perspective, a Member State may, for example, choose to tax income earned in its jurisdiction by a non-resident employee or not. It may choose to tax capital gains realised in its jurisdiction (especially from immovable property) by a non-resident or not. It may choose to tax artistes and sportsmen performing in that jurisdiction or not. It may choose to tax payments made to a non-resident individual for government services rendered in the source state or not. Alternatively, Member States may coordinate with other Member States (or third countries) on how to tax certain items of income to avoid double taxation, so that in certain cases, when acting as a state of residence or a state of source they forgo their taxing rights and in other cases not. Such pre-agreed allocation of taxing rights is epitomised in tax treaties which usually follow the OECD Model. Member States’ allocation of taxing rights tends to be respected by the Court of Justice.3 There would only be an issue of compatibility with EU law if a Member State in exercising its taxing rights discriminates against EU nationals or restricts their fundamental freedoms contrary to EU law. This would be the case, for example, if a permanent establishment (however defined) of a foreign company were taxed more heavily than a subsidiary of a foreign company,4 or if a tax resident person (however defined) upon becoming non-resident were taxed more heavily than a remaining tax resident person.5 These examples are derived from established case law of the Court of Justice, where a breach of EU law was found. In these 2  See for example the UK test on central management and control. For a review of the issues, see Christiana HJI Panayi, ‘UK Report’, ch 22 in Residence of Companies under Tax Treaties and EC Law, EC and International Tax Law Series, vol 5 (IBFD, 2009). 3  See section 4.3.3 in Christiana HJI Panayi, European Union Corporate Tax Law (Cambridge University Press, 2013). For examples of case law, see Case C-336/96 Gilly v Directeur des services fiscaux du Bas-Rhin [1998] ECR I-2793; and Case C-376/03 D v Rijksbelastingdienst (D case) [2005] ECR I-5821; Case C-513/03 Heirs of MEA Van Hilten-van der Heijden v Inspecteur van de Belastingdienst/­ Particulieren/Ondernemingen buitenland te Heerlen [2006] ECR I-1957; Case C-265/04 Bouanich v Skatteverket [2006] ECR I-923; Case C-374/04 Test Claimants in Class IV of the ACT Group Litigation v Inland Revenue Commissioners (ACT GLO case) [2006] ECR I-11673; Case C-414/06 Lidl ­Belgium GmbH & Co KG/Finanzamt Heilbronn [2008] ECR I-3601; Case C-128/08 Damseaux v État belge [2009] ECR I-6823. 4  Case 270/83 Commission v France (‘Avoir Fiscal’) [1986] ECR 273. 5  Case C-9/02 Hughes de Lasteyrie du Saillant v Ministere de l’Economie, des Finances et de l‘Industrie [2004] ECR I-2409; Case C-470/04 N v Inspecteur van de Belastingdienst Oost/Kantoor Almelo [2006] ECR I-7409.

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cases, the problem was not the formulation of the source or residence tests and the ­conditions imposed for an undertaking to be considered resident. Rather, what was problematic was the additional tax rules that, intentionally or incidentally, taxed undertakings more heavily when they engaged in cross-border activities. Roughly speaking, two thirds of the action items of the BEPS Action Plan relate to the determination and/or allocation of taxing rights and, one way or another, their aim is to refine the application of source-based or residence-based taxation tests in some highly complex arrangements. This is notwithstanding the OECD’s initial declaration that ‘these actions are not directly aimed at changing the existing international standards on the allocation of taxing rights on cross-border income’.6 Therefore, it is submitted that from an EU law perspective, there is nothing immediately objectionable, to the extent that the proposals would indeed be limited to the refinement of the rules on allocation of taxing rights. The European Union has no competence to force Member States to tax (or not to tax) commissionaire arrangements or to dictate the conditions for taxing the legal owner of intangibles and the functions that need to be performed and controlled for income allocation purposes. Nor does it have any power to force Member States to use certain methods of allocation of income (eg formulary apportionment or profit split methods) over other methods. It is very unfortunate that the Commission seems to be ignoring this very basic fact in its high-profile state aid investigations examined in the following chapter. Nevertheless, there are a number of proposals made in the context of the rest of the BEPS deliverables that do not fall under the category of allocation of taxing rights. Very importantly, the proposals in Action items 2 to 6 deal with the application of anti-abuse rules. However legitimate from an OECD and an international tax law perspective, anti-abuse rules are still rules which potentially hinder crossborder economic activities, contrary to the fundamental freedoms of the TFEU as interpreted by the Court of Justice. As such, these proposals need to be assessed in terms of their compatibility with EU law.7

6.2.  Unilaterally-Imposed and Mechanical Linking Rules: BEPS Action 2 One example of rules produced in the BEPS discourse which may be incompatible with EU law is the linking rules proposed under Action 2. It was shown in Chapter two that the OECD is recommending a primary rule that should be applicable in the primary jurisdiction with a defensive rule that would apply in the secondary

6 

OECD (2013), Action Plan on Base Erosion and Profit Shifting, p 11. Also see Ch 2 of this volume. For a general analysis, see Amanda Athanasiou, ‘EU Perspectives on BEPS’, 2014 WTD 182-2 (19 September 2014); Eric Kemmeren, ‘Where is EU Law in the OECD BEPS Discussion?’ (2014) 23 EC Tax Review 190–93. 7 

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jurisdiction in the absence of a primary rule in the first.8 Specific transactions are identified and there are no exceptions for genuine commercial transactions. The rules are very mechanical. This proposal may be problematic from an EU law perspective. First, a Member State which applies rules that are incompatible with EU law may not be able to justify this incompatibility on the basis that there is a tax mismatch which is not ‘cured’ by legislation in another Member State. The Court of Justice tends to follow the per country approach. In examining whether or not a national tax measure is compatible with EU law, either under the discrimination or the restriction approach, the Court of Justice rarely takes into account the overall context in which the measure is applied.9 The Court only considers the impugned treatment in the one Member State where the treatment is incurred. Tax benefits in the other Member State are irrelevant and cannot offset any fiscal hindrances in the Member State concerned. In the context of free movement of workers, the Eurowings10 and Danner11 cases unequivocally held that any tax advantage resulting for providers of services from the low taxation to which they are subject in the Member State in which they are established cannot be used by another Member State to justify less favourable treatment in tax matters given to recipients of services established in the latter State.12

Similarly, but in a factually different context, in Denkavit13 and Amurta14 the Court of Justice considered whether a discriminatory withholding tax in the host state could be neutralised by the provision of a unilateral tax credit in the taxpayer’s home state or a treaty-based tax credit.15 In both cases, the Court of Justice r­eiterated that a unilateral tax credit by the home state was not enough to ­neutralise the discriminatory treatment by the host state. In Amurta, it was emphasised that only neutralisation as a result of an underlying tax treaty was relevant. The difference between a treaty-based tax credit and a unilateral one was that the tax system resulting from the tax treaty formed part of the legal background of the proceedings and the Court of Justice had to take it into account in order to give an interpretation of EU law.16 Therefore, a Member State could ensure compliance with its obligations under EU law through the conclusion of 8 

See section 2.4 of this volume. See HJI Panayi (2013), n 3 above, pp 165–69. 10  Case C-294/97 Eurowings Luftverkehrs AG v Finanzamt Dortmund-Unna [1999] ECR I-7447. 11  Case C-136/00 Rolf Dieter Danner [2002] ECR I-8147. 12  Ibid, para 56; citing Eurowings, n 10 above, para 44. In the free movement of capital context, see Case C-35/98 Staatssecretaris van Financiën v BGM Verkooijen, [2000] ECR I-04071, para 61 and Case C-315/02 Anneliese Lenz v Finanzlandesdirektion für Tirol [2004] ECR I-7063, para 41, contain similar dicta. See HJI Panayi (2013), n 3 above, ch 4. 13  Case C-170/05 Denkavit Internationaal BV v Ministre de l’Economie, des Finances et de l’Industrie [2006] ECR I-11949. 14  Case C-379/05 Amurta SGPS v Inspecteur van de Belastingdienst/Amsterdam [2007] ECR I-9569. 15  See Georg Kofler, ‘Tax Treaty ‘Neutralisation’ of Source State Discrimination under the EU Fundamental Freedoms?’ (2011) 65 Bulletin for International Taxation 684, 685. 16  Amurta, n 14 above, para 80. 9 

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a tax treaty with another Member State.17 These cases give therefore a qualified endorsement to the per country approach by suggesting that tax treaties are to be factored into the equation. The recent Philip Electronics18 case arguably presents a more direct precedent against linking rules. However, it is not clear whether the ruling should be limited to situations where a Member State applies a restrictive rule in anticipation of beneficial tax treatment in the other Member State or whether it also applies to situations where there is already beneficial treatment in the other Member State. In this case, Philips Electronics UK Ltd, a UK taxpayer, made various consortium claims for group relief in its tax returns, in respect of losses incurred by the UK permanent establishment of a Dutch company, which was also the parent company of the taxpayer. The claims were refused on the basis that the losses could have been taken into account in the Netherlands. This was found to be incompatible with freedom of establishment. The restriction could not be justified on the basis of preserving the allocation of taxing powers, since only UK losses were to be surrendered against the profits of the UK taxpayer. Such losses as well as profits were within the scope of UK tax. Neither was the restriction justified by the need to prevent the double use of losses.19 In any case, according to the Court of Justice the prevention of the double use of losses did not constitute an autonomous justification—it had to be combined with another justification.20 In this case, the Court found that the restriction could not be justified by these grounds on their own or combined.21 Arguably, the question here was not about the ability to use losses that had already been used by an undertaking in another jurisdiction (ie double deduction) but rather the ability to use losses that might or could be used in another jurisdiction but which had not yet been used. Whether the same result would have been reached if the losses had already been used in another jurisdiction and the UK taxpayer wanted to use them again is not certain. The judgment seems to be phrased rather vaguely. For the Court of Justice, it would seem that the important point is that the UK has power to tax the permanent establishment. The losses were linked to the UK’s power to impose taxes. ‘That power is not at all impaired by the fact that the losses transferred might also, in appropriate circumstances, be used in the Netherlands’.22 In any case, as already mentioned, the Court found that double use

17 

Ibid, para 79. C-18/11 The Commissioners for Her Majesty’s Revenue & Customs v Philips Electronics UK Ltd [2012] ECR-I 532. 19  Although there was a risk of double use of losses (both in the host state where the permanent establishment was situated and also in the Member State where the non-resident company had its seat), the host state’s power of taxation was not affected: ibid, paras 30 and 31 (Court of Justice). The UK’s tax revenue was the same irrespective of whether losses of the permanent establishment were also taken into account in the Member State of the head office. 20  Ibid, para 33. Also see para 67 of the opinion of the Advocate General. 21  Ibid, para 35. 22  Ibid, para 31. 18  Case

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of losses was not enough by itself as a justification; it would have to be combined with another justification, most likely prevention of tax avoidance. This latter, more subjective justification is unlikely to be factored in mechanical rules though. Therefore, if under the OECD proposals on Action 2, a Member State would have to disallow the interest on a hybrid loan as a deductible expense upon application of the primary rule, because the corresponding interest income was not taxed by the Member State in which the recipient is tax resident, this is likely to be incompatible with EU law.23 The same analysis would apply vis-à-vis the secondary/defensive rule. However, case law suggests that if these linking rules are encompassed in a tax treaty between the relevant Member States, then any discriminatory tax treatment might be neutralised. There is a further possible complication. As already mentioned in Chapter two, the OECD hybrid rules would eliminate mismatches without a distinction between intended and unintended mismatches—ie there would be no need for any ‘purpose or intention test’, but merely an analysis of tax outcome. This mechanical nature of the test does not factor in the commerciality or artificiality of the arrangement. Nor does it satisfy the proportionality test developed by the Court of Justice. In the seminal case of Cadbury Schweppes,24 followed by numerous cases,25 it was held that a national measure restricting freedom of establishment (in that case) could be justified on the basis of prevention of tax avoidance and evasion only where it specifically related to wholly artificial arrangements aimed at circumventing the application of the legislation of the Member State concerned.26 The Court of Justice also held that restrictive anti-abuse rules had to be ­proportional—they had to exclude from their scope situations whereby, despite the existence of tax motives, the arrangements reflected economic reality. Later cases emphasised that the taxpayer must be given the opportunity, without being subjected to undue administrative constraints, to provide evidence of any commercial justification that there may have been for that transaction. Also, where there is re-characterisation­ of an interest payment, this re-characterisation would be limited to the proportion of that interest which exceeds the arm’s length amount. The relevance of this case law for mainstream anti-abuse rules such as CFC (Controlled Foreign Corporation) rules and thin cap rules, also in the context of the BEPS deliverables, is considered in greater detail in the next section. What is obvious though is that, to the extent that the OECD hybrid rules apply irrespective of the artificiality of the arrangement, they are at odds with the above case law. 23  Also see Peter Cussons, ‘Analysis—BEPS: possible EU law issues’, Tax Journal, Issue 1221, p 16 (20 June 2014). Cussons further argues that the possible carve-out from hybrid rules for certain taxpayers (eg banking regulatory capital requirements, or certain collective investment arrangements) may give rise to state aid concerns as well. 24  Case C-196/04 Cadbury Schweppes plc and Cadbury Schweppes Overseas Ltd v Commissioners of Customs & Excise [2006] ECR I-7995. 25  See ch 8 in HJI Panayi (2013), n 3 above. Also see analysis in section 6.3 immediately below. 26  Cadbury Schweppes, n 24 above, para 51.

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It should be noted that the same arguments and concerns which apply to the linking rules of Action 2, are equally applicable to the subject-to-tax approach suggested under the Recommendation on Aggressive Tax Planning.27 Similarly to the linking rules, a subject-to-tax approach would apply automatically without consideration of the commerciality of the arrangement. Notwithstanding the fact that this is a clear policy paper aligned with recent international trends, the ­Recommendation is technically soft law and as such does not supersede the case law of the Court of Justice discussed above. It simply evinces the Commission’s tax policy aspirations in this area. These should nevertheless be compatible with the principles set out in the case law of the Court of Justice. It could be argued that the anti-hybrid amendment of the Parent-Subsidiary Directive also applies mechanically28 and as such, it suggests an acceptance of all such mechanical rules—not just by the Commission that drafted the amendment but also by Member States that unanimously approved it. While this may be true, it does not mean that rules approved by Member States to become EU secondary legislation cannot be in breach of EU law, if they are in fact incompatible with the principles set out by the Court of Justice in its case law. However, is an anti-hybrid rule sewn into the fabric of a multilateral instrument more compliant with EU law than any co-ordinated but effectively unilaterally imposed anti-hybrid rules? It could be argued that as the linking rule is in an instrument (here, a Directive) that forms part of the legal background of the Member State that applies it, then the tax treatment in the other Member State which has triggered the rule could be taken into account. By analogy to the Denkavit29 and Amurta30 cases discussed above, if discriminatory treatment by one Member State can be neutralised by a tax treaty credit given by another Member State, then there is no reason why it cannot be neutralised as a result of a provision in a Directive, such as the Parent-Subsidiary Directive. Therefore, a Member State wishing to neutralise beneficial tax treatment given in another Member State is likely to be able to do so if there is a legal agreement between these Member States—whether as a result of a tax treaty or a multilateral convention or a Directive—allowing it. Furthermore, it could be argued that the anti-hybrid amendment of the ­Parent-Subsidiarity Directive ultimately aims to achieve a symmetrical treatment of intra-group profit distributions on a multilateral basis—it reflects an internationally agreed allocation of taxing rights, albeit unilaterally enforced.31 As such, it should be treated similarly to other tax treaty arrangements (on allocation of taxing rights) which, as explained elsewhere in this chapter,32 have been tolerated 27 

See Ch 5, section 5.2.4 of this volume. See Ch 5, section 5.3.2 of this volume. 29  Denkavit, n 13 above. 30  Amurta, n 14 above. 31  As the author suggested in Ch 5, section 5.3.2 of this volume, Member States seem to have discretion on whether to apply the anti-hybrid provision. If not applied consistently, there could be jurisdiction-shopping. 32  See sections 6.1 and 6.6 of this volume. 28 

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by the Court of Justice. By contrast, the OECD hybrid rules, unless incorporated in the multilateral agreement suggested under Action 15 of the BEPS project, are likely to be presented as a single-country response to hybrid mismatches and not as part of a bilateral/multilateral treaty arrangement. In other words, the OECD hybrid rules may be a different species of rules than those derived under a tax treaty arrangement or a Directive, which would not necessarily be protected the same way under EU tax law. Therefore, adoption of the anti-hybrid rule in the Parent-Subsidiary Directive does not mean that the OECD’s linking rules would be similarly welcome and, most importantly, compatible under EU law. The fact that, as shown in Chapter five, the Code of Conduct Group in its work on hybrid mismatches33 seems to be following a similar approach to the OECD’s linking rules should be a reason for concern.

6.3.  Rules Targeting Wholly or Partly Artificial Arrangements: BEPS Action 3 As explained in the previous section, the proposed hybrid rules and in fact any anti-abuse rules proposed under the BEPS Action Plan, such as Actions 3 and 4, have to comply with the principles set out by the Court of Justice in its case law. Cadbury Schweppes34 with its wholly artificial arrangements test is considered to be the main precedent in this area. Although this judgment was in the context of the CFC rules, the principles set out in this case have been applied in other areas dealing with anti-abuse rules.35 As already discussed in the previous section, in Cadbury Schweppes it was held that a Member State CFC regime which restricted the freedom of establishment could be justified on the basis of prevention of tax avoidance and evasion but only where it specifically related to wholly artificial arrangements aimed at circumventing the application of the legislation of the Member State concerned.36 The Court of Justice also held that restrictive anti-abuse rules had to be proportional—they had to exclude from their scope situations whereby, despite the existence of tax motives, the arrangements reflected economic reality. In determining whether or not economic reality existed, in addition to the subjective element, which consisted of the intention to obtain a tax advantage, objective factors had to be taken into account.37 33 

See section 5.6 of this volume. Cadbury Schweppes, n 24 above. See ch 8 in HJI Panayi (2013), n 3 above. 36  Cadbury Schweppes, n 24 above, para 51. 37  Ibid, paras 64–65. These objective factors, which were ascertainable by third parties, included, in particular, the extent to which the CFC physically existed in terms of premises, staff and equipment. In his opinion, Advocate General Léger had explained in greater detail some relevant criteria in establishing artificiality. First, the degree of physical presence of the subsidiary, ie examining whether or not the subsidiary has the premises, staff and equipment necessary to carry out the services provided to the 34  35 

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In the Thin Cap GLO,38 a case which examined the UK thin capitalisation rules, the proportionality requirement was further elaborated. There had to be a consideration of objective and verifiable elements which could be used to determine whether a transaction represented a purely artificial arrangement. More specifically, national legislation had to satisfy two requirements. First, the taxpayer had to be given the opportunity, without being subject to undue administrative constraints, to provide evidence of any commercial justification that there may have been for the impugned arrangement.39 Secondly, in these circumstances, the re-characterisation of interest paid as a distribution was limited to the proportion of that interest which exceeded what would have been agreed had the relationship between the relevant parties been at arm’s length.40 In other words, compliance with the arm’s length principle became part of the proportionality test, as far re-characterisation of interest was concerned. Although in a later transfer pricing case, the SGI case,41 the Court did not insist on finding wholly artificial arrangements, the proportionality test was followed.42 More recently, in Itelcar43 and Commission v UK,44 the Court of Justice again placed emphasis on the wholly artificial arrangements test. It was presented as a principle of established case law, that a national measure restricting the free movement of capital (in those cases) may be justified where it specifically targets wholly parent company. Secondly, the genuine nature of the activity provided by the subsidiary, ie considering the competence of the subsidiary’s staff in relation to the services provided and the level of decisionmaking in carrying out those services. Thirdly, the economic value of that activity with regard to the parent company and the entire group, ie whether or not the value reflects the exercise of genuine activities in the state of the subsidiary. Cadbury Schweppes, n 24 above, paras 111–14 (Advocate General). Also see analysis in ch 8 in HJI Panayi (2013), n 3 above. 38  Case C-524/04 Test Claimants in Thin Cap Group Litigation Order [2007] ECR I-2107. For commentary, see Christiana HJI Panayi, ‘Thin Capitalisation GLO et al—a thinly concealed agenda?’ (2007) 35 Intertax 298. 39  Ibid, para 82. 40  Ibid, para 83. 41  Case C-311/08 Société de Gestion Industrielle (SGI) v État belge [2010] ECR I-0487. 42  Under Belgian law, exceptional or gratuitous benefits given by a Belgian company to a non-­ resident company were automatically added to the taxable base of the Belgian company, if the recipient company was, directly or indirectly, in a relationship of interdependence with the Belgian company. In similar circumstances, if the recipient company was a Belgian company, such benefit was not automatically added back. The Court of Justice found that the Belgian transfer pricing rules restricted the freedom of establishment. This restriction was justified on the basis of preserving the balanced allocation of taxing powers between Member States. The Belgian legislation was also justified on the basis of preventing tax avoidance. Even though it was not specifically designed against purely artificial arrangements, the Court of Justice thought that it was justified by the objective of preventing tax avoidance, taken together with that of preserving the balanced allocation of the power to impose taxes between Member States. In subsequent paragraphs, the Court of Justice emphasised that the two justifications were to be taken together. As far as proportionality was concerned, the Court of Justice followed previous case law. The author has argued elsewhere that the SGI case should be interpreted as allowing Member States to apply their transfer pricing and thin capitalisation rules to a non-arm’s length arrangement, notwithstanding the arrangement’s otherwise commercial nature. This would help prevent a conflict with the OECD Model and the OECD Transfer Pricing Guidelines. It would also ensure more consistency with the Court’s case law on thin capitalisation and transfer pricing. See HJI Panayi (2013), n 3 above, pp 363–64. 43  Case C-282/12 Itelcar v Fazenda Publica [2013] ECR I-0000, para 34. 44  Case C-112/14 Commission v United Kingdom [2014] ECR I-0000, para 25.

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artificial arrangements which do not reflect economic reality and the sole purpose of which is to avoid the tax normally payable on the profits generated by activities carried out in the national territory. The EFTA Court used similar language in the Fred Olsen case.45 It comes, therefore, as a bit of a surprise that the OECD in its CFC Discussion Document46 described the case law of the Court of Justice as suggesting that, on the basis of the Thin Cap GLO case,47 a CFC regime may not be limited to wholly artificial arrangements. It was also argued that on the basis of the Thin Cap GLO case,48 a CFC rule in a Member State that targeted income earned by a CFC that was not itself wholly artificial may be justified so long as the transaction giving rise to the income was at least partly artificial. Reference was also made to the SGI49 and Oy AA50 case as supporting the claim that a CFC regime may not be limited to wholly artificial arrangements if the regime explicitly ensured a balanced allocation of taxing powers.51 The OECD’s reliance on the language of ‘partly artificial arrangement’ is very suspicious. First, Cadbury Schweppes remains the main, directly relevant authority for CFC rules and not the Thin Cap GLO case, which dealt with rules restricting interest deductibility.52 Secondly, the analysis in the CFC Discussion Document ignores subsequent cases where the wholly artificial arrangements test was emphatically reiterated,53 particularly in the context of CFC regimes.54 Thirdly, while there was mention once in the Thin Cap GLO judgment of ‘the transaction in question representing, in whole or in part, a purely artificial arrangement’,55 not much importance was placed on this point by the Court of Justice—or by commentators since then. The wholly artificial arrangements test of Cadbury Schweppes was repeated throughout the judgment as being the guiding authority. Perhaps references to a transaction being in part a purely artificial

45  Joined Cases E-3/13 and E-20/13 Fred Olsen and Others and Petter Olsen and Others v The Norwegian State, represented by the Central Tax Office for Large Enterprises and the Directorate of Taxes, [2015] OJ C68/5–6, 26.2.2015, paras 166 et seq. 46  See Ch 2, section 2.4 of this volume. 47  Thin Cap GLO, n 38 above. 48  Ibid, para 76. 49  SGI case, n 41 above. 50  Case C-231/05 Oy AA [2007] ECR I-6373. 51  Similar arguments were made in an article by Evgenia Kokolia and Evgenia Chatziioakeimidou, a fiscal attaché at the EU permanent representation of Greece and a member of the Legal Service of the Council of the European Union, respectively. See Evgenia Kokolia and Evgenia Chatziioakeimidou, ‘BEPS Impact on EU Law: Hybrid Payments and Abusive Tax Behaviour’ (2015) 55 European Taxation 149–56. 52  See ch 8 in HJI Panayi (2013), n 3 above, where it is explained how there have been slight variations to the Cadbury Schweppes test in different areas of the anti-abuse case law, especially for transfer pricing. 53 See Itelcar v Fazenda Publica, n 43 above and Commission v UK, n 44 above. 54  See, for example, Case C-201/05 Test Claimants in the CFC and Dividend Group Litigation v ­Commissioners of Inland Revenue (CFC GLO) [2008] ECR I-2875. 55  Thin Cap GLO, n 38 above, para 81.

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arrangement were relevant to the specific transaction in question: an excessive loan interest payment. Part of this payment was at arm’s length, part of this was non-arm’s length. Technically, the impact of the thin cap legislation was on the non-arm’s length amount. This is arguably why the Court of Justice referred to the transaction being in part a purely artificial arrangement. But the (excessive) interest payment does not arise out of nowhere—it is part of a loan agreement. While to an extent the entirety of the loan agreement could be seen as an artificial arrangement, technically, it was only a part of it—the non-arm’s length part of the interest payment—that was to be re-characterised under the relevant anti-abuse legislation. Extrapolating a new interpretation of the artificial arrangements test from a brief passing remark in a relatively old judgment is clearly aimed at eroding the importance of the Cadbury Schweppes test. Moreover, it seems slightly ­disingenuous for the OECD to argue that the relevant authority in a CFC context is a case on thin capitalisation rather than the case on CFC regimes which has hitherto been considered as the main authority. It is respectfully submitted that any proposals made under Action 3, to be compatible with EU law, should follow the established ­Cadbury Schweppes test and not the interpretation of it suggested under the CFC Discussion Draft. Whether this furthers the aims of the BEPS Action Plan is another question—very much irrelevant as far as the issue of compatibility with EU law is concerned.

6.4.  Group-Wide Rules and Comparability Issues: BEPS Action 4 A few issues also arise from the Interest Deductibility Discussion Draft.56 As shown in Chapter two, under the proposals of this Discussion Draft, there seems to be reliance on mechanical tests which do not necessarily target wholly artificial arrangements. Nor do these proposals seem to give the taxpayer an opportunity, without subjecting him to undue administrative constraints, to provide evidence of any commercial justification that there may have been for that transaction. Such tests are arguably incompatible with the case law of the Court of Justice analysed in the previous two sections—6.2 and 6.3. Member States are well-advised to eschew mechanical tests relying on fixed benchmarking ratios. While the Interest and Royalties Directive only affects the tax position of the interest creditor and does not prevent Member States from making interest payments non-deductible at the level of the payer,57 the thin

56 

See Ch 2, section 2.6 of this volume. See Case C-397/09 Scheuten Solar Technology GmbH v Finanzamt Gelsenkirchen-Süd [2011] ECR I-6455. 57 

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c­ apitalisation case law of the Court of Justice is still relevant.58 Any rules curbing interest ­deductibility must be proportional and must give the taxpayer an opportunity, without subjecting him to undue administrative constraints, to provide evidence of any commercial justification that there may have been for that transaction. Also, where there is re-characterisation of interest, this re-characterisation must be limited to the proportion of that interest which exceeds the arm’s length amount. Furthermore, it is noteworthy that under one of the suggested approaches of the Interest Deductibility Discussion Draft, the group-wide approach, a company’s net interest deductions should be limited to a proportion of the group’s actual net third party interest expense. While this approach may have unitary flavours and may (further) evince the OECD’s shift away from strict separate entity accounting and towards group formulae, it may be problematic from an EU law perspective. As explained above, the Court of Justice in its case law tends to follow the per country approach in examining whether or not a national tax measure is compatible with EU law. Therefore, the Court of Justice may not accept a Member State rule which restricts the deductibility of an interest payment to a nonresident group company on the basis of the rest of the group’s overall third party interest expenses.59 Repeating the principles derived from the Eurowings60 and Danner61 cases, tax benefits in another Member State are irrelevant and cannot offset any fiscal hindrances in the Member State concerned. Although the groupwide approach aligns individual entities’ interest expenses with the overall group’s interest expenses and as such gives more economic substance to the structure, paraphrasing Eurowings, less favourable treatment in one Member State cannot be justified by any tax advantage resulting from low taxation or other tax benefits in another Member State. If the European Union is keen to go down this path, a better alternative would be to consider formulary apportionment in the context of the Common Consolidated Corporate Tax Base. This suggestion could also lead to the odd situation where the same interest payment paid to two different non-resident group companies for the same underlying loan may be taxed differently depending on the overall leverage of their group. It might be hard to argue that the interest recipients are not in a comparable situation because of the overall leverage of a multinational group. The comparator exercise, for the purposes of finding different treatment, is likely to be undertaken 58  See Case C-324/00 Lankhorst-Hohorst GmbH v Finanz Steinfurt [2002] ECR I-11779; Thin Cap GLO, n 38 above; Case C-105/07 NV Lammers and Van Cleeff [2008] ECR I-173. For an overview of the relevant case law, see ch 8, HJI Panayi (2013), n 3 above. 59  If the whole group is resident in the Member State imposing the group-wide approach, then arguably there is no cross-border issue and no restriction of the freedom of establishment. It is an issue of domestic law. If some of the group members are resident and some are non-resident, then, arguably, taking into account the leverage of the non-resident group companies may not be consistent with the per country approach and the Eurowings, n 10, and Danner, n 11 cases discussed above and in section 6.2. 60  Eurowings, n 10 above. 61  Danner, n 11 above.

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only in the source Member State where the interest deduction is sought. The ­leverage of other group companies in other jurisdictions is likely to be irrelevant.

6.5.  Modified Nexus Approach and Economic Substance: BEPS Action 5 As explained in Chapter two, Action 5 aims to develop rules to counter h ­ armful tax practices more effectively, taking into account transparency and substance. Two important components of the OECD’s proposals in this area were reviewed: first, the methodology which had been developed in defining the substantial activity requirement in the context of intangible property (the nexus approach) and, secondly, the proposed framework for compulsory spontaneous exchange of tax rulings. The analysis in this chapter focuses on the first component. The nexus approach, later on refined as the modified nexus approach,62 has raised a few eye-brows. As discussed in Chapter five, following intense lobbying mainly from Germany, the UK agreed to change its patent box regime so as not to permit inbound transfers of IP anymore.63 Under the UK patent box regime, acquired IP could be imported to the UK, regardless of where it was developed. With the Code of Conduct Group and the OECD agreeing to this modified approach,64 and apparently the Commission and EU Council legal services giving their blessings,65 the UK regime in its current form will gradually be phased out. However, this modified nexus approach may in fact be in violation of the fundamental freedoms as, notwithstanding the availability of the 30 per cent uplift, it could still disallow most of the R&D expenses incurred in other Member States to benefit from the benefits of a domestic patent box regime. Whilst the 30 per cent uplift of the eligible R&D expenditures outsourced to related parties and IP acquisition costs does not seem to be restricted to expenditures incurred in the jurisdiction providing the patent box benefits, the mischief of this provision is to (partly) reduce the negative impact of an IP box company choosing to outsource R&D activities to group companies. It does not open the gateways for foreign R&D expenditure to be taken into account. Therefore, arguments of incompatibility with EU law persist. In the past, the Court of Justice had struck down regimes that did not extend benefits such as deductions or tax credits to expenditure incurred in other Member States, when such benefits were given for domestic expenditure.

62 

See analysis in ch 2, section 2.7 of this volume which looks at the deliverables on Action 5. See Ch 5, section 5.6 of this volume. 64  Ibid. 65  See interview of Pascal Saint Amans, where he states that the nexus approach has been agreed by the European Commission and by the Council legal services. See ‘Conversations: Jeffrey Owens and Pascal Saint-Amans’ (2015) 77 Tax Notes International 797, 2 March 2015. 63 

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In Baxter,66 the Court of Justice examined French legislation which imposed a special levy on the pre-tax turnover of French undertakings that exploited proprietary medicinal products. The undertakings were allowed to deduct from the amount payable expenditure incurred during the same tax year on research carried out in France only. The legislation was found to be in breach of freedom of establishment and the free movement of capital. As the Court of Justice explained, the imposition of a levy against which only expenditure on research carried out in France was to be deducted, was such as to put the (French) secondary places of business of pharmaceutical companies whose headquarters were located in another Member State at a disadvantage in relation to pharmaceutical undertakings whose principal places of business were located in France. This was because in the majority of cases, research units were located in the same Member State as the undertaking’s principal place of business.67 The restriction could not be justified on the basis of preserving the effectiveness of fiscal supervision. A Member State could apply measures which enabled the amount of costs deductible in that state as research expenditure to be ascertained clearly and precisely. However, national legislation which absolutely prevented the taxpayer from submitting evidence that expenditure relating to research carried out in other Member States had actually been incurred could not be justified on this basis.68 Similarly, in Laboratoires Fournier,69 the Court of Justice struck down French rules which disallowed the deduction of R&D expenses not incurred in France. The disallowance restricted the right of companies in other Member States to provide services in the form of research. The Court rejected the French government’s argument that the disallowance was justified on the basis of preserving the coherence of the tax system. Here, there was no direct link between general corporation tax, on the one hand, and a tax credit for part of the research expenditure incurred by a company, on the other hand. Therefore, the justification was inapplicable.70 The French government had also argued that the restriction was justified by the objective of promoting research—a justification which was rejected by the

66  Case C-254/97 Société Baxter, B Braun Médical SA, Société Fresenius France and Laboratoires Bristol-Myers-Squibb SA v Premier Ministre, Ministère du Travail et des Affaires sociales, Ministère de l’Economie et des Finances and Ministère de l’Agriculture, de la Pêche et de l’Alimentation [1999] ECR I-4809. 67  Ibid, para 21. 68  Ibid, paras 18–19. As noted by the Court of Justice in para 20: ‘The taxpayer should not be excluded a priori from providing relevant documentary evidence enabling the tax authorities of the Member State imposing the levy to ascertain, clearly and precisely, the nature and genuineness of the research expenditure incurred in other Member States’. 69  Case C-39/04 Laboratoires Fournier SA v Direction des vérifications nationales et internationals [2005] ECR I-2057. 70  Ibid, paras 20–21.

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Court of Justice. Although the promotion of research and development could be an ­overriding reason relating to the public interest, the fact remains that it cannot justify a national measure such as that at issue in the main proceedings, which refuses the benefit of a tax credit for research for any research not carried out in the Member State concerned.71

A justification based on the effectiveness of fiscal supervision was not accepted either. While a Member State may apply measures which enable the amount of costs deductible in that state as research expenditure to be ascertained clearly and precisely, national legislation which absolutely prevents the taxpayer from submitting evidence that expenditure relating to research carried out in other Member States has actually been incurred and satisfies the prescribed requirements cannot be justified in the name of effectiveness of fiscal supervision.72

It was reiterated that the possibility of the taxpayer being able to provide relevant documentary evidence enabling the tax authorities of the Member State of taxation to ascertain, clearly and precisely, the nature and genuineness of the research expenditure incurred in other Member States could not be excluded a priori.73 It is difficult to see how the OECD’s nexus approach, as modified following the adoption of the UK-Germany compromise, can be aligned with the above case law. More worrying is the fact that when the above arguments arose in the context of the UK patent box regime, the UK’s defence—that the ‘extraterritorial’ element of its patent box regime was necessary under EU law—was completely ignored (or dismissed) by the Code of Conduct Group.74 This distortion of the hierarchy between soft law and hard law, which is likely to continue in the post-BEPS world, might lead to unexpected and damaging outcomes, as explained in Chapter nine. In any case, the need remains for an economic substance criterion to be determined for the purposes of the Code of Conduct on Business Taxation, as shown in Chapter five. How can this criterion be interpreted compatibly with EU law? Here, freedom of establishment is likely to be the relevant freedom, as the aim of the Code of Conduct is to identify potentially harmful tax measures which have a significant impact on the location of business in the European Union.75 In other words, the mischief which the Code of Conduct tries to address is the distortion of competition by the provision of tax benefits in the absence of economic activity (leading to relocation), when such economic activity should be present. While the

71  Ibid, para 23. The Court of Justice also found that the French legislation was directly contrary to the objective of the Community policy on research and technological development which was set out in ex Article 163 EC. 72  Ibid, para 25. 73  Ibid. 74  See ch 5, section 5.6 of this volume. 75  See Code of Conduct on Business Taxation, para A(1).

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g­ uidance may also have an incidental effect on the movement of capital, freedom of ­establishment is likely to be considered the predominantly relevant freedom.76 What nexus requirement could be demanded that is (more) compatible with freedom of establishment? In other words, what is the de minimis degree of nexus that triggers the protection of this freedom so that everything below that can be legitimately attacked? In order to answer this question, a prior issue has to be resolved—what type of establishment qualifies for the purposes of freedom of establishment? The concept of establishment is broadly construed under the case law of the Court of Justice. An establishment allows a Community national to participate, on a stable and continuous basis, in the economic life of a Member State other than his State of origin and to profit therefrom, so contributing to economic and social interpenetration within the Community, in the sphere of activities of self-employed persons.77

However, in order to trigger freedom of establishment, an establishment must involve ‘the actual pursuit of an economic activity through a fixed establishment in another member state for an indefinite period’.78 [T]he rules of the Treaty on the free movement of persons cover only the pursuit of effective and genuine activities to the exclusion of activities on such a small scale as to be regarded as purely marginal and ancillary. The physical presence in the territory of the country of establishment must therefore be such as to enable such effective and ­genuine activities to be pursued … [P]resence in the territory of the country of establishment must be intended to be permanent, or at least of an indefinite duration. (emphasis added)79

This was reiterated by Advocate General Léger in Cadbury Schweppes.80 The EFTA Court in the Fred Olsen case also followed this reasoning.81 Here, one of the issues at stake was whether a trust, whose beneficiaries were made subject to CFC taxation, fell within the scope of Article 31 of the EEA Agreement as a form of

76  See 4.3.1 in HJI Panayi (2013), n 3 above. For recent cases confirming this point, see Bouanich II (Case C-375/12 Margaretha Bouanich v Directeur des services fiscaux de la Drôme [2014] ECR I-0000) and Case C-47/12 Kronos International Inc v Finanzamt Leverkusen [2014] ECR I-0000. Here, the Court of Justice reiterated established case law in that national legislation intended to apply only to those shareholdings which enable the holder to exert a definite influence on a company’s decisions and to determine its activities falls within the scope of freedom of establishment. By contrast, national provisions which apply to shareholdings acquired solely with the intention of making a financial investment without any intention to influence the management and control of the undertaking must be examined exclusively in light of the free movement of capital: Kronos, para 31. 77  Case C-55/94 Gebhard v Consiglio dell’Ordine degli Avvocati e Procuratori di Milano [1995] ECR I-4165, para 25. 78  Case C-221/89, The Queen v Secretary of State for Transport, ex parte Factortame Ltd and others [1991] ECR I-3905, para 20. 79  Ibid, paras 44–45 (Opinion). Also Case C-216/87, The Queen v Ministry of Agriculture, Fisheries and Food ex parte Jaderow [1989] ECR 4509, para 25. 80  Cadbury Schweppes, n 24 above, para 42. 81  Fred Olsen, n 45 above.

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establishment. On this point, the EFTA Court concluded that the trust in q ­ uestion fell within the scope of Article 31 of the EEA Agreement provided that the trust pursued a real and genuine economic activity within the EEA for an indefinite period and through a fixed establishment. This question was for the national court to assess. If indeed that was the case, then all interested parties—here, the trust’s settlors, trustees and beneficiaries—enjoyed the rights under ­Articles 31 and 34 of the EEA Agreement.82 The EFTA Court gave some useful guidance. The essential feature of real and genuine business activities that constituted an establishment was that a person or an entity carried on a business, such as by offering services, which were effected for consideration, for an indefinite period through a fixed establishment.83 A fixed establishment may be gained and maintained by activities such as settling personally in the host state, establishing the seat of management there and/or recruiting staff to perform the services that may be required from the establishment there. In contrast, an entity not carrying out any business in another EEA State, due to the extent it exists in terms of premises, staff and equipment, and whose incorporation may thus not reflect economic reality, cannot invoke Articles 31 and 34 of the EEA Agreement because of its lack of actual economic activity.84 Whether there is real and genuine economic activity cannot be answered in the abstract. It depends on the actual terms of the entity’s statutes, and the actual activities of that entity and its management.85 If a specific assessment reveals, for example, that the trust is involved in the management of a group’s companies or other activities for a group, such as managing a pool of resources, and its actual incorporation reflected its actual activities, it has to be regarded as a real and genuine economic activity, which constitutes establishment.86

It was not necessary for the economic activities to take effect in the EEA state of establishment, as long as they took effect in the EEA. Provided that those conditions were fulfilled, neither the status under national law of the legal entity employed to that end, the income level of the establishment nor the origin of its funds can have any consequence as to whether or not there is an establishment for the purposes of EEA law.87

Therefore, on the basis of this case law, the concept of establishment for the purposes of freedom of establishment requires some genuine economic activity and presence intended to be permanent. It could be argued that when these factors are not present, then freedom of establishment cannot be engaged. As such,

82  Ibid, para 102. Article 31 EEA sets out the general freedom of establishment and Article 34 EEA is more specific as to companies. 83  Ibid, para 97. 84  Ibid, para 98. 85  Ibid, para 99. 86  Ibid. 87  Ibid, para 100.

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when an economic substance criterion based on these factors is not satisfied, then the refusal of benefits would arguably be compatible with EU law.88 This is the approach that the Code of Conduct Group ought to have taken in its analysis of the economic substance criterion. Adopting the modified nexus approach in the context of patent regimes without taking into account the particularities of the fundamental freedoms may prove to be problematic. Further guidance can also be sought by the interpretation of the notion of ‘­economic activity’ in the context of VAT Directives and EU competition law, which also draw some distinctions between active conduct and mere passive investment. Here, the notion of economic activity was interpreted broadly as an activity likely to be carried out on a continuing basis, by a private undertaking on a market, organised within a professional framework and generally performed in the interests of generating profit.89 The activity must not be of a purely marginal or ancillary nature.90 Arguably, the essence of the matter lies in whether there is some sort of active conduct or merely passive investment. For example, in Pavlov, a competition case, the Court of Justice found that any activity which consisted of offering goods and services to a given market was an economic activity.91 By contrast, it was found that the mere acquisition, holding and sale of shares, did not constitute economic activities. In other words, the mere passive exploitation of the property did not qualify.92 It has also been found that where a transaction relating to shares or holdings in a company is carried out in order to secure a direct or indirect involvement in the management of the company in which the holding has been acquired, then there could be economic activity for the purposes of competition rules.93 Similar guidance was given by Advocate General Léger in the EDM case,94 in the context of VAT legislation. In this case, it was questioned whether for the purposes of VAT legislation the annual granting of interest-bearing loans by a holding company to the companies in which it held shares constituted an economic activity, where the

88  Of course, there could be an issue with the free movement of capital but that is another question to be considered. 89  See Opinion of Advocate General Maduro in Case C-08/03 Banque Bruxelles Lambert SA v The Belgian State, Minister of Finance, Department of administration of value added tax, registration and public property [2004] ECR I-10157, para 10. 90  Case C-176/96 Lehtonen et al v Fédération Royale Belge des Sociétés de Basket-ball ASBL [2000] ECR I-2681, para 44. 91  Cases C-180/98 to C-184/98 Pavlov and Others [2000] ECR I-6451, para 75. 92  Also see Case C-80/95 Harnas & Helm CV v Staatssecretaris van Financiën [1997] ECR I-745, para 15; Case C-333/91 Sofitam SA (anciennement Satam SA) v Ministre chargé du Budget [1993] ECR I-3513, para 12; Case C-77/01 Empresa de Desenvolvimento Mineiro SA v Fazenda Publica (EDM case) [2004] ECR I-4295, para 58. For commentary, see Daniël S Smit, ‘Substance Requirements for Entities Located in a Harmful Tax Jurisdiction under CFC Rules and the EU Freedom of Establishment’ (2014) 16 Derivatives & Financial Instruments 259–65, section 3.2; Aleksandra Bal, ‘Secondary Establishments in EU VAT and Treaty Law’ (2015) 55 European Taxation 143–48. 93  Case C-142/99 Floridienne SA and Berginvest SA against the Belgian State [2000] ECR I-9567, para 18; Case C-222/04 Cassa di Risparmio di Firenze and others [2006] ECR I-289, paras 112–13. 94  EDM case, n 92 above.

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holding company’s principal activity was to manage those shareholdings and, to a certain extent, also to guarantee the loans taken out by them. Citing older case law, Advocate General Léger said that the activity could be an economic activity for the purposes of the VAT legislation if it was not carried out merely on an occasional basis and it was not confined to managing an investment portfolio in the same way as a private investor. It had to be carried out with a business or commercial purpose characterised, in particular, by a concern to maximise returns on capital investment.95 According to the Advocate General, the business purpose involves a holding company introducing permanent human and logistical resources arranged in the same way as the resources of a credit institution and on a greater scale than the resources belonging to a private investor which are used merely for his own needs.96

Also, the loans must have been agreed on conditions which were comparable to the relevant market conditions—as if they had been agreed between a financial institution and its customer.97 The Court of Justice did not go into so much detail, simply concluding that the annual granting by a holding company of interestbearing loans to companies in which it has a shareholding constituted economic activities.98 Therefore, there is ample material that the Code of Conduct Group and Member States in general could resort to in interpreting economic substance, as well as the type of harmful tax practices that should not be protected under freedom of establishment. This material ought to be taken into account in reviewing any proposals under Action 5 of the BEPS Project and any proposals of the Code of Conduct Group in its work on patent regimes.

6.6.  Double Non-Taxation, LOBs and PPTs: BEPS Action 6 Action 6 mandated the OECD to develop model treaty provisions and recommendations to prevent the granting of treaty benefits in inappropriate circumstances and to curb double non-taxation. The OECD proposals here also raise serious concerns as to their compatibility with EU law. As discussed in Chapter three, the latest reports suggest that a three-pronged approach is to be adopted. First, there will be a clear indication in the OECD Model title and preamble that Contracting States, when entering into a treaty, intend to avoid creating opportunities for non-taxation or reduced taxation through tax 95 

Ibid, para 42 (opinion). Ibid, para 44 (opinion). 97  Ibid, para 45 (opinion). 98  Ibid, para 70 (Court of Justice). 96 

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evasion or avoidance, including through treaty-shopping arrangements. Secondly, a limitation on benefits clause based on the US Limitation of Benefits (LOB) is recommended. This is, thirdly, to be buttressed by a more general anti-abuse rule based on the principal purposes of transactions or arrangements (principal purposes test or PPT rule).99 The preferred approach was to combine these two rules to cover the widest range of treaty abuses. However, flexibility was allowed to accommodate constitutional and EU law restrictions. The emphasis on avoiding double non-taxation is aligned with the Commission’s proposals in its Recommendation on Aggressive Tax Planning and its previous consultation on Double Non-Taxation.100 It was argued in Chapter five that in the Recommendation on Aggressive Tax Planning the concept of aggressive tax planning as set out goes beyond the EU concept of abuse and covers also the existence of legal gaps or mismatches leading to double non-taxation. This approach is also aligned with the rationale behind the amendments to the Parent-Subsidiary Directive, as explained in Chapter five. It should, however, be pointed out that technically, intended or unintended ­double non-taxation caused by national tax laws of the Member States is not incompatible with EU law, provided that the tax treatment does not constitute harmful tax competition or state aid.101 EU law does not require Member States to levy any income taxes or corporation taxes or, if they do impose such taxes, to impose them at any level. If lack of imposition of such taxes leads to double nontaxation, so be it. Arguably, this is the reverse of juridical double taxation with which the Court of Justice has consistently refused to interfere, finding that juridical double taxation (but not economic double taxation) is a disadvantage arising from the parallel exercise of tax competences by different Member States.102 To the extent that such an exercise is not discriminatory, juridical double taxation is not prohibited under EU law. Member States are not obliged to adapt their own tax systems to different Member State tax systems in order to eliminate this type of double taxation. By analogy, the same reasoning ought to apply to double nontaxation—if it is the result of the parallel (and non-discriminatory) exercise of tax competences by different Member States, then it is not prohibited by EU law, notwithstanding the tax advantages that might accrue to some taxpayers.

99 

See Ch 3, section 3.1 of this volume. See Ch 5, sections 5.2.2 and 5.2.4 of this volume. 101  Marjaana Helminen, ‘The Problem of Double Non-Taxation in the European Union—To What Extent Could This Be Resolved through a Multilateral EU Tax Treaty Based on the Nordic Convention?’ (2013) 53 European Taxation 306–12, 307. 102  See Case C-513/04 Mark Kerckhaert and Bernadette Morres v Belgian State [2006] ECR I-10967 and Case C-128/08 Jacques Damseaux v Etat Belgique [2009] ECR I-6823. For commentary, see chs 4 and 6 in HJI Panayi (2013), n 3 above; Christiana HJI Panayi ‘Tax Treaties post-Damseaux’ [2009] Tax Journal, 14 September 2009, 9; Luca Cerioni, ‘Double Taxation and the Internal Market: Reflections on the ECJ’s Decisions in Block and Damseaux and the Potential Implications’ (2009) 63 Bulletin for International Taxation 543. The above two cases were followed by Joined Cases C-436/08 and Case C-437/08 Haribo & Österreichische Salinen and Case C-67/08 Block v Finanzamt Kaufbeuren [2009] ECR I-0883. 100 

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Furthermore, double non-taxation may not even be accepted as a justification for a restriction of fundamental freedoms. The mischief of double non-taxation is that it leads to loss of tax revenue for the Member State concerned. However, the loss of tax revenue (also called erosion of tax base in the Court’s judgments) was never allowed as a justification.103 The emphasis has always been on justifications on the basis of tax avoidance and tax evasion.104 Obtaining a mere tax saving has never been equated to tax avoidance or evasion in the eyes of the Court of ­Justice.105 Recently, in the Felixstowe case, the Court found that a restrictive measure might be justified by the objective of combating tax havens,106 though at the time of writing, this justification has not featured in any later cases and in any case cannot be equated with loss of tax revenue. Therefore, notwithstanding the Commission’s initiatives to address double non-taxation examined in greater detail in the previous chapter, technically, there is no competence in the European Union to tackle double non-taxation. This is the result of lack of harmonisation of Member State laws. Arguably, only to the extent that double non-taxation can be viewed from the spectre of abuse is there some limited legal base for EU action. Otherwise, it is submitted that there is technically none. What about LOB clauses and their compatibility with EU law? In the past decade, the compatibility of anti-treaty-shopping provisions with EU law was a topic of intense academic debate. It was argued that anti-treaty-shopping provisions and especially the LOB were in breach of the freedom of establishment and/or the free movement of capital.107 Could Member States include anti-treaty-shopping provisions in tax treaties between themselves or with non-EU Member States? For this argument to succeed, it has to be shown that treaty shopping, ie the activity that these anti-abuse provisions seek to curb, is an activity protected under EU law. Of course, there has to be genuine (cross-border) activity. The more abusive the structure, the less likely that the fundamental freedoms will be triggered at all. For, if the intermediary entity is a complete sham, then, arguably, there is no genuine exercise of establishment in that jurisdiction; nor is there any movement of capital. Therefore, the more economic substance there is in the intermediary

103  See, for example, Danner, n 11 above; Case C-422/01 Försäkringsaktiebolaget Skandia (publ) and Ola Ramstedt v Riksskatteverket [2003] ECR I-6817; Case C-264/96 Imperial Chemical Industries plc (ICI) v Kenneth Hall Colmer (Her Majesty’s Inspector of Taxes) [1998] ECR I-4695, para 28; Case C-307/97 Compagnie de Saint-Gobain, Zweigniederlassung Deutschland v Finanzamt Aachen-Innenstadt [1999] ECR I-6161, para 50; Case C-385/00 FWL de Groot v Staatssecretaris van Financiën [2002] ECR I-11819, para 103. 104  See ch 8, HJI Panayi (2013), n 3 above. 105  See, for example, Eurowings, n 10 above, paragraph 44 and other cases cited therein. 106  See Case C-80/12 Felixstowe Dock & Railway Co Ltd v HM Revenue & Customs [2014] ECR I-0000, para 32. 107  See, for example, Christiana HJI Panayi, ‘Open Skies for EC Tax?’ [2003] 3 BTR 189; Georg W Kofler, ‘European Taxation Under an “Open Sky”: LoB Clauses in Tax Treaties Between the U.S. and the EU Member States’ (2004) 35 Tax Notes International 45; Christiana HJI Panayi, Double Taxation, Tax Treaties, Treaty Shopping and the European Community (Kluwer, 2007).

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company itself, the more likely that the setting up of the establishment itself will be recognised as an activity that could be prima facie covered by the freedom of establishment.108 Similarly, the more economic substance there is in the intermediary, the more likely that investment through it will be prima facie covered by the free movement of capital. Assuming this first threshold issue is satisfied and the aforementioned fundamental freedoms are prima facie engaged, is there a restriction on them?109 From a freedom of establishment perspective, it could be argued that treaty shopping, ie the use of the intermediary entity located in a favourable tax jurisdiction to effect the investment, is an exercise of freedom of establishment. The fact that the intermediary entity has limited economic substance (but is short of a complete sham for threshold purposes) should not prevent the arrangement from being characterised as an exercise of establishment. An analogy may be drawn with a line of non-tax related cases (Centros110/Überseering).111 These cases dealt with corporate forum shopping. Here, the Court of Justice approved the formation of primary and secondary establishments, even if they lacked economic substance in one Member State and were thought to have been set up in order to circumvent the company law formation requirements applicable in another Member State.112 Just because the undertaking was corporate forum shopping within the European Union with little economic substance in the establishment did not necessarily mean that the protection under the freedom of establishment was withdrawn. Can this strand of reasoning also apply to tax treaty shopping? Does the fact that tax treaty shopping entails tax-location shopping rather than corporate forum ­shopping change matters? There is no reason why it should, at least prima facie. As emphatically held in Cadbury Schweppes,113 profiting from tax advantages in force in another Member State is not per se abuse.114 Citing the case law on corporate forum shopping, the Court of Justice reiterated that the fact that a company was established in a Member State for the purpose of benefitting from more favourable legislation did not in itself suffice to constitute abuse of that freedom—which would have ab initio prevented enjoyment of the freedom. The same reasoning applied to a company established in another Member State ‘for the avowed purpose of b ­ enefitting

108 

On freedom of establishment and economic substance, see section 6.5 of this volume. Most of the arguments raised in this section were initially raised by the author in her PhD thesis and later on in ch 5 of HJI Panayi (2007), n 107 above. For a later analysis see also Christiana HJI Panayi and Reuven Avi-Yonah, ‘Rethinking treaty-shopping: Lessons for the European Union’ in M Lang et al (eds), Tax Treaties: Building Bridges between Law and Economics (IBFD Publications, 2010). 110  Case C-212/97 Centros Ltd v Erhvervs-og Selskabsstyrelsen [1999] ECR I-1459. 111  Case C-208/00 Überseering BV v Nordic Construction Company Baumanagement GmbH (NCC) [2002] ECR I-9919. 112  See Christiana HJI Panayi, ‘Corporate Mobility under Private International Law and European Community Law: Debunking Some Myths’ (2009) 28 Yearbook of European Law 124–76. 113  Cadbury Schweppes, n 24 above. 114  Ibid, paras 34–38. 109 

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from the favourable tax regime which that establishment enjoyed’.115 Such exercise of tax-forum shopping did not, according to the Court of Justice, deprive a company of the opportunity to rely on the rights conferred under freedom of ­establishment.116 The arrangement had to be examined on its facts. It would seem that just because treaty shopping entails a type of forum shopping, this does not necessarily mean it is abusive. If anything, it appeared to be encouraged by the Court of Justice in its earlier case law. As such, it could be argued that treaty shopping is an exercise of establishment, regardless of the motives behind it. What anti-treaty-shopping provisions tend to do is to disregard the intermediary entity and treat another company as the ultimate recipient of the income. Therefore, it could be argued that anti-treaty-shopping provisions restrict the freedom of establishment. Of course, this restriction could be justified, as explained below, but this is nonetheless a restriction. From a free movement of capital perspective, it could be argued that a treaty shopper exercises its free movement of capital by investing in a company indirectly (ie through another Member State entity) and as a result receives its return from such investment indirectly. The analysis here focuses on the existence (or lack of) indirect investment rather than the use of an intermediary entity. The issue is not so much the fact of establishing a related entity through which investment is made. What is important is the fact that the treaty shopper (whether EU national or not) takes advantage of the tax treaty network of another Member State in order to invest in a third Member State, by channelling income through an intermediary entity which it does not control. In other words, this is an instance of indirect rather than direct investment (investment through a related entity) and as such, should prima facie be protected under the free movement of capital. Anti-treaty-shopping provisions tend to disregard the intermediary entity and/or re-characterise the payment as being directly made to another company. As a result, they may ultimately make the investment of capital through an intermediary in another Member State more expensive. Therefore, it could be argued that anti-treaty-shopping provisions restrict the free movement of capital. Of course, as under freedom of establishment, this restriction could be justified by imperative requirements in the general interest. It also has to be suitable and 115 

Ibid, para 38. See, similarly, the reasoning of Advocate General Léger in para 40 et seq. The Advocate General went a step further and linked the absence of economic activity in the establishment as an important factor in assessing abuse. He argued that ‘as long as there is genuine and actual pursuit of an activity by the controlled subsidiary in the Member State in which it was established, the reasons for which the parent company decided to establish the subsidiary in that host State cannot call into question the rights which that company derives from the Treaty’: see para 49 of the opinion. Even more in point, the Advocate General argued that ‘the fact that a company centralises in another Member State with a low tax rate the carrying on of certain activities of use to the entire group and seeks by that means to reduce the group’s overall tax burden does not in itself constitute abuse … as long as the subsidiary responsible for those intra-group services is carrying on genuine economic activity in the host State, under the tax sovereignty of which it falls, the territorial allocation of the Member States’ power to impose taxes is not, a priori, affected’ (emphasis added): see para 109 of the opinion. 116 

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proportional.117 Not every kind of structure will ultimately be protected under EU law. For example, the restriction could be justified on the basis of preventing tax avoidance/evasion.118 In order for this ground to succeed, as discussed above in the context of Actions 2 to 4 of the BEPS project, the anti-treaty-shopping p ­ rovisions must have the specific purpose of preventing wholly artificial arrangements. Broad anti-abuse clauses which do not distinguish between bona fide activities and abusive situations have been struck down. Prevention of tax avoidance/­evasion could, therefore, exonerate a restrictive treaty provision if this is sufficiently targeted to that end. The provision must also be suitable and must not go beyond what is necessary to attain the objective pursued, whether this is prevention of tax evasion or of tax avoidance. Therefore, if less than wholly artificial arrangements are caught by an anti-treaty-shopping provision, then the restriction is unlikely to be justified. As a corollary, the more artificial the treaty-shopping arrangement, the more likely it is to have tax avoidance connotations—against which an anti-treatyshopping provision can more readily be justified. The restriction could also be justified on the basis of safeguarding the allocation of tax jurisdiction.119 It could be argued that what anti-treaty-shopping provisions seek to do is restore the allocation choices of the tax treaty ‘shopped’. As the original allocation choices of the relevant tax treaty are respected under EU law after the D case,120 so should measures to protect and restore those allocation choices. In fact, as explained immediately below, this line of case law and the treaty allocation ground may be used to pre-empt any argument of incompatibility of the LOB with EU law altogether. Assuming though it is not so used and allocation of taxing rights is considered as a justification for a restriction, then the application of this justification has to be fine-tuned and proportional. In this context, the allocation of tax jurisdiction is less threatened by intermediary entities imbued with economic substance. The more substance there is in the treaty-shopping arrangement, the less likely it is that the allocation choices under the underlying tax treaty would be frustrated. Anti-treaty-shopping provisions have to factor that in. Also, the applicability of this ground as an imperative requirement could depend on the actual effect of the anti-treaty-shopping provisions on the ­structure.

117 

Gebhard, n 77 above, para 37. for example, ICI, n 103 above; Case C-9/02 Hughes de Lasteyrie du Saillant v Ministère de L’Economie des Finances et de l’Industrie [2004] ECR I-2409. The Court of Justice, in the early cases ­especially, tended to use the terms ‘avoidance’ and ‘evasion’ without distinction. In some cases, it referred to the justification as being based on tax avoidance (eg ICI, para 26) whereas in others it referred to tax evasion (eg Lankhorst-Hohorst, n 58 above, para 37; Case C-436/00 X & Y v ­Riksskatteverket, [2002] ECR I-10829, para 62). 119  See Case C-376/03 D v Rijksbelastingdienst (D case) [2005] ECR I-5821; Case C-446/03 Marks & Spencer plc v Halsey (HM Inspector of Taxes) [2005] ECR I-10837; Oy AA, n 50 above; Case C-470/04 N v Inspecteur van de Belastingdienst Oost/kantoor Almelo [2006] ECR I-7409l; Case C-414/06 Lidl Belgium GmbH & Co KG/Finanzamt Heilbronn [2008] ECR I-3601, para 51; Case C-182/08 Glaxo Wellcome GmbH & Co KG v Finanzamt München II [2009] ECR I-8591 para 88. 120 See D case, n 119 above. Also see analysis in ch 4 in HJI Panayi (2013), n 3, and below. 118  See,

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Do they restore the original withholding tax rate that would have applied absent the treaty-shopping arrangement or do they impose a (penal) statutory withholding tax rate? If the former, then it could be argued that what the anti-treatyshopping provision actually does is to restore the treaty balance. However, if the statutory withholding tax rate applies, then it is more difficult to see how the antitreaty-shopping provision restores the treaty balance, since that balance is itself overridden. A point to note is that under the free movement of capital, it does not matter whether the capital movement is to or from a non-Member State, so long as there is some capital movement to or from a Member State. However, this could be relevant at the justification stage.121 A restriction may be more readily justified if it affects third-country nationals than if it affects EU nationals. Nevertheless, this has to be proven. Another point to note is that the freedom of establishment is only available to EU nationals. Therefore, if the intermediary entity is in a nonEU Member State, then an anti-treaty-shopping provision frustrating the arrangement may not be incompatible with EU law. In conclusion, it is possible that anti-treaty-shopping provisions restrict the freedom of establishment and/or the free movement of capital. However, they could be justified, depending on how these provisions are phrased, and whether they are sufficiently targeted against wholly artificial arrangements and proportional. It also depends on whether these provisions try to curb treaty shopping through a non-EU Member State. Of course, the above discussion may simply be theoretical and/or at best academic, for the time being. If a case were to arise at the Court of Justice today, it is likely that the Court would seize on the D case122 and the ACT GLO case123 and avoid a clash with the LOB altogether by finding lack of comparability and non-discrimination. The D case established that when dealing with tax benefits conferred to nonresidents through tax treaties, there is no comparability between a non-resident of one treaty partner and a non-resident of another. Therefore, the fact that a Member State applied different treaty rates to non-residents did not mean that the Member State was discriminating between those two non-residents. In the D case, the Court of Justice accepted the allocation attained in the relevant tax treaties, even if this meant that some non-residents were treated more harshly than other non-residents. It was found that the Netherlands was not obliged to extend to a German resident the treaty benefits given to Belgian residents. The Germany–Netherlands tax treaty did not provide for the same allowances as the Belgium–Netherlands tax treaty. This was a question of pre-agreed allocation of tax powers between these countries. The relevant treaties were not to be interfered

121  See, for example, Case C-446/04 FII Group Litigation case [2006] ECR I-11753, paras, 169–72; Thin Cap GLO, n 38 above; Case C-101/05 Case A [2007] ECR I-11531; CFC GLO, n 54 above; Case C-540/07 Commission v Italy [2009] ECR I-10983. 122  D case, n 119 above. 123  ACT GLO case, n 3 above.

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with by extending benefits given to Belgian residents also to German residents. In other words, the tax treaty benefits given under a tax treaty were unique to that tax treaty, so an EU national not benefiting under the treaty could not demand the extension of treaty benefits. This reasoning was followed in the ACT GLO case and extended to LOBs showing the Court’s reluctance to interfere with anti-treaty-shopping provisions. It was found that there was no comparability between two non-residents benefiting from the same tax treaty, owned by residents from different treaty partners. This meant that withdrawal of tax treaty benefits on the basis of the ownership of the nonresident entity would not necessarily constitute discrimination, precisely because there would be no comparable situations being treated differently to start with. Otherwise, the ‘equilibrium and reciprocity underlying the existing DTCs [double taxation conventions] would be undermined, taxpayers would be able more easily to avoid the provisions of DTCs intended to combat tax avoidance and the legal certainty of taxpayers would be affected accordingly’.124 LOBs were considered to be a natural corollary of the bilateralism enshrined in tax treaties. They were characterised by the Court of Justice as ‘an inherent consequence of bilateral double taxation conventions’,125 not precluded by Treaty provisions on freedom of establishment. The Advocate General had similarly held that the tax treaty distinction of ­non-residents on the basis of the country of residence of their controlling shareholder was ‘part of the equilibrium of jurisdiction and priority reached by the Contracting States in the exercise of their competence’.126 As a result, enquiry into the reasons and justifications for this choice of equilibrium did not fall within the ambit of the non-discrimination provisions.127 It is noteworthy that the fact that the impugned anti-treaty-shopping provision was an LOB clause, which can be applied quite mechanically without taking into account the bona fides of the structure or the similarity of the two non-resident situations, did not concern the Court of Justice. Neither did it venture to explain the situation from the viewpoint of a restriction, for which a comparator test was not necessary. Furthermore, the Court of Justice omitted to explain the difference between not relieving certain double taxation as a result of tax treaty allocation and forfeiting relief otherwise applicable pursuant to the tax treaty allocation.128 The author has argued elsewhere129 that there is a very fine distinction between the D case and the situation in the ACT GLO case. In the D case, no comparability was found between two non-resident individuals from different Member States benefiting under two different tax treaties. In the ACT GLO case, no comparability

124 

Ibid, para 80. Ibid, para 91. 126  Ibid, para 101 (opinion). 127  Ibid. 128  See analysis in section 5.2.1.2 (ii) in HJI Panayi (2007), n 107 above. 129  Ibid, ch 5. 125 

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was found between two non-resident entities in the same Member State benefiting from the same tax treaty on the basis of ownership. Isn’t the latter situation much more comparable than the former? Another difference between the cases is that if comparability was found in the D case, this would have led to a de facto multilateralisation of the underlying tax treaty. The source state would have been under a positive obligation; namely, to confer a specific tax treaty benefit on a non-resident person that was not ­entitled to the benefit under its own tax treaty. By contrast, what the ACT GLO case entailed was the refusal of tax treaty benefits otherwise available to a non-resident entity, purely on the basis of its ownership. In other words, if comparability was found, the source state would have been under a negative obligation; namely, not to treat a certain non-resident entity worse than another. The two cases could have been distinguished on these grounds. Other scholars have also expressed their disagreement with the analysis in the ACT GLO case which openly accepted LOBs. It has been argued that the Court’s judgment was far from satisfactory because the nature of LOBs was not considered130 and the analysis was in contradiction to previous case law.131 However, case law since the D case and ACT GLO case overwhelmingly suggests that the Court of Justice shows respect for the allocation of taxing rights under a tax treaty and, generally, respect for tax treaties.132 Therefore, although LOBs contain mechanical tests, similar to those which the Court of Justice has found to be disproportional in its general case law, nevertheless, they are likely to survive any future legal challenge. Furthermore, as the LOB is a treasured US treaty clause, the status of which has been fully endorsed and enhanced by the OECD in its BEPS project,133 this anti-abuse mechanism is unlikely to be challenged in the European Union in any meaningful way, any time soon. As a corollary, it should also be stated that strictly speaking, derivative benefits are not yet required under EU law, because the Court of Justice in the D case accepted the bilateralism of tax treaties and did not demand an MFN (most favoured nation) clause. Arguably, the same conclusions would seem to apply to discretionary relief provisions under tax treaties—they would be considered as part of the treaty package. However, the ability to give discretionary relief could generate many problems and perpetuate base erosion arrangements. Lack 130  Ana Paula Dourado, ‘Aggressive Tax Planning in EU Law and in the Light of BEPS: The EC Recommendation on Aggressive Tax Planning and BEPS Actions 2 and 6’ (2015) 43 Intertax 42–57. Dourado poses an interesting question at p 55: ‘Are they entitlement rules, allocation of taxing rights rules or anti-abuse rules containing unrebuttable presumptions?’. 131  Ibid, she refers to Case C-55/00 Gottardo v Instituto Nazionale della Previdenza Sociale, Case C-1/93 Halliburton Services BV v Staatssecretaris van Financiën [1994] ECR I-1137 and the Open Skies cases. See fn 184 below. 132  See, for example, Case C-414/06 Lidl Belgium GmbH & Co KG v Finanzamt Heilbronn [2008] ECR I-3601, para 51; Case C-182/08 Glaxo Wellcome GmbH & Co KG v Finanzamt München II, para 88. For a review of the case law, see ch 4, HJI Panayi (2013), n 3 above. 133  See the progression in the various discussion drafts on Action 6, in Ch 3, section 3.1 of this volume.

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of ­transparency in tax rulings is a big problem as shown with the Luxembourg leaks.134 Therefore, the parameters for discretion ought to be clearly defined. Certainly, if the Commission’s proposal for automatic exchange of information on tax rulings is approved, Member States may be more reluctant to exercise their discretionary powers either too leniently or too harshly. If too leniently, then the Member State’s power to give discretionary relief may be incompatible with the state aid prohibition. There is a detailed discussion of this topic in the next chapter. If discretionary powers are exercised too harshly, then this might give rise to an incompatibility with fundamental freedoms, to the extent that the exercise of discretion by the Member State is considered as unilateral action rather than action pursuant to a tax treaty.135 In any case, the OECD in its latest discussion draft on Action 6, the Treaty Abuse Second Revised Discussion Draft, does not take compatibility of the LOB discretionary relief provision with EU law for granted. It sets out further commentary on issues to be taken into account by the competent authorities such as the availability of clear non-tax business reasons, the purposes of the treaty, the existence of a substantial relationship with the state etc.136 A similar conservative approach is taken by the OECD vis-à-vis the derivative benefits clause: proposals are made to amend the commentary to address specific EU issues related to the publiclylisted entity and pension fund exceptions of the LOB rule.137 As regards the third main proposal in Action 6, the ‘principal purpose’ test (PPT), this is very similar to the GAAR test that has been inserted in the ParentSubsidiary Directive. One difference is that in the GAAR of the Parent-Subsidiary Directive, reference is made to the ‘main purpose or one of the main purposes’ rather than ‘one of the principal purposes’ which is used in the OECD’s proposals under Action 6. This is not considered to be a substantive difference. In fact, in the initial discussion draft on Action 6, the OECD had used the ‘main purpose’ test. It was only in the September 2014 discussion draft that this was replaced with the ‘principal purpose’ test. It was argued that the PPT rule incorporated principles already recognised in the Commentary on Article 1 of the OECD Model.138 It is interesting to note that the GAAR test suggested in the Recommendation on Aggressive Tax Planning139 refers to the essential purpose, not one of the main purposes. This is more aligned with the case law of the Court of Justice.140

134 

See Ch 1 of this volume. analogous reasoning in Denkavit, n 13 above and Amurta, n 14 above. Also see analysis of these cases in section 6.2 above. 136  See analysis in section 3.1 of Ch 3 of this volume. 137  Ibid. 138  See Treaty Abuse Revised Discussion Draft, p 12. See analysis in section 3.1 of Ch 3 of this volume. 139  See para 4.2 of Recommendation on Aggressive Tax Planning: ‘An artificial arrangement or an artificial series of arrangements which has been put into place for the essential purpose of avoiding taxation and leads to a tax benefit shall be ignored. National authorities shall treat these arrangements for tax purposes by reference to their economic substance’. Also see section 5.2.4 of Ch 5 of this volume. 140  See discussion in the VAT context, in Ch 5, section 5.1 above. As mentioned, in the Ocean Finance case (Case C-653/11 HM Revenue & Customs v Paul Newey, trading under the business name Ocean 135  See

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Of course, it should be reminded that, irrespective of whether these tests rely on the main purpose or one of the main purposes or the sole purpose, simple tax forum shopping does not constitute abuse under the case law of the Court of ­Justice. As stipulated in Cadbury Schweppes, the fact that a Community national, whether a natural or legal person, sought to profit from tax advantages in force in a Member State other than his State of residence cannot in itself deprive him of the right to rely on [the fundamental freedoms].141

Therefore, for EU purposes, the focus of any PPT or GAAR test needs to be on the artificiality of the impugned arrangement and not (only) the purposes or intentions when entering into the arrangement. Another difference in the various PPT clauses is the result of these anti-abuse rules being triggered. With the PPT under Action 6, tax treaty benefits are not to be given. By contrast, under the GAAR of the Recommendation on Aggressive Tax Planning, there is possibility for further action, possibly re-characterisation— ‘[n]ational authorities shall treat these arrangements for tax purposes by reference to their economic substance’.142 While this possibility is not mentioned in the ­Parent-Subsidiary Directive’s new GAAR, it cannot be excluded, as the Directive does not preclude the application of domestic or agreement-based provisions required for the prevention of tax evasion, tax fraud or abuse. Another point of deviation is the relevance and impact of commercial justifications—ie the subjectivity of the rules. Under the amended Parent-Subsidiary Directive, an arrangement or a series of arrangements shall not be regarded as genuine to the extent that they are not put into place for valid commercial reasons which reflect economic reality. This resonates with the Court’s reasoning in Cadbury Schweppes, Thin Cap GLO and more recently in the VAT context, the Ocean Finance case.143 There is similar stipulation in the GAAR proposed in the Recommendation on Aggressive Tax Planning.144 There is no such provision in the recommended PPT under Action 6, which suggests a more objective analysis which cannot be rebutted by commercial reasons. Arguably, valid commercial reasons could be taken into account if a discretionary relief provision is inserted in the PPT rule under Action 6, something proposed by the OECD in its latest discussion draft.145

Finance [2013] ECR I-0000), the Court of Justice seem to have reverted to the sole purpose test rather than ‘one of the purposes’ of a transaction test. Also see ch 8 in HJI Panayi (2013), n 3 above, for the pre-Ocean Finance case law. 141 

Cadbury Schweppes, n 24 above, para 36. See para 4.2 of the Recommendation on Aggressive Tax Planning. 143  See Ch 5 of this volume. 144  See para 4.4 of the Recommendation on Aggressive Tax Planning: ‘For the purposes of point 4.2 an arrangement or a series of arrangements is artificial where it lacks commercial substance’. But also see 4.5: ‘For the purposes of point 4.2, the purpose of an arrangement or series of arrangements consists in avoiding taxation where, regardless of any subjective intentions of the taxpayer, it defeats the object, spirit and purpose of the tax provisions that would otherwise apply’. 145  See paras 87–90 in Treaty Abuse Second Revised Discussion Draft, where it is considered whether some form of discretionary relief should be provided under the PPT rule. See Ch 3, section 3.1. 142 

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It should also be noted that under the PPT proposed under Action 6, there seems to be a presumption that a tax treaty benefit is not in accordance with the object and purpose of the tax treaty, unless proven otherwise. It is stated that a benefit under a given tax treaty shall not be granted if it is reasonable to conclude, having regard to all relevant facts and circumstances, that obtaining that benefit was one of the principal purposes of any arrangement or transaction. The onus is on the taxpayer to show that ‘granting that benefit in these circumstances would be in accordance with the object and purpose of the relevant provisions of this Convention’.146 This is further illustrated in the commentaries. By contrast, there is no such presumption under the GAAR of the Recommendation on Aggressive Tax Planning and that of the Parent-Subsidiary Directive.147 Notwithstanding the above technical analysis of the legal credentials of the Action 6 PPT rule under EU law, it is unlikely that the Court of Justice would treat a PPT (especially if combined with an LOB) more harshly than the much more pre-emptive and mechanical LOB test. There is however another angle which needs to be considered. The PPT rule, however ‘un-mechanical’ and subjective, can still be problematic if deemed to be uncertain.148 In Itelcar,149 it was held that anti-abuse rules must be sufficiently clear, precise and predictable; otherwise they do not meet the requirements of legal certainty. As such, ‘rules which do not meet the requirements of the principle of legal certainty cannot be considered to be proportionate to the objectives pursued’.150 Therefore, anti-abuse rules must make it possible, at the outset, to determine their scope with sufficient precision. Is the PPT as an anti-abuse rule sufficiently clear, precise and predictable? This would depend on how it is interpreted and applied. While the suggested wording has similarities with the GAARs under the Parent-Subsidiary Directive and the Recommendation on Aggressive Tax Planning, if the Action 6 PPT rule is applied in a way that catches both commercial and uncommercial arrangements, then arguably its ambit would not be sufficiently clear and it would risk being found in breach of EU law.151 This point should not be ignored by Member States either in applying their GAARs or in the incorporation of the Parent-Subsidiary Directive’s GAAR. The above analysis also suggests that, in the end, there might not be much scope for widely diverging—in terms of leniency or strictness—GAARs. It is noteworthy that smaller Member States, such as Ireland, Cyprus and Malta, have expressed concerns about the application of the PPT rule in tax arrangements affecting their jurisdictions. In a report published by KPMG Ireland mentioned in 146  See the proposed wording for the PPT rule, set out in p 12 of the September 2014 discussion draft, n 138 above. See section 3.1 of this volume. 147  Also see Dourado, n 130 above, p 56. 148  Eric Kemmeren, ‘Where is EU Law in the OECD BEPS Discussion?’ (2014) 23 EC Tax Review 190–93. 149  Case C-282/12 Itelcar v Fazenda Publica [2013] ECR I-0000. 150  Ibid, para 44. Also see Case C-318/10 Société d’Investissement pour l’Agriculture Tropicale SA (SIAT) v Belgian State [2013] ECR I-0000, para 58 and 59. 151  More guidance is given on the application of the PPT rule in the latest discussion draft—see Treaty Abuse Second Revised Discussion Draft, n 145 above, paras 73–99.

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Chapter three, it was argued that the proposals under Action 6 of the BEPS Action Plan were heavily biased against small countries and would potentially damage legitimate economic activity in such countries. This was because it was much easier to satisfy a main purpose test or fail to satisfy an active business/trade test in smaller countries than in larger industrial countries.152 It was recommended that business support activities should suffice even where those activities are provided for the benefit of related group parties and where there are no or limited sales of the relevant group products or services in the small country concerned.

6.7.  Country-By-Country Reporting, Dispute Resolution and Multilateralisation of Tax Treaties: Actions 13, 14 and 15 Regarding the transfer pricing deliverables and especially Action 13, there seems to be some interesting cross-fertilisation of ideas from the European Union. It has been argued that the OECD and G20 are effectively taking up some of the ideas that came out of the EU Joint Transfer Pricing Forum (JTPF).153 The JTPF was formally set up in 2002 to assist and advise the Commission on transfer pricing tax matters. On the basis of the JTPF’s work, in 2011, the Commission published a Communication setting out guidelines on technical issues related to transfer pricing taxation, including low-value-adding intra-group services and non-EU triangular services.154 The JTPF’s work on this is thought to have influenced the OECD in preparing its discussion draft on low-value-adding intra-group services.155 Furthermore, it would appear that in the European Union, templates and guidance for uniform country-by-country reporting long preceded the BEPS deliverables. In 2006, again as a result of the work of the JTPF, a Code of Conduct on the transfer pricing documentation for associated enterprises in the European Union

152  See KPMG Ireland’s report on Action 6 and Fairness for Small Countries, replicated in KPMG’s Response to OECD/G20 BEPS Project—Follow Up Work on BEPS Action 6: Preventing Treaty Abuse (­Fairness for Smaller Economies), dated 9 January 2015. Available on: www.kpmg-institutes.com/­ content/dam/kpmg/taxwatch/pdf/2015/1-9-15-kpmg-ie-comment-letter.pdf. Also see discussion in ch 3, section 3.1. 153  Amanda Athanasiou, ‘EU Perspectives on BEPS’, 2014 WTD 182-2 (19 September 2014). 154  Communication setting out guidelines on technical issues related to transfer pricing taxation, including low-value-adding intra-group services and non-EU triangular services (COM(2011)16 final). Also see Council conclusions on the communication from the Commission on the work of the EU Joint Transfer Pricing Forum in the period April 2009 to June 2010 and related proposals: 1. Guidelines on low value adding intra-group services and 2. Potential approaches to non-EU triangular cases (Council of the European Union, 3088th Economic and Financial Affairs Council meeting, Brussels, 17 May 2011). 155  Public Discussion Draft—BEPS Action 10: Proposed Modifications to Chapter VII of the Transfer Pricing Guidelines relating to Low Value-Adding Intra-Group Services, 3 November 2014—14 January 2015 (OECD). See Ch 3, section 3.4.1 of this volume.

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was published.156 The Code of Conduct provided a template for standardised and partially centralised transfer pricing documentation for associated enterprises in the European Union. It was addressed to Member States but was also intended to encourage MNEs to apply the standardised approach. Member States were urged to accept the standardised and partially centralised transfer pricing documentation and consider it as a basic set of information for the assessment of an MNE’s transfer prices. The use of the standardised documentation was optional for a multinational group, though it provided an incentive to minimise the administrative costs of complying with several national transfer pricing documentation requirements. A multinational group adopting the standardised template had to do so in a way that was consistent throughout the European Union and from year to year. The template for standardised documentation consisted of two main parts. First, there was one set of documentation containing common standardised information relevant for all EU group members (the ‘masterfile’), and secondly, there were several sets of standardised documentation each containing country-specific information (‘country-specific documentation’). The standardised documentation had to contain enough information to allow the tax administration to make a risk assessment for case selection purposes. It had to enable the tax authorities at the beginning of a tax audit, to assess the MNE’s transfer pricing and the transfer prices of the inter-company transactions. Member States retained the right to require under domestic law that a taxpayer provide more information and documents than would be contained in the documentation but only upon specific request or during a tax audit.157 However, Member States were urged not to impose unreasonable compliance costs or administrative burden on enterprises in requesting documentation to be created or obtained, not to request documentation that had no bearing on transactions under review and to ensure that there was no public disclosure of confidential information contained in the documentation.158 It is generally thought that the EU approach linked country-by-country reporting with corporate social responsibility (CSR).159 This is also aligned with the attitude taken vis-à-vis some other corporate transparency measures.160 In the 2013 OECD White Paper on Transfer Pricing Documentation, the OECD noted 156  See Resolution of the Council and of the representatives of the governments of the Member States, meeting within the Council, of 27 June 2006 on a code of conduct on transfer pricing ­documentation for associated enterprises in the European Union (EU TPD), [2006] OJ C176/1–7, 28.7.2006. Available on: eur-lex.europa.eu/legal-content/EN/TXT/?uri=CELEX:42006X0728%2801%29. 157  See para 18 of the Annex to the Code of Conduct on Transfer Pricing Documentation for Associated Enterprises in the European Union, ibid. 158  See para 6 of the Code of Conduct on Transfer Pricing Documentation for Associated Enterprises in the European Union, ibid. 159 Maria A Grau Ruiz, ‘Country-by-Country Reporting: The Primary Concerns Raised by a Dynamic Approach’ (2014) 68 Bulletin for International Taxation 557–66, at 557. 160  See the new Accounting Directive 2013/34/EU which introduces an obligation for large extractive and logging companies to report country-by-country the payments made to governments, and also on a project-basis. Also see Revised Capital Requirements Directive 2013/36/EU which improves transparency in the activities of banks and investment funds in different countries. See analysis in Ch 5, section 5.3.1 of this volume.

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that the EU approach appeared to be less detailed and the information that the ­common template required seemed to be less extensive than the information required in some non-EU countries.161 It is no surprise, therefore, that the OECD’s ­country-by-country template developed under Action 13 is much more comprehensive than the template developed by the EU’s JTPF. Both, however, share the same basic aim: to improve transparency and enhance compliance by MNEs, and to ensure effective supervision by tax authorities worldwide. The OECD has rightly eschewed the vague language of CSR to justify its actions. Given recent developments and the Commission’s drive for further tax transparency,162 the EU transfer pricing reporting standards are likely to be aligned with those eventually derived from the BEPS proposals and probably supersede them in terms of strictness and comprehensiveness. Indicatively, recently, the European Parliament Development Committee has unanimously passed a resolution calling for MNEs to adopt country-by-country reporting and make beneficial ownership information publicly available.163 More initiatives are likely to follow in this area. As far as Action 14 of the BEPS Action Plan is concerned, it should be pointed out that arbitration (whether mandatory or not), which was not put forward as a proposal under the first discussion draft on Action 14,164 is a route available to Member States under the Arbitration Convention.165 Arguably, any further suggestions made to improve dispute resolution mechanisms and the tax treaty mutual agreement procedures affecting Member States ought to be aligned with the Arbitration Convention. The Arbitration Convention seeks to establish an arbitration procedure which eliminates double taxation in the course of transfer pricing disputes between Member States.166 Unlike a Directive or Regulation, it is merely an agreement under public international law and, as such, subject to the jurisdiction of national courts and not that of the Court of Justice. The Arbitration Convention is based on the arm’s length principle. It applies when profits of an enterprise of a Member State are included or are likely to be included in the profits of an enterprise in another Member State.167 The Arbitration Convention applies to all taxes on 161 See White Paper on Transfer Pricing Documentation, para 30, published on 30 July 2013. ­vailable on: www.oecd.org/ctp/transfer-pricing/white-paper-transfer-pricing-documentation.pdf. A Also see literature cited therein, inter alia, Ágúst K Guðmundsson, ‘Lost in Transfer Pricing: The Pitfalls of EU Transfer Pricing Documentation’ [2009] 1 International Transfer Pricing Journal 25–28; W Nichols and L Hughes, ‘EU Transfer Pricing Documentation—White Elephant or Missed Opportunity?’ [2010] Transfer Pricing International Journal, BNA (February 2010); ‘European Companies Questioning Benefits of EU Masterfile Documentation Approach’, Tax Management Transfer Pricing Report, BNA (May 2006). 162  See analysis in Ch 5 and more specifically, section 5.4 of this volume. 163  See press release of 1 June 2015, published in Tax Analysts: ‘European Parliament Committee Passes CbC Reporting Resolution’, 2015 WTD 106-14 (1 June 2015). 164  See analysis in Ch 4, section 4.4 of this volume. 165  Convention 90/436/EEC of 23 July 1990 on the Elimination of Double Taxation in Connection with the Adjustment of Profits of Associated Enterprises. 166  Croatia was the last Member State to accede to the Arbitration Convention in December 2014. For a general analysis, see Jasmin Kollmann, Petra Koch, Alicja Majdanska and Laura Turcan, ‘Arbitration in International Tax Matters’ (2015) 77 Tax Notes International 1189 (30 March 2015). 167  Arbitration Convention, n 165 above, Art 1.

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income and in particular to taxes listed therein.168 The objective of the Arbitration ­Convention is to establish a procedure to eliminate double taxation arising from profit adjustments made by Contracting States because of a violation of the arm’s length principle between associated enterprises; or the attribution of profits to a permanent establishment not equivalent to what it might be expected to derive if it were a distinct and separate enterprise engaged in the same or similar activities under the same or similar conditions and dealing on an arm’s length basis.169 The Arbitration Convention sets out a three-stage procedure for eliminating double taxation. First, the Member State has to notify the affected enterprise of its intention to make a tax adjustment and to hear any objections. It must give the enterprise time to let the relevant associated party inform the other Member State, but it is not prevented from making the proposed adjustment.170 Secondly, if the enterprise disagrees with the proposed adjustment, there is a three-year limit for it to present its case to its competent authorities, requesting a mutual agreement. This is irrespective of any remedies provided under the domestic law of the ­Contracting States.171 Thirdly, if the competent authorities of the two relevant Member States fail to reach a mutual agreement within two years, they have to establish an Advisory Commission.172 An appeal in national courts delays proceedings. The Advisory Commission has to deliver its opinion within six months.173 ­Following that, the competent authorities must make a decision which eliminates double taxation within the next six months.174 Double taxation is regarded as eliminated if either the profits are included in the computation of taxable profits in one Member State only or the tax chargeable on those profits in one Member State is reduced by an amount equal to the tax chargeable on them in the other.175 This three-stage procedure has to be concluded within six years. There are certain escape routes for the competent authorities of the Contracting States eg where the complaint does not appear to be well-founded,176 or where domestic law does not permit competent authorities to derogate from the decisions of their judicial bodies or where legal or administrative proceedings have resulted in a final ruling in that, because of the transactions that gave rise to the adjustment, one of the enterprises concerned is liable to a serious administrative or criminal penalty.177 The JTPF has examined issues relating to the implementation of the Arbitration Convention such as the effective implementation of the Arbitration Convention and the transfer pricing documentation for associated enterprises in the 168 

Ibid, Art 2(2). Ibid, Art 4. 170  Ibid, Art 5. 171  Ibid, Art 6. 172  Ibid, Art 7. 173  Ibid, Art 9. 174  Ibid, Art 10. 175  Ibid, Art 14. 176  Ibid, Art 6(2). 177  Ibid, Art 8(1), (2). 169 

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­ uropean Union, discussed previously. The JTPF has also produced Codes of E Conduct on these matters178 and monitors compliance issues,179 overseen by the ­Commission.180 Recently, the JTPF has issued a report on improving the functioning of the Arbitration Convention.181 As far as Action 15 of the BEPS Action Plan is concerned, it should be pointed out that there is nothing stopping Member States from entering into multilateral agreements. Nordic countries, for example, entered into a multilateral tax treaty in 1983.182 This multilateral tax treaty was revised several times since then but is still effective and binding on the participating countries, most of which are EU M ­ ember States as well. Member States have also entered into the Council of Europe/OECD Convention on mutual administrative assistance in tax matters in 1988. From an EU law perspective, technically, in the area in which Member States have retained exclusive competence, such as for direct taxes, there is nothing objectionable in entering into multilateral tax agreements. At least, it is not more objectionable than a bilateral tax agreement. This, however, comes with the usual caveat that established principles of EU law are to be respected. If the multilateral tax treaty is between Member States only, then technically, the treaty cannot include any provisions that are incompatible with EU law. If the multilateral tax treaty is between Member States and third countries, then ­Member States may not be in a position to dictate what provisions are included and what

178  See the Code of Conduct for the effective implementation of the Arbitration Convention. This Code of Conduct establishes common procedures concerning (a) the starting point of the three-year period which is the deadline for a company suffering double taxation to present its case to the tax administration of the relevant Member State; (b) the starting point of the two-year period during which Member States’ tax administrations must attempt to reach an agreement that eliminates the double taxation that is the subject of the complaint; (c) the arrangements to be followed during this mutual agreement procedure (the practical operation of the procedure, transparency and taxpayer participation); and (d) the practical arrangements for the second phase of the dispute resolution procedure (the establishment and functioning of the Advisory Commission). This Code of Conduct also contains a recommendation to Member States to suspend the collection of taxes during the dispute resolution procedure. Also see the Revised Code of Conduct (2009/C 322/01). 179  See, for example, the questionnaire sent regarding the implementation of the Code of Conduct on EU Transfer Pricing Documentation and the summary of the Member States’ responses published by the Commission in the summer of 2010. See EU Joint Transfer Pricing Forum: Secretariat’s paper summarising MS’ replies on the EUTPD questionnaire, Meeting of 8 June 2010. 180  For example, in September 2009, the Commission published a Communication on the work of the JTPF, including a proposal for a revised Code of Conduct, as well as a staff working paper containing a summary report on penalties in transfer pricing. See Communication on the work of the EU Joint Transfer Pricing Forum in the period March 2007 to March 2009 and a related proposal for a revised Code of Conduct for the effective implementation of the Arbitration Convention (90/436/EEC of 23 July 1990) COM(2009) 472 final. 181  See EU Joint Transfer Pricing Forum, Final Report on Improving the Functioning of the Arbitration Convention—Meeting of 12 March 2015 (DOC: JTPF/002/2015/EN). For the latest overview of the Arbitration Convention and suggestions for reform, see Harm Mark Pit, ‘Improving the Arbitration Procedure under the EU Arbitration Convention (1)’ (2015) 24 EC Tax Review 15–33 and Harm Mark Pit, ‘Improving the Arbitration Procedure under the EU Arbitration Convention (2)’ (2015) 24 EC Tax Review 78–95. 182  Nordic Convention on Income and Capital entered into by Denmark, Finland, Iceland, Norway and Sweden, concluded in 1983 and replaced in 1987, 1989 and 1996.

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not. This is likely to be the case with a post-BEPS multilateral tax treaty. To the extent that Member States cannot prevent multilateral treaty provisions which are incompatible with EU law,183 then they ought to abstain from enforcing such provisions or opt out or enter reservations in the text of the treaty. As held in the Open Skies cases,184 Member States have a duty to comply with their obligations under EU law when exercising their competence to conclude international agreements. Although EU-incompatible agreements with third countries may not be automatically invalid, Member States may be forced to terminate them.185 Notwithstanding the fact that taxation is not an area where Member States have any shared competence with the European Union, the Court of Justice might extend the Open Skies reasoning to a post-BEPS multilateral tax treaty containing potentially discriminatory clauses, even if the discriminatory behaviour results from a non-Member State’s act or omission.186 It has been suggested that if the compatibility issues are not clear and the Commission decides to request a legal opinion from the Court of Justice, then the OECD and EU Member States should consider awaiting such an opinion before proceeding with the signing of the multilateral agreement.187 Overall, any measures taken by the European Union or Member States in tackling aggressive tax planning should factor in established principles set out by the Court of Justice in its case law, considered in this and in the previous chapters. While such measures may now, more than ever, be politically appealing and feasible, both the EU institutions and Member States should resist the challenge of taking action without careful forethought and a detailed legal analysis. As shown in the next chapter in the discussion of the Commission’s state aid decisions relating to several transfer pricing tax rulings, politically-motivated actions risk eroding established legal doctrines. As such, these actions generate legal uncertainty and damage the credibility of the EU institutions, with no guarantee of reciprocal actions by third countries.

183  Eg the imposition of withholding taxes in situations in which the Parent-Subsidiary Directive would apply or contrary to the principles set out in the case law etc. See ch 6 in HJI Panayi (2013), n 3 above. 184  The eight so-called Open Skies judgments are Case C-466/98 Commission v UK [2002] ECR I-9427; Case C-467/98 Commission v Denmark [2002] ECR I-9519; Case C-468/98 Commission v ­Sweden [2002] ECR I-9575; Case C-469/98 Commission v Finland [2002] ECR I-9627; Case C-471/98 Commission v Belgium [2002] ECR I-9681; Case C-472/98 Commission v Luxembourg [2002] ECR I-9741; Case C-475/98 Commission v Austria [2002] ECR I-9797; and Case C-476/98 Commission v Germany [2002] ECR I-9855. 185  See the various repercussions in international law discussed in Christiana HJI Panayi, ‘Exploring the Open Skies: EC-incompatible treaties between Member States and Third Countries’ [2006] Yearbook of European Law 315–62. 186  See analysis in Christiana HJI Panayi, ‘Open Skies for European Tax?’, n 107 above. 187  See CFE Fiscal Committee, Opinion Statement FC 15/2014 on Developing a Multilateral Instrument to Modify Bilateral Tax Treaties (BEPS Action 15). Available on: www.cfe-eutax.org/node/4087.

7 State Aid, Taxation and Aggressive Tax Planning It is becoming obvious that the state aid prohibition under EU law has also been ‘enlisted’ as a powerful weapon in the fight against aggressive tax planning. In order to assess whether this Treaty provision is correctly applied, as well as the actual impact and limitations of this approach, it is important to examine in some detail the state aid prohibition and its procedures. The role of the Commission and of national tax authorities are considered, as well as the rights of competitors and third parties. There is a review of recent important cases in the area of tax law. In the last part of this chapter, the use of the state aid prohibition in tackling some (perceived) examples of aggressive tax planning is considered.

7.1. Introduction Enshrined in Article 107(1) TFEU, the state aid prohibition reads as follows: Save as otherwise provided in this Treaty, any aid granted by a Member State or through State resources in any form whatsoever which distorts or threatens to distort competition by favouring certain undertakings or the production of certain goods shall, in so far as it affects trade between Member States, be incompatible with the common market.

Article 107(1) TFEU does not have direct effect.1 There has to be an aid in the sense of a benefit or advantage,2 granted by a Member State or through Member State resources. This encompasses regional or local authorities and public bodies.3 Very importantly, the aid must favour ­certain undertakings or the production of certain goods (the ‘selectivity’ principle),4 1  Case 74/76 Ianelli & Volpi SpA v Meroni [1977] ECR 557. See also Case 78/76 Steinike und ­Weinlig v Germany [1977] ECR 595; Case C-354/90 Féderation National de Commerce Extérieur des Produits ­Alimentaire (FNCEPA) et al v France [1991] ECR I-5505. 2  The salient question is whether the recipient of the advantage is receiving a benefit which it would not have otherwise received under normal market conditions. See also below. 3 Eg Case C-323/82 Intermills v Commission [1984] ECR 3809; Case 177/78 Pigs and Bacon ­Commission v McCarren & Co Ltd [1979] ECR 2161. 4  A measure can be selective even if it applies to a large number of undertakings. See, for example, Case C-143/99 Adria-Wien Pipeline GmbH and Wietersdorfer & Peggauer Zementwerke GmbH v

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­ istort or threaten to distort competition, and must be capable of affecting trade d between Member States. Under Article 107(2) TFEU, certain types of aid such as aid of a social character or aid to help in case of a natural disaster are deemed to be compatible with EU law.5 Furthermore, aid may be compatible with the internal market if it falls within any of the six derogations laid down in Article 107(3) TFEU.6 Unsurprisingly, these derogations have been construed strictly. Whether or not a given measure is state aid is a question that the courts both at European and national level have competence to decide. However, whether such state aid is compatible or not with the common market is a question that the national courts do not have legal competence to deal with.7 There has been no attempt to formulate a precise definition of the concept of state aid, the ­Commission preferring a broad brush approach which examines each aid on its own merits.8 The salient question is whether the recipient of the advantage is receiving a benefit which it would not have otherwise received under normal market conditions.9 The benefit should improve the undertaking’s financial position or reduce the costs that it would have to bear. The Commission need not prove that trade will be affected.10 It is sufficient to show that the measure threatens c­ ompetition,11 ie that intra-EU trade may be affected and not necessarily permanently.12 In such circumstances, ­ inanzlandesdirektion für Kärnte [2001] ECR I-8365 and Case C-148/04 Unicredito Italiano SpA v F Agenzia della Entrate, Ufficio Genova 1 [2005] ECR I-11137 etc. 5 

More specifically, the following aids are encompassed in Art 107(2) TFEU: (a) aid having a social character, granted to individual consumers, provided that such aid is granted without discrimination related to the origin of the products concerned; (b) aid to make good the damage caused by natural disasters or exceptional occurrences; (c) aid granted to the economy of certain areas of the Federal Republic of Germany affected by the division of Germany, in so far as such aid is required in order to compensate for the economic disadvantages caused by that division. Five years after the entry into force of the Treaty of Lisbon, the Council, acting on a proposal from the Commission, may adopt a decision repealing this point. 6  Under Art 107(3) TFEU, the following may be considered to be compatible with the internal market: (a) aid to promote the economic development of areas where the standard of living is abnormally low or where there is serious underemployment, and of the regions referred to in Art 349, in view of their structural, economic and social situation; (b) aid to promote the execution of an important project of common European interest or to remedy a serious disturbance in the economy of a Member State; (c) aid to facilitate the development of certain economic activities or of certain economic areas, where such aid does not adversely affect trading conditions to an extent contrary to the common interest; (d) aid to promote culture and heritage conservation where such aid does not affect trading conditions and competition in the European Union to an extent that is contrary to the common interest; (e) such other categories of aid as may be specified by decision of the Council on a proposal from the Commission. 7  See section 7.3 below. 8  Conor Quigley, ‘The Notion of State Aid in the EEC’ [1988] European Law Review 242–56. 9  Case C-39/94 Syndicat français de l’Express international (SFEI) v La Poste [1996] ECR I-3547, para 60; Case C-241/95P Tiercé Ladbroke v Commission [1997] ECR I-7007, para 35; Case T-67/94 Ladbroke Racing v Commission [1998] ECR II-1, para 52. 10  See Cases T-298, 312, 313, 315 & 600–607/97 Alzetta Mauro v Commission [2000] ECR II-2319, paras 76–90. 11  Case T-288/97 Regione Autonoma Friuli Venezia Giulia v Commission [2001] ECR II-1169, paras 49–50; Case T-35/99 Keller SpA v Commission [2002] ECR II-261, para 85. 12  In Case T-211/05 Italy v Commission [2009] ECR II-2777, the General Court examined the compatibility of tax incentives for companies involved in initial public offering procedures with the state

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distortion of competition may be easily inferred.13 The above requirements form part of a global question. Initially, the Commission attacked the ‘paradigm’ state aids such as direct grants, subsidiaries, state guarantees and loans. In the last few years, it has turned its attention to more indirect forms of state aid, with particular emphasis on social and fiscal measures. State aid has become very important in the tax field.14 Important guidance on state aid end taxation was first given by the Commission in its 1998 Notice on the application of state aid rules to measures relating to direct business taxation (henceforth, the 1998 Notice).15 Measures which relieve the recipients of charges that are normally borne from their budgets, such as reductions in the tax base,16 total or partial reduction in the amount of tax (exemption or tax credit), deferral, cancellation or even special rescheduling of tax debt are, according to the Commission, examples of state aid. Such tax measures are thought to be granted by the Member State or through Member State resources. This is because a tax exemption mitigates the charge that would normally be recoverable from the undertaking. Therefore, the state loses tax revenue. This loss of tax revenue is equivalent to consumption of state resources in the form of fiscal expenditure.17 The fact that legislation is in breach with one of the fundamental freedoms does not mean that it cannot also be incompatible with the state aid prohibition. These issues are revisited later on in this chapter.18 A company may be affected by the state aid prohibition whether it is the ­recipient of aid or the competitor of such company. Aid given to a company may

aid prohibition. The General Court argued that the Commission was not obliged to show that competition was undermined permanently, or to carry out a more detailed investigation of the substantial impact of the measures at issue on the competitive position of the recipients. The decision of the General Court was followed by the Court of Justice upon appeal. See Case C-458/09. See, inter alia, Christian Montinari, ‘­Italian Tax Incentives for New Companies Constitute Illegal State Aid, ECJ Confirms’, 2011 WTD 234-4 (6 December 2011). 13  Case C-730/79 Philip Morris Holland BV v Commission [1980] ECR 2671, para 11; Case C-53/00 Ferring SA v Agence centrale des organismes de sécurité sociale (ACOSS) [2001] ECR I-9067, para 21; Case C-234/84 Belgium v Commission [1986] ECR 2263, para 22. See also a more recent case: Case C-522/13 Ministerio de Defensa and Navantia SA v Concello de Ferrol [2014]not yet reported. Here, the Court of Justice found that a property tax exemption for state-owned land that was made available to a private company which trades goods and services within the EU constituted state aid. 14  See Conor Quigley, European State Aid Law, 2nd edn (Hart Publishing, 2008); Pierpaolo RossiMaccanico, ‘Commentary of state aid review of multinational tax regimes’ [2007] 1 European State Aid Law Quarterly 25; Christiana HJI Panayi, ‘State Aid and Tax: The Third Way?’ (2004) 32 Intertax 287–311; Michael Rydelski, ‘Distinction between State Aid and General Tax Measures’ (2010) 19 EC Tax Review 149; Mélanie Staes, ‘The Combined Application of the Fundamental Freedoms and the EU State aid Rule: In Search of a Way Out of the Maze’ (2014) 42 Intertax 106; Conor Quigley, ‘Direct Taxation and State Aid: Recent Developments Concerning the Notion of Selectivity’ (2012) 40 Intertax 112. 15  Commission Notice on the application of the State aid rules to measures relating to direct business taxation, [1998] OJ C384, 10 December 1998, pp 3–9, para 9. For a commentary on the 1998 Notice, see Commission, Report on the implementation of the Commission notice on the application of the state aid rules to measures relating to direct, COM(2004) 434. 16  For example, by means of special deductions, special or accelerated depreciation arrangements or the entering of reserves on the balance sheet. 17  1998 Notice, n 15 above, para 10. 18  See analysis in section 7.5 below.

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have to be repaid if it is unlawful or has not been properly notified or approved by the Commission. If repayment is demanded, the taxpayer will have to reimburse within a period of four months the full amount of the financial benefit, including interest, for up to a maximum of 10 years prior to the start of an investigation. No recovery is necessary when the unlawful aid was paid more than 10 years before the Commission’s decision.19 Also, companies themselves may trigger investigations by lodging complaints with the Commission. In fact, when the Commission has doubts about the compatibility of a proposed aid measure, it invites interested parties to submit comments and opens a formal investigation procedure. The important role of competitors is increasingly being taken into account and is discussed further in section 7.4 below. On 3 February 2014, the Commission released its draft notice on the notion of state aid and invited comments so as to develop practical guidance for identifying state aid measures that need approval before being implemented (henceforth, the 2014 Draft Notice).20 The 2014 Draft Notice sets out and clarifies a number of important issues, including issues specific to taxations. The Draft Notice, once finalised, would replace the 1998 Notice, which codified the case law at the time and provided useful guidance.21 Specific parts of the 2014 Draft Notice, especially those relating to tax law, are analysed throughout this chapter.

7.2.  The Role of the Commission The Commission has a pivotal role in the application of the state aid p ­ rohibition.22 It keeps constant review of existing aids offered by Member States.23 Furthermore, Member States are required to notify the Commission as to any plans to grant or alter state aid.24 The Court of Justice has interpreted this Article as if it

19  It has been noted that almost any communication about the aid between the Member State and the Commission, which need not be known to the beneficiary, restarts the ten year limitation period. See George Peretz, ‘The Consequences of Unlawful State Aid’, Tax Journal, Issue 1253, pp 11–13 (6 March 2015) p 11, citing Case C-276/03P Scott SA v Commission [2005] ECR I-8437. 20 Draft Commission Notice on the notion of State aid pursuant to Article 107(1) TFEU, COM(2014)XXX. Available on ec.europa.eu/competition/consultations/2014_state_aid_notion/ draft_guidance_en.pdf. The Notice was to be reviewed by the Commission under the 2005–2009 State Aid Action Plan but was eventually produced pursuant to the State Aid Modernisation initiative of the Commission in 2012. Also see Claire Micheau, Tax Selectivity in European law of State Aid—Legal Assessment and Alternative Approaches, University of Luxembourg Law Working Paper No 2014-06. Also see commentary by Timothy Lyons, ‘The modernisation of EU state aid law and taxation’ [2014] British Tax Review 113–19. 21  1998 Notice, n 15 above. 22  For an excellent review of the Commission’s role in reviewing tax measures, see Pierpaolo RossiMaccanico, ‘European Commission Competence in Reviewing Direct Business Tax Measures’ (2009) 18 EC Tax Review 221–35. 23  See Art 108(1) TFEU. 24  Art 108 TFEU.

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imposes a standstill obligation on Member States during the period of review by the ­Commission.25 The Commission must reach a decision within two months, otherwise the standstill obligation comes to an end.26 During the notification procedure, the Commission applies a balancing test— thought to be derived from Article 107(3) TFEU.27 The test balances the positive effects of the aid for achieving a common interest objective and its negative effects on competition and trade.28 This test includes an economic evaluation of the aid. If the Commission finds that the aid (whether existing or new) is incompatible with Article 107 TFEU, ‘it shall decide that the State concerned shall abolish or alter such aid within a period of time to be determined by the Commission’.29 This procedure is meant to intensify co-operation between the Commission and ­Member States. The Commission may also ask the Court of Justice to order a Member State to recover illegal state aid. Furthermore, Article 109 TFEU empowers the Council, acting by qualified majority on a proposal from the Commission, and after consulting the European Parliament, to make any appropriate regulations for the application of the state aid provisions and in particular to determine the conditions under which Article 108(3) TFEU shall apply, and the categories of aid exempt from this procedure. This Article has provided the basis for Council action empowering the Commission to make regulations exempting certain categories of aid. Under the so-called General Block Exemption Regulations (GBER),30 the Commission has declared 25 

Case C-120/73 Gebrüder Lorenz GmbH v Germany [1973] ECR 1471. Art 4 of Council Regulation 659/1999 of 22 March 1999. Also see Case 120/73 Lorenz v ­Germany, n 25 above, para 4; Case 84/82 Germany v Commission [1984] ECR 1451, para 11. 27  This was introduced by the State Aid Action Plan of 2005 and refined in the Staff Working Paper entitled Common Principles for an Economic Assessment of the Compatibility of State Aid under Article 87.3 (2009). Available on: ec.europa.eu/competition/state_aid/reform/economic_assessment_en.pdf. For a review of the application of the balancing test, see Phedon Nicolaides and Ioana Eleonora Rusu, ‘The “Binary” Nature of the Economics of State Aid’ (2010) 37 Issues of Economic Integration 25–40. 28  There are three steps to this test. (1) Is the aid measure aimed at a well-defined objective of common interest (eg economic growth, employment, cohesion, environment)? (2) Is the aid well designed to deliver the objective of common interest ie does the proposed aid address a market failure or other objective? (i) Is the aid an appropriate policy instrument to address the policy objective concerned? (ii) Is there an incentive effect, ie does the aid change the behaviour of the aid recipient? (iii) Is the aid measure proportionate to the problem tackled, ie could the same change in behaviour not be obtained with less aid? (3) Are the distortions of competition and effect on trade limited, so that the overall balance is positive? See Common Principles for an Economic Assessment of the Compatibility of State Aid under Article 87.3 (2009), n 27 above, p 3, para 9. 29  Art 108(2) TFEU. 30  See, for example, Council Regulation (EC) No 994/98 of 7 May 1998 on the application of Articles 92 and 93 of the Treaty establishing the European Community to certain categories of horizontal State aid ([1998] OJ L142/1); Council Regulation No 733/2013 of 22 July 2013 amending Regulation (EC) No 994/98 on the application of Articles 92 and 93 of the Treaty establishing the European Community to certain categories of horizontal State aid ([2013] OJ L204/11, 31 July 2013); Commission Regulation (EC) No 1407/2013 of 18 December 2013 on the application of Articles 107 and 108 of the Treaty on the Functioning of the European Union to de minimis aid; and Commission Regulation (EU) No 651/2014 of 17 June 2014 declaring certain categories of aid compatible with the internal market in application of Articles 107 and 108 of the Treaty Text with EEA relevance ([2014] OJ L187/1–78, 26 June 2014). 26  See

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specific categories of state aid compatible with the Treaty if they fulfil certain ­conditions.31 Such categories of aid are exempt from the requirement of prior notification and Commission approval. Instead, the Member State simply informs the Commission that it has brought a scheme into place that complies with the GBER. In May 2012, the Commission announced plans to overhaul the state aid ­control process.32 In its Communication on State Aid Modernisation,33 the Commission set out three specific objectives. The first objective was to foster growth in a strengthened, dynamic and competitive internal market.34 To this end, the Commission would develop common principles for the compatibility assessment of national support projects and revise and streamline some existing texts.35 ­Secondly, state aid enforcement would focus more on cases with the biggest impact on the internal market.36 This would include stronger scrutiny of large and potentially distortive aid as well as enquiries by sector, across Member States.37 Thirdly, procedures would be streamlined to deliver decisions within business-relevant timelines.38 The Commission was also to revise the relevant regulations, seek to clarify and better explain the notion of state aid39 and increase transparency of state aid awards. On 17 January 2013, the European Parliament adopted a resolution supporting the initiative and its objectives.40 The European Economic and Social ­Committee,41 as well as the Committee of the Regions,42 have also adopted an opinion in favour of modernisation. There is no specific reference to taxes in the modernisation

31  The conditions invariably determine eligible beneficiaries, maximum aid and eligible expenses. The criteria used are thought to be derived from the Commission’s market experience and decisionmaking practice. 32  See ec.europa.eu/competition/state_aid/modernisation/index_en.html. For information on the 2005–2009 State Aid Reform initiative, see ec.europa.eu/competition/state_aid/reform/archive.html. 33  Communication from the Commission to the European Parliament, the Council, the European Economic and Social Committee and the Committee of the Regions, EU State Aid Modernisation, (COM/2012/0209 final). For commentary, see Phedon Nicolaides, ‘State Aid Modernization: Institutions for Enforcement of State Aid Rules’ [2012] World Competition 457–69. 34  Ibid, paras 10–18. 35  For example, the Environmental, Regional or Risk Capital Guidelines, Research & Development & Infrastructure, the Guidelines for the Rescue & Restructuring of firms etc. 36  Ibid, paras 19–21. 37  See para 19: ‘That outcome could be achieved by defining more proportionate and differentiated rules and by modernising State aid control procedures, with increased responsibility of Member States in designing and implementing support measures. It will require a clearer definition of the rules and an enhanced ex post monitoring by the Commission to ensure adequate compliance. It will also lower administrative burden for public authorities and for beneficiaries when smaller amounts of aid are involved’. 38  Ibid, paras 22–23. 39  See Consultation on the Notion of State Aid, which opened on 17 January 2014. Available on: ec.europa.eu/competition/consultations/2014_state_aid_notion/index_en.html. 40  European Parliament resolution of 17 January 2013 on state aid modernisation (2012/2920(RSP)). 41  Opinion of the European Economic and Social Committee on the Communication from the Commission to the European Parliament, the Council, the European Economic and Social Committee and the Committee of the Regions, Report on Competition Policy 2013 (COM(2014) 249 final). 42  Opinion of the Committee of the Regions on EU State Aid Modernisation (SAM) (2013/C 17/06).

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communication. However, the 2014 Draft Notice43 deals extensively with tax and sets out the various developments of the case law.

7.3.  Litigation Avenues—European Courts and National Courts State aid cases may reach the European courts in one of the three following ways: First, Member States may challenge a Commission decision under Article 263 TFEU. This challenge may relate to a review of the legality of the Commission’s or Council’s decision, or it might be an application for annulment of any binding act taken by Community institutions. Secondly, the Commission may bring an action against a Member State under Article 108(2) TFEU when the Member State has not removed aid previously determined incompatible by the Commission (ie to enforce a negative decision). The Commission may also commence proceedings under general law for failure to act,44 but these Articles are more cumbersome as they involve more procedural steps. Thirdly, a person individually concerned45 may bring an action under Article 263 TFEU against decisions prohibiting aid. The Court of Justice insists on some tangible connection between the aid and the recipient and not just for the recipient to belong to a group that could potentially benefit from the prohibited aid.46 The decision must affect the person(s) bringing the action by reason of certain attributes which are peculiar to them, or by reason of circumstances in which they are differentiated from other persons.47 Similarly, an action may be brought by a competitor of the recipient but the competitor needs to show that there are specific circumstances which allow them to be singled out from a potentially large group of competitors of the recipient of the aid.48 Although initially very few cases were brought by competitors,49 there has been an increase in the number of cases where third parties and competitors have claimed for the recovery of unlawfully granted state aid. National courts also play an important role in the enforcement of the state aid rules.50 The Commission has issued a Notice on the co-operation between 43 

See 2014 Draft Notice, n 20 above. Articles 258–260 TFEU. 45  Case 730/79 Philip Morris, n 13 above. 46  Case 67/85 Van Der Kooy and others v Commission [1988] ECR 219. 47  See the Plaumann test in Case 25/62 Plaumann v Commission [1963] ECR 95. 48  Case 10 and 18/68 Eridania Zuccherifici and others v Commission [1969] ECR 459. Also see Case C-198/91 Cook v Commission [1993] ECR I-2487; Case C-313/90 CIRFS v Commission [1993] ECR I-1125. 49 See Application of EC State Aid Law by the Member State Courts (Commission, 1999), at 244. 50  For an overview of the relationship of the European courts and national courts, see Malcolm­ Ross, ‘State Aids and National Courts: Definitions and Other Problems—A case of Premature Emancipation?’ (2000) 37 Common Market Law Review 401. 44 

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national courts and the Commission in the field of state aid.51 In the Notice, it is acknowledged that both national courts and the Commission play essential, but distinct roles in the context of state aid enforcement.52 Such co-operation is essential in order to guarantee the strict, effective and consistent application of EU competition law. A national court may rule that a given aid is state aid within the meaning of Article 107(1) TFEU but it cannot rule on the compatibility of the aid with the common market, as this is a matter falling within the absolute discretion of the Commission.53 However, a national court may rule aid to be illegal when it has not been properly notified. National courts have ordered interim injunctive measures in several cases to prevent or suspend the granting of unlawful aid.54 It is noteworthy that a national court has power to assess ex officio whether the state aid rules have been infringed, even if the argument has not been brought by the parties themselves.55 Guidance may be sought in the Commission’s decision-making practice and its notices and guidelines. When the Commission decides pursuant to Article 108(2) TFEU that an aid is incompatible with the internal market and it requires repayment of the aid, the national authorities have a duty to seek recovery without delay.56 National courts may also order remedial action when there is unlawful aid without a Commission decision. This is, for example, where a claimant has successfully invoked the direct effect of the prohibition on the implementation of unapproved aid in Article 108(3) TFEU. A recovery decision is addressed to the Member State that granted the unlawful aid and not to the beneficiary. However, the Member State must implement the recovery decision by seeking reimbursement of the aid from the beneficiary. Recovery of aid is limited to 10 years from the day the aid was awarded to the ­beneficiary. Where a beneficiary refuses to repay the aid, the Member State must commence enforcement proceedings in national courts. If national p ­ rocedural 51 Notice on Cooperation between national courts and the Commission in the State aid field, [2007] OJ C312, 23 November 1995. This was replaced by the Notice on the Enforcement of State Aid Law by National Courts, [2009] OJ C85, 9 April 2009, pp 1–22. Also see Commission Handbook on Enforcement of EU State aid law by national courts (2010), available on: ec.europa.eu/competition/ publications/state_aid/national_courts_booklet_en.pdf. For more information on the rights of competitors, see section 7.4 below. 52  Notice on the enforcement of State aid law by national courts (2009), n 51 above, para 19 et seq. 53  Ibid, para 20. 54  See 2009 update of the 2006 Study on the enforcement of State aid rules at national level—Final Report. Available on: ec.europa.eu/competition/state_aid/studies_reports/enforcement_study_2009. pdf. 55  Ibid. 56  See Article 14(3) of Council Regulation 659/1999, n 26 above: ‘recovery shall be effected without delay and in accordance with the procedures under the national law of the Member State concerned, provided that they allow the immediate and effective execution of the Commission’s decision. To this effect and in the event of a procedure before national courts, the Member States concerned shall take all necessary steps which are available in their respective legal systems, including provisional measures, without prejudice to Community law’. Also see Notice on the enforcement of State aid law by national courts (2009), n 51 above, paras 30–36.

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rules do not enable the enforcement of recovery, the Member State must take steps to put the required mechanisms in place. The obligation to recover aid ­overrides any a­ rgument that national procedural rules preclude recovery. Therefore, national courts play a hugely important role in the enforcement of recovery decisions adopted by the Commission. There is a Commission notice providing guidance on this.57 National courts are under an obligation to apply all appropriate devices and remedies to protect the rights conferred on individuals under Article 108(3) TFEU. Such course of action may include setting aside any conflicting provisions of national law, repayment of aid, granting orders for interim relief, re-establishment­ of the pre-existing competitive position of the relevant parties and even awarding damages to parties whose interests were harmed.58 The amount to be recovered is calculated on the basis of a comparison between the tax actually paid and the amount that would have been paid if the generally applicable rule had applied, irrespective of the fact that a beneficiary would not have entered into the transaction absent the aid. Interest may also be ordered on the amount repayable and this could be on a compound basis.59 In general, national courts have a duty to ensure that the effet utile of Article 108(3) TFEU is respected, by ensuring that state aid rules have primacy over national procedural rules. There may be exceptional circumstances in which the recovery of unlawful state aid would not be appropriate; for example, if it is absolutely impossible or if legitimate expectations have been generated by the Commission justifying non-recovery­ or if it is contrary to the general principles of EU law.60 These grounds are to be strictly construed. Statements by Member States are irrelevant, only legitimate expectations generated by the Commission or other EU institutions are relevant. Also the beneficiary must have received precise assurances from the Commission or other EU institutions to justify these expectations. This is rarely the case if the fiscal measure had not been notified to the Commission.61 In several cases, the Commission recognised that previous decisions in which a tax scheme was approved may have created legitimate expectations for beneficiaries of similar tax schemes.62 57 Notice from the Commission—Towards an effective implementation of Commission decisions ordering Member States to recover unlawful and incompatible State aid, [2007] OJ C272, 15 November 2007, p 4–17. 58  Notice on the enforcement of State aid law by national courts (2009), n 51 above, paras 28–62. 59  See Council Regulation 659/1999, n 26 above, Art 14(2); Council Regulation 794/2004 Art 11(2) and Notice on the enforcement of State aid law by national courts, n 51 above, para 41. 60  Notice on the enforcement of State aid law by national courts (2009), n 51 above, paras 32–33. Also see Case C-354/90 FNCEPA v France, n 1 above; Case C-332/98 France v Commission [2000] ECR I-4833. 61  See Margarida Afonso, ‘Recovery of Fiscal Aid’ in Alexander Rust and Claire Micheau (eds), State Aid and Tax Law (Kluwer, 2013) p 67. Also see George Peretz, ‘The Consequences of Unlawful State Aid’, n 19 above, p 11. 62  Afonso (2013), n 61 above, p 67, citing Decision C54/2001 on Ireland’s aid relief for foreign income, [2003] OJ L204/51, 13 August 2003, recitals 54–57 and Commission Decision 2011/5/EC on the tax amortisation of financial goodwill for foreign shareholding acquisitions implemented by Spain, [2011] OJ L7, 11 January 2011, recitals 158–69.

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The Commission and the Member State must work together in good faith with a view to overcoming difficulties of recovery. As held in Commission v France [t]he condition that it be absolutely impossible to implement a decision is not fulfilled where the defendant Member State merely informs the Commission of the legal, political or practical difficulties involved in implementing the decision, without taking any real steps to recover the aid from the undertakings concerned, and without proposing to the Commission any alternative arrangements for implementing the decision which could have enabled those difficulties to be overcome.63

In applying Article 107(1) TFEU, the Commission urges national courts to refer preliminary questions to the Court of Justice under Article 267 TFEU when in doubt.64 National courts can also ask the Commission to transmit relevant information in its possession.65 As stated in a 2006 Commission study on the enforcement of state aid law at national level,66 national courts could offer claimants very effective remedies in the event of a breach of the state aid rules. However, in a later study, it was noted that national courts’ powers of inquiry remained limited as far as state aid matters were concerned. This was because national courts had to judge cases on the basis of the facts presented by the parties. As state aid cases were often complex and involved economic considerations, national courts often lacked the appropriate means to establish the factual information necessary for their decision. ‘The burden of proof, therefore, is often a hurdle that leads to the claimant being ­unsuccessful. Claimants are often unable to present sufficient evidence to support the view that the State aid criteria have been fulfilled’.67

7.4.  The Rights of Interested Parties, Competitors and Third Parties The Commission is entitled to set priorities in relation to state aid complaints and give differing degrees of priority.68 Although the European courts have retained control over the concept of aid, the Commission still has substantial discretion in the overall process. It has been argued that there are fundamental defects in the state aid p ­ rocedure,69 as there are no material procedural rights conferred on interested parties. 63 

Case C-214/07 Commission v France [2008] ECR I-8357, para 46. Notice on the enforcement of State aid law by national courts (2009), n 51 above, paras 89–96. 65  Ibid, paras 82–88. 66  Commission Handbook on Enforcement of EU State aid law by national courts (2010), n 51 above. 67  See 2009 update of the 2006 Study on the enforcement of State aid rules at national level, Final Report, n 54 above, p 4. 68  See Case C-119/97P Ufex and others v Commission [1999] ECR I-1341, para 88; Case T-475/04 Bouygues SA v Commission [2007] ECR II-2097, para 158. 69  See Keith O’Donnell and Anne Muller, ‘State Aid and Tax Law: Enter the Taxpayer’ in State Aid and Tax Law, n 61 above. Also see paper (2014) by John Temple Lang, The Charter and EU 64 

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The ­procedure is essentially a bilateral one between the Commission and the Member State that has conferred the aid. The Commission is required, in the interests of sound administration, to conduct a diligent and impartial examination of the complaint, which may make it necessary for it to examine matters not expressly raised by the complainant.70 However, interested parties have no rights at all during the preliminary examination stage. There is no right to be informed of the commencement or development of the investigation, or to have access to the evidence available to the Commission. Also, there is no right to be consulted—except on the decision to open the procedure—and there is no appointed hearing officer for state aid cases, as with other anti-trust cases. A beneficiary is very dependent on the Member State to mount a vigorous defence, even though it is the beneficiary that will ultimately suffer the brunt of a recovery decision and not the Member State. This position is not thought to change following the proposed modernisation plan. The lack of procedural rights of interested parties has been criticised for being in breach of the Charter of Fundamental Rights; namely Article 47 of the Charter, which confers the right to an effective remedy and a fair trial (corresponding to Article 6 of the European Convention on Human Rights) and Article 41 of the Charter, which confers the right to good administration.71 A number of suggestions have been made on how to improve the procedural rights of material parties72 and how to make the whole procedure more transparent for companies involved and less discretionary for the Commission. For third parties and competitors, involvement in the state aid procedure is even more problematic.73 Locus standi remains an important hurdle. In the State aid procedure. Available on: uksala.org/state-aid-modernisation-seminar-slides/. Also see John Temple Lang, ‘Three Possibilities for Reform of the Procedure of the European Commission in Competition Cases Under Regulation 1/2003’, Centre for European Policy Studies (CEPS) Special Report—18 ­November 2011. Available on: papers.ssrn.com/sol3/papers.cfm?abstract_id=1996510. See also submission of John Temple Lang to European Ombudsman, regarding the consultation on public service principles for EU civil servants. Available on: www.ombudsman.europa.eu/en/resources/ otherdocument.faces/en/10447/html.bookmark. For the results of the public consultation, see: www. ombudsman.europa.eu/en/resources/otherdocument.faces/en/11069/html.bookmark. 70  Case T-512/11 Ryanair Ltd v European Commission, judgment of 24 November 2014, para 105, citing Case C-367/95 Commission v Sytraval and Brink’s France [1998] ECR I-1719, para 62. 71  Quigley (2012), n 14 above, at p 410 mentions Case T-198/01R Technische Glaswerke Ilmenau GmbH v Commission [2002] ECR II-2153, para 85, where the Court of First Instance (the predecessor of the General Gourt) held that the Commission must carry out its investigations in a manner which is impartial as between all the relevant parties. There was reference to Article 41(1) of the Charter of Fundamental Rights which provides that everyone has the right to have his affairs treated impartially and without discrimination by the EU institutions. For a general overview of some of the fundamental rights of the Charter that may be relevant to taxpayers, see Eric Poelmann, ‘Some Fiscal Issues of the Charter of Fundamental Rights of the European Union’ (2015) 43 Intertax 173–78. 72  Some of the suggestions made by Temple Lang in his 2014 paper, n 69 above, are the following: (a) access to the file for interested parties subject to confidentiality, similar to the regime for mergers, which is policed by the hearing officer; (b) imposing a legal obligation on the Commission and the Member States to act impartially throughout the investigation and to offer full and equal opportunity to interested parties to make submissions; (c) imposing an obligation to immediately publish the summary of all aid notifications and an invitation to comment; (d) having a hearing officer; (e) giving a formal right to attend settlement negotiations with Member States representatives or an oral hearing. 73  See Lisa Paterno, ‘State aid and fiscal protectionism in the European Union from the perspective of competitors’ (2011) 65 Bulletin for International Taxation 343. For an earlier analysis of the subject

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­ ommission Notice on enforcement of state aid law by national courts74 there was C a separate section on standing issues in tax cases.75 In that Notice, it was reiterated that the imposition of an exceptional tax burden on specific sectors or producers can also amount to state aid in favour of other companies.76 However, third party taxpayers may only rely on the standstill obligation where their own tax payment forms an integral part of the unlawful state aid measure.77 If exemptions have been granted from general taxes, these criteria are usually not met. An undertaking liable to pay such taxes cannot generally claim that someone else’s tax exemption is unlawful under Article 107(3) of the TFEU.78 Extending an illegal tax exemption to the competitor is no appropriate remedy for breaches of state aid, as such a measure would not eliminate the anti-competitive effects of unlawful aid, but would on the contrary, strengthen them.79 If a competitor can show loss or future loss as a result of the unlawful state aid, then damages may be obtained from the relevant public authorities.80 Many cases were alerted to the Commission as a result of complaints. For example, recently the Commission has been reviewing a complaint by the ­ ­Luxembourg-based RTL Group, that an advertising tax which was implemented by ­Hungary was confiscatory and was contrary to the fundamental freedoms. Also, as Hungarian-based media companies paid a much lower tax rate, it was argued that there was breach of Article 107 TFEU.81 Another recent state aid case was also brought by competitors.82 Here, Ryanair complained that the Irish air travel tax unfairly benefited rivals Aer Lingus and Aer Arann. The Irish air travel tax was set at €2 for any flight to a destination within

see Jan A Winter, ‘The Rights of Complainants in State Aid cases: Judicial Review of Commission ­Decisions adopted under Article 88 (ex 93) EC’ (1999) 36 Common Market Law Review 521–68. 74 

Notice on the enforcement of State aid law by national courts (2009), n 51 above, p 1–22. Ibid, section 2.4.3. 76  Ibid, para 73. 77  This is the case where, under the relevant national rules, the tax revenue is reserved exclusively for funding the unlawful state aid and has a direct impact on the amount of state aid granted. See Notice on the enforcement of State aid law by national courts (2009), n 51 above, para 74. Citing, inter alia, Joined Cases C-266/04 to C-270/04, C-276/04 and C-321/04 to C-325/04 Casino France and Others, [2005] ECR I-9481, para 40; and Case C-174/02 Streekgewest Westelijk Noord-Brabant v Staatssecretaris van Financiën [2005] ECR I-85, para 26. 78  Notice on the enforcement of State aid law by national courts (2009), n 51 above, para 75. 79  Joined Cases C-393/04 and C-41/05 Air Liquide Industries Belgium SA v Ville de Seraing and Province de Liège [2006] ECR I-5293, para 45. As Peretz, n 19 above, p 13 notes, it is only in exceptional circumstances that relief may be available to a competitor, such as when the tax paid by the competitor was levied in order to grant the advantage to the beneficiary or was hypothecated to that advantage. See Case T-473/12 Aer Lingus Ltd [2014] nyr, paras 67–70 and cases cited therein. 80  See Case C-199/06 Centre d’exportation du livre français (CELF) and Ministre de la Culture et de la Communication v Société internationale de diffusion et d’édition (SIDE) [2008] ECR I-469, paras 53–55. 81 William Hoke, ‘European Commission Reviewing Hungarian Ad Tax’, 2014 WTD 203-4 (21 October 2014). 82  Case T-512/11 Ryanair Ltd v European Commission, judgment of 25 November 2014. For commentary, see William Hoke, ‘Court Annuls EU State Aid Ruling on Ireland’s Air Travel Tax’, 2014 WTD 229-4 (28 November 2014). 75 

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300 km from Dublin and €10 for any other flight. Transfer and transit passengers were exempt from payment of the tax. Ryanair complained in that the non-application of the tax to transit and t­ ransfer passengers was illegal state aid in favour of airlines such as Aer Lingus and Aer Arann who handled a high proportion of such passengers and flights, as well as passengers travelling to destinations located less than 300 miles from Dublin. Also, the flat-rate amount of the tax accounted for a higher proportion of the ticket price for low-cost airlines than traditional airlines. In its decision,83 the Commission found that the tax was not state aid because it was not selective. The General Court annulled this decision on procedural grounds, on the basis that the Commission should have initiated a formal investigation procedure to verify the selectivity of the contested measure and should not have been limited to the preliminary investigation because of the existence of serious doubts. There were various indicia for this.84 For example the length of time it took the Commission to conduct the preliminary investigation suggests that it encountered serious difficulties in its review. Also the inconsistencies in the contents of the decision and the incomplete and insufficient nature of the overall examination ‘[permitted] the inference that the Commission was not able, at the date of adoption of the contested decision, to resolve all the serious difficulties identified concerning the question whether the disputed measure … was ­selective’.85 The General Court concluded that in so far as the exemption for transit and transfer passengers was concerned, the decision was adopted in breach of Ryanair’s procedural rights and must be annulled. There was no need to examine Ryanair’s other complaints and arguments.86

7.5.  Differences Between Fundamental Freedoms and State Aid There are some obvious differences between fundamental freedoms and state aid.87 Fundamental freedoms deal with inter-state differentiation between economic operators but state aid deals with intra-state differentiation. In addition, fundamental freedoms offer protection to individuals as well and not just ­undertakings. There are also differences in terms of remedies. Nevertheless, the

83 

Decision C(2011) 4932 final of 13 July 2011. See paras 66–105. 85  Ibid, para 106. 86  Ibid, para 107. 87  For commentary, see, inter alios, Claire Micheau, ‘Fundamental freedoms and state aid rules under EU law: The example of taxation’ (2012) 52 European Taxation 210; Frank Engelen, ‘State Aid and Restrictions on Free Movement: Two Sides of the Same Coin?’ (2012) 52 European Taxation 204–9; Staes (2014), n 14 above. 84 

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Court of Justice has refrained from declaring the two courses of action mutually exclusive. It has, however, held that the Commission cannot use its state aid powers to pursue infringements of other Treaty rules, or approve infringements of fundamental freedoms. In Iannelli & Volpi,88 a case decided in the late 70s, the Court of Justice developed its so-called severability test. Here, the Court had to examine whether the tax measure at issue should be examined under the state aid rules or the free movement of goods rules. The Court recognised that sometimes a case may fall simultaneously within the field of application of both provisions. However, it applied a severability test in finding that those aspects of aid which contravene specific provisions of the Treaty other than the state aid prohibition may be so indissolubly linked to the object of the aid that it is impossible to evaluate them separately so that their effect on the compatibility or incompatibility of the aid viewed as a whole must therefore of necessity be determined in the light of the procedure prescribed in [ex-] Art 93.89

Only the aspects of an aid which are not necessary for the attainment of its object or for its functioning can be held to be incompatible with another Treaty provision. This is without prejudice to the state aid review of the measure.90 In Ianelli, the Court of Justice came to the conclusion that the measure should not be regarded as falling within the scope of the free movement of goods but should rather be dealt with exclusively under the provisions of state aid. Reference should also be made to another early case, Hansen.91 In this request for a preliminary ruling, the Court was asked to consider how to deal with a dual infringement, when one Treaty rule was more specific than another. The Court of Justice argued that when a tax measure constitutes both state aid and an infringement of another specific and directly applicable Treaty rule, then the more specific infringement prevails and obliges the Court to examine the rule in light of that.92 This approach may, however, be difficult to apply if the lex specialis is considered to be the state aid prohibition and the general rule is the non-discrimination ­provision, in cases where the Commission is inclined to authorise the state aid. The case is not mentioned in the 1998 Notice,93 or in the 2014 Draft Notice.94 In fact, the 2014 Draft Notice does not deal with the topic at all. It is arguably qualified by the later Sovrapprezzo95 judgment which stipulated that the state aid

88 

Case 74/76 Iannelli & Volpi SA v Meroni [1977] ECR 557. Ibid, para 14. 90  Pierpaolo Rossi-Maccanico, ‘EU Review of Direct Tax Measures: Interplay between Fundamental Freedoms and State Aid Control’ (2013) 22 EC Tax Review 19–28, 21–23. He calls this the principle of cumulative but disjoined reviews of national tax measures. 91  Case 91/78 Hansen GmbH & Co v Hauptzollamt Flensburg [1979] ECR 935. 92  See also Rossi-Maccanico (2013), n 90 above, p 24–25. 93  1998 Notice, n 15 above. 94  2014 Draft Notice, n 20 above. 95  Case C-73/79 Commission v Italy [1980] ECR 1533. 89 

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procedure must never produce a result which is contrary to the specific provisions of the Treaty.96 Overall, it would seem that the Commission cannot exercise its discretion to authorise the granting of state aid when the measure infringes another Treaty provision. Discriminatory tax practices are not exempt by reason of the fact that they may also be a state aid.97 This was reiterated in the 1998 Commission Notice. Here, it was stated that the Commission could not authorise aid which was in breach of both rules under the Treaty, ‘particularly those relating to the ban on discrimination and to the right of establishment, and of the provisions of secondary law on taxation’.98 It was further noted that the case law provided that those aspects of aid which are indissolubly linked to the object of the aid, and which contravene specific provisions of the Treaty other than the state aid prohibition, must nevertheless be examined in light of the procedure under the state aid provision ‘as part of an overall examination of the compatibility or the incompatibility of the aid’.99 As state aid practices encompass, at some level, unequal treatment of undertakings of other Member States, it should not be presumed that every state aid amounts in itself to covert discrimination or restriction of fundamental freedoms. However, it has been held in a number of subsequent cases that the same tax measure could be incompatible with both rules.100 The most recent case is the Regione Sardegna case.101 In this case, the Court of Justice found that a national measure imposing a stopover tax only on passenger transport operators who were not domiciled in Sardinia could constitute both state aid and a restriction on the freedom to provide services which could not be justified on public interest grounds. Therefore, here, there was no issue of using the state aid procedure to validate a discriminatory practice. It has been argued that it is not always the case that both state aid and ­fundamental freedoms apply.102 More specifically, considering the tax that would normally be due, there cannot be both an advantage for resident undertakings and a disadvantage for non-resident undertakings. A tax rule should only be reviewed under the state aid rules when it favours resident undertakings and the free 96 

Ibid, para 8. See Rossi-Maccanico (2013), n 90 above, p 23. 98  1998 Notice, n 15 above, para 29. 99  Ibid. 100  Case 18/84, Commission v France [1985] ECR-1339; Case C-21/88 Du Pont de Nemours Italiana SpA v Unità sanitaria locale No 2 di Carrara [1990] ECR I-889, para 20. 101  Case C-169/08 Presidente del Consiglio dei Ministri v Regione Sardegna [2009] ECR I-10821. Raymond­Luja, ‘Revisiting the balance between aid, selectivity and selective aid in respect of taxes and special levies’ [2010] 1 European State Aid Law Quarterly 161–68. 102  Engelen (2012), n 87 above, at p 209. ‘If the measure in question reduces the tax that, in light of its object and purpose, should also have been imposed on resident undertakings and not only on nonresident undertakings, it confers a selective advantage on those resident undertakings that constitutes State aid … However, if the legislation in question imposes a tax on non-resident undertakings that should not have been due in the light of the object and purpose of that legislation, it does not create an advantage for resident undertakings but a disadvantage for non-resident undertakings that constitutes a restriction on the fundamental freedoms but not State aid’. 97 

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­ ovement provision should only be applied when the tax measure disadvantages m non-residents. Therefore, less favourable taxation of non-resident undertakings compared to taxation of resident undertakings that are in an objectively comparable situation does not always fall under both rules. In order to find which one should apply, the benchmark practice—i.e. the norm—and the deviation from it need to be ascertained first. This may not be an easy task. Overall, the combined application of state aid rules and fundamental freedoms remains a complex matter.

7.6.  State Aid and Taxes As already explained in the introduction to this chapter, as far as taxes are concerned, state aid law began to be systematically applied in the past 20 years.103 Reductions in the tax base,104 tax exemptions,105 tax credits,106 deferment of the payment of taxes,107 cancellation or even special rescheduling of tax debts, a favourable tax regime for the restructuring of banks,108 the conversion of tax debt into share capital,109 the cancellation of tax debts in bankruptcy proceedings110 and specific tax amnesties111 have been found to be state aid.

103  Peter J Wattel, ‘Interaction of State Aid, Free Movement, Policy Competition and Abuse Control in Direct Tax Matters’ (2013) 5 World Tax Journal 128–44; Staes (2014) n 14 above; Wolfgang Schön, ‘Taxation and State Aid Law in the European Union’ (1999) 36 Common Market Law Review 911. 104  For example, by means of special deductions, special or accelerated depreciation arrangements or the entering of reserves on the balance sheet. See Case C-66/02 Italy v Commission [2005] ECR I-10901, para 78; Case C-222/04 Ministero dell’ Economia e delle Finanze v Cassa di Risparmio di Firenze SpA [2006] ECR I-289, para 132. 105  See, inter alia, Case C-387/92 Banco de Crédito Industrial SA, now Banco Exterior de España SA v Ayuntamiento de Valencia [1994] ECR I-877; Joined cases C-465/09P to C-470/09P Comunidad Autónoma de La Rioja v Territorio Histórico de Álava—Diputación Foral de Vizcaya and Others [2011] ECR I-83. 106  See Cases T-92/00 and T-103/00 Territorio Histσrico de Alava—Diputaciσn Foral de Αlava [2002] ECR II-1385. 107  Case C-156/98 Germany v Commission [2000] ECR I-6857; Case C-66/02 Italy v Commission, n 104 above, para 78. 108  Case C-452/10P BNP Paribas v Commission, judgment of 21 June 2012, ECLI:EU:C:2012:318. 109  Case C-124/10P Commission v EDF, ECLI:EU:C:2012:318. 110  Case C-73/11P Frucona Košice as v Commission, ECLI:EU:C:2013:32. 111  See Case C-417/10 Ministero dell’Economia e delle Finanze [2012] ECR I-0000 and Commission Decision of 11 July 2012 on the tax amnesty measure notified by Latvia, S.A. 33183, [2013] OJ C1/6, 4 January 2013. See also 2014 Draft Notice, n 20 above, paras 167–69 where, on the basis of existing case law, it is stipulated that a tax amnesty measure that applies to undertakings can be considered a general measure if the following conditions are met. First, the measure should be of an exceptional nature, provide a strong incentive for undertakings to voluntarily comply with the tax obligations and enhance tax debt collection. Secondly, it should be open to any undertaking of any sector or size ­without favouring any pre-defined group of undertakings. Thirdly, there should be no de facto selectivity in favour of certain undertakings or sectors. Fourthly, the tax administration’s action should be limited to administering the implementation of tax amnesty without any discretionary power to intervene in the granting or intensity of the measure. Fifthly, the measure should not entail a waiver

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In 1998, the Commission had issued a Notice on the application of State aid rules to measures relating to direct business taxation.112 In the 1998 Notice, it was emphasised that tax measures which reduce a firm’s tax burden in various ways113 could be considered to be granted by the state or through state resources, as they mitigate the charge that would normally be due from the undertaking.114 Therefore, the state loses tax revenue and this loss of tax revenue is equivalent to consumption of state resources in the form of fiscal expenditure.115 As for the criterion of affecting competition and trade between Member States, in the 1998 Notice, it was emphasised that this ‘presupposes that the beneficiary of the measure exercises an economic activity, regardless of the beneficiary’s legal status or means of financing’.116 The mere fact that the aid strengthens the firm’s position compared to that of other firms which are competitors in intra-EU trade is enough to allow the conclusion to be drawn that intra-EU trade is affected. The fact that aid is relatively small in amount and the fact that the recipient is moderate in size does not alter this conclusion.117 The 1998 Notice also discussed the concept of selectivity. Consolidating existing case law at the time, the following test was set out. The main criterion in applying [Art 107(1) TFEU] to a tax measure is therefore that the measure provides in favour of certain undertakings in the Member State an exception to the application of the tax system. The common system applicable should thus first be determined. It must then be examined whether the exception to the system or differentiations within that system are justified ‘by the nature or general scheme’ of the tax system, that is to say, whether they derive directly from the basic or guiding principles of the tax system in the Member State concerned. If this is not the case, then State aid is involved.118

The application of this test has proved quite challenging at times, as shown in subsequent case law. A few years later, the Commission published an Implementation Report on the application of state aid rules to measures relating to direct business taxation.119 As mentioned in section 7.1 above, the 1998 Notice is to be replaced by a new and more general Notice on the Notion of State Aid.120 The 2014 Draft Notice contains very useful and ‘updated’ guidance on the notion of selectivity,

from verification. The limited temporal application of tax amnesties is also important. Tax amnesty measures may also be considered as general measures if they follow the national legislature’s objective of ensuring compliance with a general principle of law, such as the principle that a judgment must be given within a reasonable period of time. 112 

See, generally, 1998 Notice, n 15 above. Ibid, para 9. 114  Ibid, paras 10–11. 115  Ibid, para 10. 116  Ibid, para 11. 117  Ibid. 118  Ibid, para 16. 119  Report on the Implementation of the Commission Notice on the Application of the State Aid rules to measures relating to Direct Business Taxation, C(2004)434, 9 February 2004. 120  See 2014 Draft Notice, n 20 above. 113 

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reflecting developments in the case law. A summary of some of the important points raised is given below. First, the distinction between material and geographical selectivity is explained.121 Material selectivity can be established de jure or de facto.122 De jure selectivity results directly from the legal criteria for granting a measure that is formally reserved for certain undertakings only. De facto selectivity can be established in cases where, although the formal criteria for the application of the measure are formulated in general and objective terms, the structure of the measure is such that its effects significantly favour a particular group of undertakings.123 It was also emphasised that selectivity could arise with measures which prima facie apply to all undertakings, but are (or may be) limited by the discretionary power of administration. In such circumstances, fulfilling the given criteria does not automatically result in an entitlement to the measure. An example given is that of tax administrations varying the conditions for granting a tax concession according to the characteristics of the investment project.124 When measures are broad and potentially applicable to all undertakings fulfilling certain criteria, then it is more difficult to establish selectivity, compared to ad hoc measures. Here, the 2014 Draft Notice summarises the three-step test developed in the case law of the Court of Justice, as a refinement to the test set out in the 1998 Notice, which was discussed immediately above. First, the system of reference against which the selectivity of a measure is assessed must be identified. The reference system is composed of a consistent set of rules that generally applies on the basis of objective criteria to all undertakings falling within its scope.125 It might be necessary to evaluate whether the boundaries of the system of reference have been designed in a consistent manner or, on the contrary, in a clearly arbitrary or biased way, so as to favour certain u ­ ndertakings which are in a comparable situation with regard to the underlying logic of the system in question. Secondly, it is determined whether the measure derogates from the system ‘insofar as it differentiates between economic operations who, in light of the objectives intrinsic to the system, are in a comparable factual and legal situation’.126 Thirdly, it is determined whether the derogatory measure is justified by the nature or the general scheme of the reference system.127 The latter would be the

121 

Ibid, paras 121–56. Ibid, paras 122–23. Also see Andreas Bartosch, ‘Is there a Need for a Rule of Reason in European State Aid Law? Or How to Arrive at a Coherent Concept of Material Selectivity?’ (2010) 47 Common Market Law Review 729–52, 751. 123  See, for example, the Gibraltar case, where following reform, Gibraltar tax laws de facto favoured offshore companies. Joined Cases C-106/09P and C-107/09P Commission and Spain v Government of Gibraltar and UK [2011] ECR I-11113. 124  2014 Draft Notice, n 20 above, para 125. 125  Ibid, paras 132–33. 126  Ibid, para 128. Also see paras 135–37. 127  Ibid. 122 

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case where a measure derives directly from the intrinsic basic or guiding principles of the reference system or where it was the result of inherent mechanisms necessary for the functioning and effectiveness of the system. External policy objectives (eg environmental, industrial policy objectives) cannot be relied upon to justify differentiated treatment.128 ‘Member States should, however, introduce and apply appropriate control and monitoring procedures to ensure that derogatory measures are consistent with the logic and general scheme of the tax system’.129 The Draft Notice reiterates previous case law in that Article 107(1) TFEU does not distinguish between measures of state intervention in terms of their causes or aims, but defines them in relation to their effects, independently of the techniques used.130 There has been criticism, in that case law on the notion of state aid is not always consistent.131 Also, selectivity and general tax measures are often difficult to delineate.132 In the Draft Notice, the Commission makes a valiant attempt to rationalise the case law. The fact that the Commission devotes a substantial part of the Draft Notice on the application of state aid law to tax shows the importance it attaches to this field.133 In reviewing the Draft Notice, on its own and in the context of existing case law, what becomes apparent is the complexity of applying general (state aid) principles in tax law. Furthermore, for tax measures especially, whilst it is often inherently difficult to ascertain the boundaries of the reference system and as a corollary derogations and justifications, this exercise becomes more troublesome in cases of regional selectivity. Some recent case law in this field and the themes arising therefrom, are briefly reviewed in the following section. The cases reviewed, most of which were also considered by the Commission in its 2014 Draft Notice, focus on fiscal aid in the field of direct taxation only and not indirect taxation.134

128 Citing, inter alia, Joined Cases C-78/08, C-79/08 & C-80/08 Ministero dell’Economia e delle Finanze and Agenzia delle Entrate v Paint Graphos Soc coop arl; Adige Carni Soc coop arl, in liquidation v Agenzia delle Entrate and Ministero dell’Economia e delle Finanze; Ministero delle Finanze v Michele Franchetto [2011] ECR I-7611, paras 69–70; Case C-88/03 Portugal v Commission [2006] ECR I-7115, para 81; Case C-279/08 P Commission v Netherlands (NOx) [2011] ECR I-7671; Case C-487/06 P ­British Aggregates Association v Commission [2008] ECR I-10515. 129  2014 Draft Notice, n 20 above, para 140. Citing Paint Graphos, n 128 above, para 74. 130  Ibid, para 129, citing, inter alia, British Aggregates v Commission, n 128 above, paras 85 and 89; Case C-279/08P Commission v Netherlands [2011] ECR I-7671, para 51 etc. 131  See general, non-tax specific analysis in Andrea Biondi, ‘State Aid is Falling Down, Falling Down: An Analysis of the Case Law on the Notion of Aid’ (2013) 50 Common Market Law Review 1719–44. For a tax specific analysis, see, inter alios, Claire Micheau, ‘Tax Selectivity in State Aid Review: A Debatable Case Practice’ (2008) 17 EC Tax Review 276–84; Staes (2014), n 14 above; Quigley (2012), n 14 above. 132  See Rydelski (2010), n 14 above. 133  See also Lyons (2014), n 20 above, p 119. 134  For the growing importance of the state aid prohibition in the field of indirect taxation and mainly VAT see Joachim English, ‘EU State Aid Rules Applied to Indirect Tax Measures’ (2013) 22 EC Tax Review 9.

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7.7.  Themes from Recent Case Law 7.7.1.  Autonomous Powers and Regional Selectivity Measures adopted by intra-state entities (decentralised, federal, regional or other) of Member States may also fall foul of the state aid provision, but the reference system need not be defined within the limits of the Member States concerned. A measure favouring undertakings active in one region of the national territory may not be selective. The conditions for assessing measures in the context of regional authorities were considered in a number of cases, the most important of which are analysed below. In Portugal v Commission,135 the Court of Justice addressed the issue of selectivity within a regional or local authority and mapped out important guidelines. In 1999 the legislative body of the Azores Region adopted detailed rules reducing income and corporation tax by 10 per cent for undertakings established in the Region. The Commission found the reduction to be selective and to be state aid. However, the aid was compatible with the common market, except in the case of undertakings carrying out financial activities or intra-group services. The Portuguese Government contested the decision arguing that the measure involved was not selective and was justified by the nature and overall structure of the tax system. The Court upheld the Commission’s decision and gave important guidance on the application of state aid rules to tax measures adopted by regions and local authorities. In order to determine whether a measure was selective, it was necessary to examine the reference framework which was not necessarily that of the territory of the Member State concerned. In the case of a measure adopted by an infra-state entity, the framework could be limited to the geographical area concerned and as such not be selective.136 As the Court held, [i]t is possible that an infra-State body enjoys a legal and factual status which makes it sufficiently autonomous in relation to the central government of a Member State, with the result that, by the measures it adopts, it is that body and not the central government which plays a fundamental role in the definition of the political and economic environment in which undertakings operate.137

In such a case it was the area in which the infra-state body responsible for the measure exercised its powers, and not the country as a whole, which was the ­relevant reference framework.

135  Case C-88/03 Portugal v Commission [2006] ECR I-7115. See Bruno Peeters, ‘European Guidelines for Federal Member States Granting Fiscal Competences c.q. Tax Autonomy to Sub-national Authorities’ (2009) 18 EC Tax Review 50–52; Daniel Armesto, ‘The ECJ’s Judgment regarding the Tax Autonomy of the Basque Country’ (2009) 49 European Taxation 11. 136  Case C-88/03 Portugal v Commission, n 135 above, para 57. 137  Ibid, para 58.

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As far as selectivity was concerned, in this context, three scenarios could be distinguished. The first scenario was when the central government of a Member State unilaterally decided to apply a lower level of taxation within a defined geographical area. Here, there would be regional selectivity.138 The second scenario entailed a symmetrical devolution of tax powers: a model of distribution of tax competences in which all local authorities at a same level (regions, districts or others) have the autonomous power to decide, within the limit of the powers conferred on them, the applicable tax rate within their territory of competence, independently of the central government.139 Here, there would be no selectivity ‘because it is impossible to determine a normal tax rate capable of constituting the reference framework’.140 In the third scenario of asymmetrical devolution of tax powers, some regional or local authorities adopt tax measures applicable only to undertakings present within their territory.141 In this situation, the legal framework appropriate to determine the selectivity of a tax measure may be limited to the geographical area concerned where the infra-state body, in particular on account of its status and powers, occupies a fundamental role in the definition of the political and economic environment in which the undertakings operate. For this to be the case, regional authorities must satisfy cumulatively three criteria. First, the tax measures must have been taken by a regional or local authority which had, from a constitutional point of view, a political and administrative status separate from that of the central government. Secondly, the tax measures must have been adopted without the central government being able to directly intervene as regards its content. Finally, the financial consequences of a reduction of the national tax rate for undertakings in the region must not be offset by aids or subsidies from other regions or the central government.142 In this case, the Court of Justice concluded that the reduction of the tax burden by the Azores authorities was inextricably linked to the correction of inequalities deriving from insularity. These two aspects of the fiscal policy were dependent, from a financial point of view, on budgetary transfers managed by central government. Consequently the relevant legal framework for assessing the selective nature of the tax measures could not be limited to the geographical area of the Azores but rather must be assessed in relation to the totality of the Portuguese territory. As such, the measures appeared to be selective, and not general, measures. The scheme could not be justified by the nature of the system or its overall structure. The Court of Justice followed this ruling in the UGT Rioja case.143 Here, the Court was asked to consider whether or not a tax advantage adopted by the 138 

Ibid, para 64. Also see 2014 Draft Notice, n 20 above, para 144. Ibid. Also see 2014 Draft Notice, n 20 above, para 144. 140  Ibid. 141  Ibid, para 65. 142  Ibid, para 67. 143  Case C-428/06 to C-434/06 Unión General de Trabajadores de La Rioja (UGT-Rioja) and Others v Juntas Generales del Territorio Histórico de Vizcaya and Others [2008] ECR I-6747. 139 

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­ istorical Territories and the Autonomous Community of the Basque Country H were state aid.144 Reproducing the reasoning set out in Commission v Portugal, the Court examined the concepts of institutional, procedural and economic autonomy. However, it left it to the referring court to decide whether the relevant infrastate bodies had such autonomy. The concept of regional selectivity was further elaborated in later cases.145 In the Gibraltar case,146 the Court of Justice found that the UK’s proposed corporate tax reform in Gibraltar was incompatible with the state aid prohibition. In so doing, the Court overturned the Court of First Instance’s (now General Court) earlier decision and confirmed the Commission’s decision. The UK had notified the Commission of its plans to replace profit-based taxation with general payroll tax and a business property occupation tax both capped at 15 per cent of business profits. In its decision,147 the Commission found that the scheme was materially and regionally specific—the assumption, for the latter, being that Gibraltar is a mere UK region and not an independent territory for tax purposes.148 The case was appealed and the decision reversed by the Court of First Instance in its entirety.149 The Court of First Instance had examined the role of the UK in the definition of the political and economic environment in Gibraltar as a criterion for ­determining the reference framework. The UK’s residual power to legislate for Gibraltar and the various powers granted to the ­Governor must be interpreted as means [of] enabling the United Kingdom to assume 144  The local authorities adopted tax legislation which set the rate of corporation tax generally at 32.5% and provided for a series of tax deductions. By contrast, the basic rate of corporation tax in Spain was 35% and did not make any provision for such deductions. 145  See analysis in ch 4 of Claire Micheau, State Aid, Subsidy and Tax Incentives Under EU and WTO Law (Kluwer Law International, 2014). 146  Joined Cases C-106/09P & C-107/09P Commission v Gibraltar and UK [2011] ECR I-11113. For commentary, see, inter alios, Pierpaolo Rossi-Maccanico, ‘The Gibraltar Judgment and the Point on Selectivity in Fiscal Aids’ (2009) 18 EC Tax Review 67–75; Lee Sheppard, ‘Do Tax Havens Violate the TFEU?’ (2011) Tax Notes International 52, 21 November 2011; 2011 WTD 224-3; Wattel (2013) n 103 above; Rossi-Maccanico (2013), n 90 above; Raymond Luja, ‘(Re)shaping fiscal state aid: selected recent cases and their impact’ (2012) 40 Intertax 120–31; John Temple Lang, ‘The Gibraltar State aid and taxation judgment—A “methodological revolution”’ [2012] 4 European State Aid Law Quarterly 805–12. 147  Commission Decision of 30/3/2004, [2005] OJ L85/1, 2/4/2005. 148  According to the Commission’s decision (see recitals 98 to 152) the proposed tax reform was both regionally and materially selective. It was regionally selective since companies in Gibraltar were taxed, in general, at a lower rate than those in the UK. Also, certain aspects of the proposed tax reform were materially selective. Also see the Court’s judgment, which refers to the Commission’s reasoning: ‘first, the requirement to make a profit before incurring liability to payroll tax and BPOT [ie business property occupation tax], since that requirement favours companies which make no profit … and second, the cap limiting liability to payroll tax and BPOT to 15% of profits, since that cap favours companies which, for the tax year in question, have profits that are low in relation to the number of employees and occupation of business property … Third and lastly, imposition of a payroll tax and BPOT is also materially selective, since both taxes inherently favour offshore companies which have no real physical presence in Gibraltar and which as a consequence do not incur corporate tax …’. See Commission v Gibraltar and UK (2011) n 146 above, para 21. 149  Joined Cases T-211/04 and T-215/04 Government of Gibraltar and United Kingdom v Commission [2008] ECR II-3745.

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its ­responsibilities towards the population of Gibraltar and to perform its obligations under international law, and not as granting an ability to intervene directly as regards the content of a tax measure adopted by the Gibraltar authorities, in particular since those residual powers have never been exercised in matters of taxation.150

The Court of First Instance concluded that the reference framework corresponded exclusively to the geographical limits of the territory of Gibraltar. As such, no comparison could be made between the tax regime applicable to companies established in Gibraltar and that applicable to UK companies for the purpose of establishing a selective advantage.151 This meant that the tax reform proposals were not regionally selective, nor materially selective. The Court of Justice reversed the Court of First Instance’s judgment, on 15 November 2011. In doing so, the Court also went against Advocate General Jääskinen’s opinion which agreed with the Court of First Instance. More specifically, the Court found the regime to be materially selective. Its basic features— ie the payroll tax and the business property occupation tax as the sole bases of assessment—excluded from the outset any taxation of offshore companies, since these companies had no employees and also did not occupy business properties.152 The classification of a tax system as selective was not conditional upon that system being designed in such a way that all undertakings were liable to the same tax burden but some benefitted from derogating provisions.153 Furthermore, for a tax system to be classified as selective, it need not be designed in accordance with a certain regulatory technique; otherwise national tax rules would fall, from the outset, outside the scope of control of state aid merely because they were adopted under a different regulatory technique although they produced the same effects.154 The Court of Justice held that the reference system, although founded on criteria that were of a general nature, discriminated in practice between companies which were in a comparable situation with regard to the objective of the tax reform, resulting in a selective advantage being conferred on offshore companies.155 The measure was, therefore, de facto selective. The fact that the offshore companies were not taxed was not a random consequence of the regime. Rather, it was the inevitable consequence of the fact that the bases of assessment were specifically designed so that offshore companies, ‘which by their nature have no employees and do not occupy business premises’,156 have no tax base under the bases of assessment adopted in the proposed tax reform. Thus, the fact that offshore companies, which constitute a group of companies with regard to the bases of assessment adopted in the proposed tax reform, avoid taxation

150 

Ibid, para 99. Ibid, para 115. 152  Commission v Gibraltar and UK (2011) n 146 above, paras 100–102. 153  Ibid, para 91. 154  Ibid, para 92. 155  Ibid, para 101. 156  Ibid, para 106. 151 

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precisely on account of the specific features characteristic of that group gives reason to conclude that those companies enjoy selective advantages.157

There was no need to examine whether the proposed tax reform was also regionally selective. The finding of material selectivity was sufficient to substantiate the operative part of the contested decision which found the proposed tax reform to be in breach of the state aid prohibition.158 The Court of Justice rejected the complaint that the Commission departed from the 1998 Notice relating to State aid in the field of taxation.159 The Court also rejected the complaint that the Commission departed from its decision-making practice,160 emphasising that ‘the question whether a measure constitutes State aid must be assessed solely in the context of [Article 107(1) TFEU] and not in the light of an alleged earlier decision-making practice of the Commission’.161 Rather boldly, the Court of Justice did not follow the three-step analysis, which has traditionally been used in analysing the concept of selectivity for state aid purposes.162 Here, even though there was no derogation from the normal tax regime, still the Court of Justice found the regime to be selective. The fact that the general tax system was effectively too narrowly defined from the outset and that it discriminated in practice between companies which were in a comparable situation was crucial to the Court. Somehow, these considerations were inserted in the analysis. As has been criticised, it was not the design of the tax system that was decisive but rather its material effect.163 It is interesting to note that the Commission’s views that the Gibraltar tax system had an inherently discriminatory character (and the relevance of this) had been discussed and rejected by the Advocate General in his opinion.164 As he noted: [T]o accept such an approach would be tantamount to triggering a methodological revolution in the application of the rules relating to State aid for the purposes of Article 87(1) EC. According to that approach, the existence of an advantage would be assessed no longer on the basis of a comparison between the measure and the generally applicable tax regime, but by virtue of a comparison between the tax regime as it exists and another—hypothetical and non-existent—system. Such an approach would require the construction of a fiscal comparator for the European Union in order to be able to assess the allegedly discriminatory effect of the choices made regarding the tax base (or tax rates) in the field of corporate taxation. However, no such common criterion exists and

157 

Ibid, para 107. Ibid, paras 184–185. 159  Ibid, paras 128–134. 160  Ibid, para 135–137. 161  Ibid, para 136. 162  See analysis in sections 7.1 and 7.6. 163 Wattel (2013) n 103, p 133. Summing up his conclusions, Wattel finds that following the ­Gibraltar case ‘[a] main rule-exception analysis is not (always) decisive, as a State may exclude certain undertakings from a tax by including them in such a crafty way that they are effectively still excluded and therefore favoured’: ibid. 164  See paras 201–202 of the opinion. 158 

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the application of the legal framework for State aid does not justify the de facto adoption of a tax harmonisation measure of that kind.165

The Advocate General also, interestingly, argued that this measure was in fact an example of harmful institutional or tax competition between Member States which clearly does not fall within the mechanism for controlling State aid established by the Treaty, even though there are cases where measures are liable to amount both to harmful tax competition and to State aid incompatible with the common market.166

In this case, the measure could only be addressed under the code of conduct on business taxation and not under the state aid provision.167 The legitimate objective of combating harmful tax competition could not ‘justify distortion of the ­European Union’s legal framework established in the area of competition law applicable to State aid, or even the adoption of ad hoc solutions conflicting with the rule of law as enshrined in Article 2 TEU’.168 Although the Gibraltar case has been widely criticised, it has not been overruled by later case law. Nor has it been followed though, which suggests that it may be a judgment on a sui generis case. The Gibraltar case also deviated from another case, decided shortly before it—the Paint Graphos case,169 discussed below.

7.7.2. Inherent Consistency with the Logic and General Scheme of a Tax System In the Paint Graphos case, the Court of Justice clarified that as regards measures derogating from the general system, to be compatible with the state aid prohibition, they must be found inherently consistent with the logic and general scheme of the tax system and proportional to that effect. Member States should introduce and apply appropriate control and monitoring procedures to ensure that. Here, the Italian Supreme Court asked whether incentives granted to cooperative companies through tax exemptions constituted state aid and whether the incentives could be considered proportionate. The Court of Justice found that the tax benefits granted to cooperative companies were financed through state resources and were liable to affect trade between Member States and distort competition contrary to the state aid prohibition. However, selectivity was to be determined by the referring national court. Guidance for this determination was given by the Court of Justice.

165 

Ibid, para 202. Ibid, para 134. 167  See para 134 of the opinion. 168  Ibid. 169  Paint Graphos, n 128 above. See Case Comment, ‘State aid: ruling on Italian tax relief measures for cooperative societies’ (2012) 52 European Taxation 27–28; Quigley (2012) n 14 above. 166 

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The Court reiterated existing case law in emphasising that aid may be selective even where it concerns a whole economic sector.170 It was necessary to determine whether the tax exemption favoured certain undertakings or the production of certain goods by comparison with other undertakings which were in a comparable factual and legal situation, in light of the objective pursued by the corporation tax regime.171 In the legal context of this case, cooperative companies conformed to particular operating principles which clearly distinguished them from other economic ­operators.172 For example, cooperatives were not managed in the interests of ­outside investors. Control was vested equally in their members, and activities were conducted for the mutual benefit of members. Reserves and assets were commonly held, non-distributable and were dedicated to the common interest of members. As a consequence, the profit margin of cooperative societies was ‘considerably lower than that of capital companies, which are better able to adapt to market requirements’.173 Therefore, the Court of Justice concluded that cooperative companies were not in a comparable factual and legal situation to that of commercial companies, provided, however, that they act in the economic interest of their members and their relations with members are not purely commercial but personal and individual, the members being actively involved in the running of the business and entitled to equitable distribution of the results of economic performance.174

This was a question for the national court to decide.175 If it did so decide, then it had to be examined whether the tax exemptions were justified by the nature or general scheme of the system of which they formed part.176 The Court of Justice reiterated that a derogation could be justified if it resulted directly from the basic or guiding principles of that tax system. In that context, a distinction must be made between, on the one hand, the objectives attributed to a particular tax regime and which are extrinsic to it and, on the other, the mechanisms inherent in the tax system itself which are necessary for the achievement of such objectives.177

Therefore, tax exemptions which were the result of an objective that was unrelated to the tax system of which they formed part could not circumvent the state aid prohibition.178 It was necessary to ensure compliance with the requirement that a benefit must be consistent not only with the inherent characteristics of 170 

Ibid, para 53, citing inter alia, Case C-75/97 Belgium v Commission [1999] ECR I-3671, para 33. Paint Graphos, n 128 above, para 54. Ibid, paras 55–61. 173  Ibid, para 60. 174  Ibid, para 61. 175  Ibid, para 63. 176  Ibid, para 64. 177  Ibid, para 69. 178  Ibid, para 70. 171  172 

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the tax system in question but also as regards the manner in which that system was ­implemented.179 Tax exemptions must also be consistent with the principle of proportionality and must not go beyond what was necessary to pursue the ­objective.180 Again it was for the referring court to determine these issues.181 Very importantly, in its judgment, the Court of Justice stated that it was for the Member States concerned to introduce and apply appropriate control and monitoring procedures in order to ensure that the tax measures introduced were consistent with the logic and general scheme of the tax system.182 It was also for the Member States ‘to prevent economic entities from choosing that particular legal form for the sole purpose of taking advantage of the tax benefits provided for that kind of undertaking’.183 As for the condition relating to the effect on trade between Member States and the distortion of competition, again, the Court of Justice gave some useful guidance. Here, there was no need to show a real effect on trade and actual distortion of competition. It was enough that aid was liable to affect such trade and distort competition.184 In particular, when aid granted by a Member State strengthened the position of an undertaking compared with other undertakings competing in intra-Community trade, the latter must be regarded as affected by that aid.185 It was not necessary that the undertaking benefiting from the aid was involved in intra-Community trade. Where a Member State grants aid to an undertaking, internal activity may be maintained or increased as a result, so that the opportunities for undertakings established in other Member States to penetrate the market in that Member State are thereby reduced. Furthermore, the strengthening of an undertaking which, until then, was not involved in intra-Community trade may place that undertaking in a position which enables it to penetrate the market of another Member State.186

Some of the important dicta from this case were discussed in the Commission’s 2014 Draft Notice on state aid. In discussing the point made that derogations must be justified by the inherent characteristics of a tax system, as already mentioned in section 7.6 above, the Commission finds that ‘external policy objectives—such as regional, environmental or industrial policy objectives—cannot be relied upon by the Member States to justify the differentiated treatment of undertakings under a certain regime’.187 The Commission repeats this claim by saying that ‘external 179 

Ibid, para 73. Ibid, paras 74–75. 181  Ibid, para 76. 182  Ibid, para 74. 183  Ibid. 184  Ibid, para 78. Citing, inter alia, Case C-372/97 Italy v Commission [2004] ECR I-3679, para 44; Case C-148/04 Unicredito Italiano v Agenzia della Entrate, Ufficio Genova 1 [2005] ECR I-11137, para 54. 185  Paint Graphos, n 128 above, para 79. 186  Ibid, para 80. 187  2014 Draft Notice, n 20 above, para 135. The Commission immediately qualifies this in paragraph 136 by stating that ‘the structure of certain special-purpose levies (and in particular their tax 180 

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policy objectives which are not inherent to the system cannot be relied upon [for the purposes of justifying a derogation]’.188 In other words, it cannot be assumed that, for example, all environmental measures would be justified, as the Court of Justice held in the British Aggregates case.189 In what follows, the Commission is perhaps opening the gateways for antiabuse provisions to be justified by the nature or general scheme of the system, even though they could be selective and/or lead to different treatment, if the Gibraltar case is to be widely followed. The basis for a possible justification could, for instance, be the need to fight fraud or tax evasion, the need to take into account specific accounting requirements, administrative manageability, the principle of tax neutrality, the progressive nature of income tax and its redistributive purpose, the need to avoid double taxation, and the objective of optimising the recovery of fiscal debts.190

There is, however, also an important caveat further down, in that although the provision of anti-abuse rules might be justified by the logic of preventing tax avoidance by taxpayers, anti-abuse rules could be selective ‘if they provide for a derogation (non-application of the anti-abuse rules) to specific undertakings or transactions, which would not be consistent with the logic underlying the antiabuse rules’.191 To an extent, these developments and the Commission’s statements in its 2014 Draft Notice seem to tie in very well with the OECD’s BEPS project and the international efforts to tackle aggressive tax planning and corporate tax abuse, considered in the preceding chapters of this volume. Certainly, there was discussion in the basis), such as environmental and health taxes imposed to discourage certain activities or products that have an adverse effect on the environment or human health, will normally integrate the policy objectives pursued. In such cases, a differentiated treatment for activities/products whose situation is different from the intrinsic objective pursued, as reflected in the structure of the tax, does not give rise to a derogatory treatment’. 188  2014 Draft Notice, n 20 above, para 138, citing, in addition to Paint Graphos, n 128 above and other cases discussed in n 128 above. 189  British Aggregates Association v Commission, n 128 above. In this case, the decision of the Court of First Instance (Case T-210/02 British Aggregates Association v Commission [2006] ECR II-278) was reversed. The Court of Justice found that the Court of First Instance had erred in holding that Member States were free to set their own priorities with respect to the protection of the environment and the goods and services on which to impose an environmental levy. State aid, as defined in the Treaty, was a legal concept which had to be interpreted on the basis of objective factors. There was nothing to justify the Commission having a broad discretion as regards to the classification of a measure as state aid. In this case, the need to take account of environmental protection requirements could not justify the exclusion of selective measures from the scope of Article 107(1) TFEU. Account could be taken of environmental objectives in the assessment of the compatibility of a state aid measure only under Article 107(3) TFEU. For commentary, see John Temple Lang (2012) n 146 above; Gianni Lo Schiavo, ‘The General Court reassesses the British Aggregates levy: selective advantages “permeated” by an exercise on the actual effects of competition?’ [2013] 2 European State Aid Law Quarterly 384–90; Gianni Lo Schiavo, ‘The role of competition analysis under article 107 paragraph 1 TFEU: the emergence of a “market analysis” assessment within the selectivity criterion?’ (2013) 34 European Competition Law Review 400–406. 190  2014 Draft Notice, n 20 above, para 139. 191  Ibid, para 184.

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past that anti-abuse measures may be regarded as intrinsic to a general system of taxation192 and as such, rules giving effect to such measures may not be selective. In any case, the use of the state aid prohibition to tackle aggressive tax planning or tax avoidance or tax abuse is likely to intensify. Recent Commission investigations into the tax ruling practices of several Member States corroborate this. These investigations are considered in section 7.8 below.

7.7.3. The Spanish Amortisation Case—Being Selective About Selectivity In another important recent case, the Spanish amortisation case,193 the Court of Justice again examined the interpretation of the selectivity requirement. ­According to Spanish tax laws, where a company which was taxable in Spain acquired a shareholding in a ‘foreign company’194 of at least five per cent and held it without interruption for at least one year, the goodwill resulting from that shareholding could be deducted through amortisation. This did not apply to goodwill resulting from the acquisition of a shareholding in a company established in Spain. In two decisions,195 the Commission found the Spanish tax regime i­ ncompatible with the state aid prohibition. Following these decisions, three undertakings established in Spain, Autogrill España, Banco Santander and Santusa Holding, asked the General Court to annul the Commission decisions. The General Court did in fact annul the Commission decisions, finding that the Commission had failed to establish the selective nature of the relevant tax measure. The fact that a tax measure was an exception from the reference framework was not sufficient to consider that the measure was selective, particularly when the measure was potentially accessible to all undertakings. Even if to benefit from a 192  Quigley (2012), n 14 above, p 118. One such important case is Case C-308/01 GIL Insurance Ltd v Commissioners of Customs and Excise [2004] ECR I-4777. Here, the introduction of a higher rate of insurance premium tax on certain contracts was not a tax scheme favouring a specified sector, since it was a system of taxation of insurance premiums intended to compensate for the fact that insurance transactions were not subject to VAT and was justified by the nature and scheme of the tax system of insurance. See, paras 70–78. This case was also cited by the Commission in its 2014 Draft Notice in discussing how anti-abuse rules may be justified by the logic of preventing tax avoidance by taxpayers. See 2014 Draft Notice, n 20 above, para 184. Also see, similarly, R v Commissioners of Customs and Excise, ex parte Lunn Poly [1999] EuLR 653. 193  Joined Cases T-219/10 and T-399/11 Autogrill España SA v Commission, and Banco Santander SA and Santusa Holding SL v Commission, judgment of 7 November 2014, EULI:T:2014:939, not yet reported. The judgment was not available in English at the time of writing. See summary in Press Release No 145/14, available on: curia.europa.eu/jcms/upload/docs/application/pdf/2014-11/cp140145en.pdf. 194  In order to qualify as a ‘foreign company’, a company had to be subject to a similar tax to the tax applicable in Spain and its income had to be derived mainly from business activities carried out abroad. 195  One decision related to the acquisition of EU shareholdings and the other to the acquisition of non-EU shareholdings. See Decision 2011/5/EC of 28 October 2009 on the tax amortisation of financial goodwill for foreign shareholding acquisitions C45/07 (ex NN 51/07, ex CP 9/07) implemented by Spain ([2011] OJ L7/48) and Decision 2011/282/EU of 12 January 2011 on the tax amortisation of financial goodwill for foreign shareholding acquisitions C45/07 (ex NN 51/07, ex CP 9/07) ­implemented by Spain ([2011] OJ L135/1).

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tax measure this required the fulfilment of certain conditions (as with the Spanish financial goodwill rules), it did not suffice to make the measure selective. It was necessary to identify a particular category of undertakings which could be differentiated from the rest of the undertakings based on their specific characteristics and not just by their eligibility for the derogation. The measure had to create a difference in treatment between undertakings in a comparable legal and factual situation. Otherwise, every tax measure the benefit of which was subject to certain conditions would be found to be selective, even though the beneficiary undertakings would not share any specific characteristics distinguishing them from other undertakings. The General Court concluded that the Spanish regime was not aimed at any particular category of undertakings or the production of goods but, rather it was aimed at a category of economic transactions. No categories of undertakings were excluded from taking advantage of it, since the application of the rules was independent of the nature of an undertaking’s activity. Also, the fact that the Spanish rules favoured the competitive position of ­Spanish undertakings was of no relevance for the purposes of the selectivity analysis. It merely showed that trade between Member States was affected. The General Court emphasised that a measure which may confer an advantage on all undertakings without distinction within the state concerned did not constitute state aid as regards the criterion of selectivity. A finding of selectivity must be based, inter alia, on a difference of treatment between categories of undertakings under the legislation of the same Member State, not a difference in treatment between companies of a Member State and those of other Member States. In other words, while the effects on trade were assessed by reference to undertakings in different Member States (inter Member States), selectivity could only stem from a difference in treatment of undertakings within the same State (intra Member State). This is an important case. It also provides a useful precedent in considering whether tax credits or exemptions conferred under tax treaties could be regarded as state aid. The author has argued in the past that tax treaty benefits, which reduce or eliminate double taxation only for certain undertakings or industries satisfying certain criteria, are a form of state aid if they are sufficiently selective.196 ­Following the Spanish amortisation case, merely imposing conditions for eligibility to tax treaty benefits or conditions for negation of tax treaty benefits (eg LOBs) may not be enough to establish selectivity. There must be a particular category of undertakings which can be differentiated from the rest of the undertakings based on their specific characteristics. The measure must create a difference in treatment between undertakings in a comparable legal and factual situation. This ­suggests that a Member State retains some limited discretion in offering tax incentives

196  For my earlier views on this point, see Christiana HJI Panayi, ‘Limitation on Benefits and State Aid’ (2004) 44 European Taxation 83–98 and ch 4 of Christiana HJI Panayi, Double Taxation, Tax Treaties, Treaty Shopping and the European Community (Kluwer Law International, EUCOTAX Series, 2007).

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through tax treaties, to the extent that these are genuinely open to all undertakings and not just nominally open to all but in fact favouring only certain categories of undertakings or economic activities. Although the Gibraltar case197 is not overruled, the Spanish amortisation case suggests that European courts are likely to be strict in the application of the selectivity criterion henceforth, reverting back to the long-standing three-step ­analysis. It has recently been announced that the Commission has filed two appeals against the decision of the General Court on grounds that it had erred in law by incorrectly interpreting Article 107(1) TFEU and more specifically the c­oncept of ­selectivity.198 The main argument of the Commission is thought to be that the General Court erred by requiring, in order to demonstrate that a ­measure is selective, the identification of a category of undertakings with specific and inherent characteristics (identifiable ex ante).199

7.8.  Tax Rulings, Advance Pricing Agreements and State Aid Four recent high-profile Commission investigations appear to have formally linked state aid with the fight against aggressive tax planning and BEPS. On 11 June 2014, the Commission formally launched three separate investigations200 to examine whether a number of MNEs had received transfer pricing tax rulings201 leading to significant tax reductions, in violation of the state aid rules. The MNEs and jurisdictions involved were Apple in Ireland, Starbucks in the Netherlands and Fiat in Luxembourg. Another investigation looking into Luxembourg’s ruling to Amazon was later launched on 7 October 2014.202 Broadly, all these cases dealt with tax rulings on transfer pricing arrangements between entities of the same corporate group. More specifically, the ­Commission 197 

Commission v Gibraltar and UK (2011), n 146 above. Cases C-20/15 P & C-21/15 P Commission v Autogrill España; Commission v Banco ­Santander SA and Santusa Holding SL. Further information was not available at the time of writing. 199  See PwC Newsalert, dated 10 March 2015. 200  See Press Release IP/14/663 dated 11 June 2014. For commentary, see Stephanie Soong Johnston, ‘EU to Investigate Apple, Starbucks and Fiat Tax Rulings’, 2014 WTD 113-1 (12 June 2014). 201  As explained in the Press Release: ‘Tax rulings are used in particular to confirm transfer pricing arrangements. Transfer pricing refers to the prices charged for commercial transactions between various parts of the same group of companies, in particular prices set for goods sold or services provided by one subsidiary of a corporate group to another subsidiary of the same group. Transfer pricing influences the allocation of taxable profit between subsidiaries of a group located in different countries. If tax authorities, when accepting the calculation of the taxable basis proposed by a company, insist on a remuneration of a subsidiary or a branch on market terms, reflecting normal conditions of competition, this would exclude the presence of state aid. However, if the calculation is not based on remuneration on market terms, it could imply a more favourable treatment of the company compared to the treatment other taxpayers would normally receive under the Member States’ tax rules. This may constitute state aid’. 202  See Press Release IP/14/1105 dated 7 October 2014. 198 Joined

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examined the following individual rulings: (a) the individual rulings issued by the Irish tax authorities on the calculation of the taxable profit allocated to the Irish branches of Apple Sales International and of Apple Operations Europe; (b) the individual ruling issued by the Dutch tax authorities on the calculation of the taxable basis in the Netherlands for manufacturing activities of Starbucks Manufacturing EMEA BV; (c) the individual ruling issued by the Luxembourgish tax authorities on the calculation of the taxable basis in Luxembourg for the financing activities of Fiat Finance and Trade; (d) the individual ruling issued by the L ­ uxembourgish tax authorities on the calculation of the taxable basis in ­Luxembourg for Amazon EU Sàrl, especially as regards the amount of royalty payments it made which significantly lowered the taxable profits of each year. On 30 September 2014, the Commission released letters it sent to the Irish and Luxembourg governments detailing its reasons for investigating whether the state aid rules were violated.203 On 14 November 2014, the Commission made public a letter to the Dutch government stating its preliminary view that the Netherlands might have violated the state aid rules by entering into an advance pricing arrangement with Starbucks Manufacturing EMEA BV that granted the Starbucks subsidiary advantages not available to other companies.204 It is useful to consider the Commission’s stance in each of these cases. The crux of the matter was whether the tax rulings under investigation allowed the MNE beneficiaries to depart from market conditions in setting the commercial conditions of intra-group transactions. As a result, the Commission argued, Member States renounced taxable revenues and as a corollary state resources. The Commission compared the transfer prices used with those of a third party prudent market operator. The premise of the Commission’s decisions in all cases seemed to be that the existence of advantage and selectivity was satisfied when the arm’s length principle was not complied with. In the Apple investigation,205 the Commission investigated the rulings206 issued by the Irish tax authorities on the calculation of the taxable profit allocated to the Irish branches of the Apple group. The tax rulings under scrutiny were granted to Apple Sales International (ASI) and Apple Operations Europe (AOE) in 1991 and later on in 2007. Both ASI and AOE were incorporated in Ireland but were not tax resident there.

203  Stephanie Soong Johnston and Kristen A Parillo, ‘European Commission Outlines State Aid Cases Against Apple and Fiat’, 2014 WTD 190-1 (1 October 2014). 204  William Hoke, ‘EU Publishes Letter Alleging Illegal Dutch State Aid to Starbucks’, 2014 WTD 221-1 (17 November 2014). 205 State aid SA.38373 (2014/C) (ex 2014/NN) (ex 2014/CP)—Ireland, Brussels, 11 June 2014, C(2014) 3606 final (henceforth, the Apple case). For commentary, see, inter alios, Mindy Herzfeld, ‘What are the Goals of the EU State Aid Investigations?’ 2014 WTD 207-2 (27 October 2014); Timothy Lyons, ‘The Q&A: State aid and tax rulings’, Tax Journal, Issue 1234, p 7 (10 October 2014). 206 It should be noted that the Irish tax authorities do not giving binding rulings but merely ­non-binding guidance when advice is sought.

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The Commission stated that in order to determine whether the method of assessment approved by the tax ruling conferred an advantage to the undertaking, it was necessary to compare that method to the ordinary tax system. ‘Thus, where a ruling concerns transfer pricing arrangements between related companies within a corporate group, that arrangement should not depart from the arrangement or remuneration that a prudent independent operator acting under normal market conditions would have accepted’.207 In this context, market conditions could be arrived at through transfer pricing established at arm’s length.208 The Commission cited the Belgium and Forum 187 case209 as confirming that if the method of taxation for intra-group transfers does not comply with the arm’s length principle and leads to a taxable base inferior to the one which would result from a correct implementation of that principle, it provides a selective advantage to the company concerned.210 However, in this case, the Court of Justice refrained from making such radical statements but rather limited itself to a more traditional state aid analysis.211 There were no references to prudent independent market operators (or something similar) in assessing the existence of an advantage for state aid purposes.212 Nor were there any references to the arm’s length test. Regardless of the strength of the authority for this test, to an extent, by introducing the prudent independent operator test, the Commission is also introducing its own transfer pricing standards. This prudent independent market operator test is likely to stir controversy. It seems to be satisfied by a strict application of the arm’s length principles—stricter than what the OECD Transfer Pricing Guidelines would appear to demand. The following extract makes this obvious. The OECD Guidelines are a reference document recommending methods for approximating an arm’s length pricing outcome and have been retained as appropriate guidance for this purpose in previous Commission decisions. The different methods explained in the OECD Guidelines can result in a wide range of outcomes as regards the amount of the taxable basis. Moreover, depending on the facts and circumstances of the taxpayer, not all methods approximate a market outcome in a correct way. When accepting

207  Apple case, n 205 above, para 54. The Commission cited Commission Decision 2003/757/EC of 17 February 2003, Belgian Coordination centres, OJ L282/25, 30.10.2003, recital 95. However, there is no such general assertion in the paragraph cited. 208  Apple case, n 205 above, para 55. 209  Joined Cases C-182/03 and C-217/03 Belgium and Forum 187 v Commission [2006] ECR I-5479. 210  Apple case, n 205 above, para 55. 211  See para 95 in Belgium and Forum 187, n 209 above: ‘In order to decide whether a method of assessment of taxable income such as that laid down under the regime for coordination centres confers an advantage on them, it is necessary, as the Commission suggests at point 95 of the contested decision, to compare that regime with the ordinary tax system, based on the difference between profits and outgoings of an undertaking carrying on its activities in conditions of free competition’. 212  The Court of Justice had mentioned ‘a prudent and alert economic operator’ in the context of legitimate expectations (ie it questions whether a prudent and alert economic operator could have foreseen the adoption of a Community measure likely to affect its interests). See Belgium and Forum 187, n 209 above, para 147. In the same context, see reference to a prudent economic operator in para 162.

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a c­ alculation method of the taxable basis proposed by the taxpayer, the tax authorities should compare that method to the prudent behaviour of a hypothetical market operator, which would require a market conform remuneration of a subsidiary or a branch, which reflect normal conditions of competition. For example, a market operator would not accept that its revenues are based on a method which achieves the lowest possible outcome if the facts and circumstances of the case could justify the use of other, more appropriate methods.213

Similar statements were made in the other Commission preliminary decisions analysed below.214 In all of these cases, the linkage of the prudent independent market operator test with the arm’s length principle meant that the Commission had to delve into a highly technical analysis in order to verify whether the contested rulings complied with the arm’s length principle, without being bound by the OECD Transfer Pricing Guidelines. In the Apple case, the Commission made the following points. First, the Commission noted that the taxable basis in the 1991 ruling was negotiated rather than substantiated by reference to comparable transactions. The fact that the methods used to determine profit allocation to ASI and AOE result from a negotiation rather than a pricing methodology, reinforces the idea that the outcome of the agreed method is not arm’s length and that a prudent independent market operator would not have accepted the remuneration allocated to the branches of ASI and AOE.215

Also, no transfer pricing report was included in the documents provided by the Irish authorities to support the calculation of taxable profits as confirmed in that ruling.216 Secondly, the Commission had doubts as to the appropriateness of the ­transfer pricing method chosen for the 2007 ruling. The Commission referred to the OECD Transfer Pricing Guidelines and the transfer pricing methods set out therein to comply with the arm’s length principle.217 The method used in this case was in effect the TNMM (ie transactional net margin method), with operating costs as a net profit indicator. However, the choice of that particular net profit indicator was not explained by the tax advisor, or by the Irish Revenue. Thirdly, the Commission noted several inconsistencies in the application of the transfer pricing method chosen to determine profit allocation to AOE and ASI. According to the Commission, it did not appear to comply with the arm’s length principle.218 Inter alia, it was argued that the mark-up of the costs a­ ttributable to

213 

Apple case, n 205 above, para 56. Fiat decision, n 227 below, para 60; Starbucks decision, n 237 below, para 75; Amazon decision, n 245 below, para 53. 215  Apple case, n 205 above, para 58. 216  Ibid, para 59. The Commission refers to OECD Transfer Pricing Guidelines paras 5.16 to 5.27, assuming that these (as well as, to an extent, the current version of the Guidelines) were available in 1991. 217  Apple case, n 205 above, para 60. 218  Ibid, para 61. 214 See

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the AOE branch appeared to be reverse engineered.219 Furthermore, the ­margin on branch costs was too wide.220 The duration of the 1991 ruling also raised ­eye-brows. This ruling was applied by Apple for 15 years without revision.221 There was also disagreement with the mark-up of the 2007 ruling.222 The ­Commission noted that the 2007 ruling did not factor in the evolution of sales, whereas it appeared that the sales income of ASI increased by 415 per cent over the three years 2009–12.223 Based on these factors, the Commission found the contested rulings to be incompatible with the arm’s length principle. From this, the Commission jumps to the conclusion that the Irish authorities conferred an advantage on Apple and that the advantage was granted in a selective manner.224 ‘To the extent the Irish authorities have deviated from the arm’s length principle as regards Apple, the contested rulings should also be considered selective’.225 And, again, from this, the C ­ ommission jumps to the question whether the aid is compatible with Article 107(2) and (3) TFEU, finding that it is not.226 The Fiat case227 followed the same format. Here, the focus of examination was the Advance Pricing Arrangement (APA) given by Luxembourg to Fiat Finance and Trade Ltd (FFT). This was considered to be state aid incompatible with the internal market. More specifically, starting from the prudent independent market operator test,228 it was questioned ‘whether the FFT APA complies with the arm’s length principle or whether they give rise to a selective advantage conferred by the Luxembourgish tax authorities upon that undertaking’.229 Again, the premise of the decision seemed to be the idea that non-compliance with the arm’s length principle generated a selective advantage sufficient for the purposes of the state aid prohibition. First, it was noted that the transfer pricing report seemed to establish a fixed tax base or a tax base which can vary only marginally. As such, the Luxembourgish tax authorities disregarded any significant increase or decrease in the activities of FFT. Such an approach—i.e. a virtually fixed tax base—could only reflect economic reality if it was very likely that the underlying business would remain stable throughout the duration of the APA’s validity. The information submitted by the Luxembourgish a­ uthorities does

219 

Ibid, para 62. Ibid, para 63. Ibid, para 65. 222  Ibid, para 66. 223  Ibid, para 67. 224  Ibid, paras 69–70. 225  Ibid, para 70. 226  Ibid, paras 72–78. The remaining components of the state aid test were briefly discussed in paras 46–51 and found to be satisfied. 227  State aid SA.38375 (2014/C) (ex 2014/NN) (ex 2014/CP)—Luxembourg, Brussels, 11 June 2014, C(2014) 3627 final (henceforth, the FIAT case). 228  Ibid, para 60. 229  Ibid, para 63. 220  221 

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not, however, contain any guarantees or predictions which indicate that FFT will maintain a stable business in the period covered by the APA. Moreover, it does not ­follow from that APA that FFT’s tax base would be modified if it doubled its underlying activities.230

In other words, Luxembourg permitted a fixed base while ignoring the actual ­performance of FFT.231 Secondly, the Commission doubted that the calculation of the taxable basis of FFT reflected an appropriate arm’s length remuneration. The TNMM, which is one of the two indirect methods for estimating the profit level under the OECD ­Transfer Pricing Guidelines, was not preferred by the Commission. The CUP (ie comparable uncontrolled price) method was preferred and ‘FFT could have attempted to value a number of the profit and loss items using the CUP method’.232 Thirdly, the Commission also had a problem with the estimation of the arm’s length remuneration on the basis of CAPM (ie capital asset pricing model) in that both components where set at too low a level: the amount of capital remunerated and the level of remuneration applied to this capital amount.233 The Commission proceeded with a lengthy technical analysis of this point.234 On the basis of these factors, the Commission concluded that through the APA the tax authorities had conferred an advantage on FFT. ‘That advantage is obtained every year and on-going, when the annual tax liability is agreed upon by the tax authorities in view of that APA’.235 Again, the Commission concluded that the advantage was also granted in a selective manner because the tax authorities had deviated from the arm’s length principle.236 The Commission’s preliminary decision in the Starbucks case was published a few weeks after the Apple and Fiat preliminary decisions.237 Again the investigation related to the use of tax rulings concluded in 2001 on the application of ­transfer pricing rules affecting a Dutch Starbucks entity—Starbucks ­Manufacturing BV (SMBV). Here, in the APA, an arm’s length remuneration was agreed for the activities performed in the Netherlands by SMBV, for the Starbucks group. The Commission argued that the ruling did not in fact comply with the arm’s length principle.

230 

Ibid, para 65. A Sheppard, ‘EU Group Finance Subsidiaries challenged’ (2014) 145 Tax Notes 156 (13 ­October 2014). 232  Fiat case, n 227 above, para 65. 233  Ibid, para 66. 234  Ibid, paras 67–80. 235  Ibid, para 81. 236  Ibid, para 82. 237  State aid SA.38374 (2014/C) (ex 2014/NN) (ex 2014/CP)—Netherlands, Brussels, 11 June 2014, C(2014) 3626 final (henceforth, the Starbucks case). See, inter alia, William Hoke, ‘EU Publishes Letter Alleging ­Illegal Dutch State Aid to Starbucks’, n 204 above; Mindy Herzfeld, ‘The Case Against ­Starbucks’, 2014 WTD 235-2 (8 December 2014). 231 Lee

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Here, the Commission’s decision was based on three factors. First, the ­ ommission had doubts that SMBV was a low-risk toll manufacturer.238 The C arm’s length remuneration accepted in the SMBV APA depended on SMBV being ­considered as a low-risk toll manufacturer, for which the Commission presented ‘evidence pointing to the contrary’.239 Secondly, the Commission questioned two adjustments which were made to the SMBV agreement in 2002 and 2004, specific elements of which were alleged to be not in line with the OECD Transfer Pricing Guidelines. Thirdly, there were doubts as to the manner in which the amount of royalties paid by SMBV was calculated. The Commission presented a number of technical arguments and made references to the OECD Transfer Pricing Guidelines to support its claims. However, the Commission’s arguments have been criticised in that there were numerous inconsistencies with the OECD Transfer Pricing Guidelines.240 The Commission essentially substituted its own judgment for the business judgment of Starbucks, which the Dutch government accepted in the APA. Yet the OECD transfer pricing guidelines explicitly state that tax authorities and judges should not try to substitute their own business judgments for those of the taxpayer.241

The Dutch tax authorities also disagreed with the Commission’s assessment and argued that they fully applied the recognised arm’s length principle.242 In a letter from the Chair of the House of Representatives, it was asserted that SMBV was

238  See fn 1, on p 2 of the Starbucks case, n 237 above. ‘A toll-manufacturer is a manufacturer that has been stripped of risks typically for tax planning purposes. These risks would have been transferred to another company of the group, in particular raw materials are to be acquired by another company of the group, not the manufacturer that processes them, they are put in consignment in the premises of the manufacturing company. A contract manufacturer is a manufacturer the risk[s] of which have been transferred to another company by contract but to a lesser extent than in the case of a tollmanufacturer’. Also see para 80. 239  Ibid, para 81. 240  For example, in applying the arm’s length standard, a range of acceptable pricing is accepted rather than a fixed price. See para 3.55 of the OECD Transfer Pricing Guidelines. In this case, the range of acceptable mark-up was argued as being 6.6 to 20.9%. Starbucks priced its transactions in the median of this range—which it found to be 9 to 12%—and the Dutch government agreed in the APA. The Commission, conducting its own separate review, concluded that this analysis was improper and that the correct median arm’s length mark-up should be 14.6%. As such, the tax liability of SMBV should have been higher. However, the median figure from the Commission’s analysis was well within the original acceptable range established by Starbucks (6.6—20.9%) and ought to have been allowed on the basis of the OECD Transfer Pricing Guidelines, which recognise the enormous variability of acceptable intercompany pricing. Another criticism made was that the Commission found that the Dutch government should have conducted an adequate analysis of the economic profiles of other members of the group, when it agreed the intercompany pricing mark-up for SMBV. By failing to properly analyse the economics of the whole group it called into question the validity of the APA. However, this is not a pre-requisite under the OECD Transfer Pricing Guidelines. See OECD Transfer Pricing Guidelines, para 2.63. See analysis by Herzfeld, ‘The Case Against Starbucks’, n 237 above. 241  See Herzfeld, ‘The Case Against Starbucks’, n 237 above, citing para 9.163 of the OECD Transfer Pricing Guidelines. 242  Letter from Chair of the House of Representatives of the States-General on the Starbucks case dated 14 November 2014.

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correctly characterised as a low-risk manufacturer, especially as it did not run a stock risk. The existence of arm’s length remuneration was determined by means of a benchmark study employing the transactional net margin method— the most commonly used method internationally for the production function and one ­recognised by the OECD. On the basis of the OECD Guidelines and national legislation, taxpayers are in principle free to choose the transfer pricing method, provided it results in an arm’s length outcome for the transaction in question. The OECD Guidelines and national legislation do not prescribe a specific method for a specific situation. So far the Commission does not seem to acknowledge this.243

The Dutch authorities were adamant that the APA with SMBV was aligned with international transfer pricing standards and was consistent with the policy framework applied by the government in its efforts to create an attractive business climate.244 This is actually a very important point. APAs and advance rulings are crucial to stimulate business investments and provide legal certainty. As a result of the Commission’s state aid investigations, Member States may become reluctant to give such rulings and taxpayers may also be reluctant to seek out advance rulings from tax authorities. This would lead to increased costs to the overall system. On 16 January 2015, the Commission published its letter to Luxembourg on its preliminary findings regarding the formal state aid investigation on the 2003 tax ruling issued to Amazon EU Sàrl, a subsidiary that recorded most of Amazon’s European profits.245 Under the ruling, which is still in force, Amazon EU Sàrl paid a tax-deductible royalty to a limited liability partnership set up in Luxembourg but not subject to corporate taxation there. The terms for calculating the royalty were set out in the ruling. Broadly, through a very complex tax structure, most of Amazon’s European profits could be booked in Luxembourg but remain untaxed. As a result of an advance tax ruling given to Amazon in 2003, there was effectively a cap and a floor on profits taxable in Luxembourg, calculated at a fixed proportion of the EU revenues. The Commission had serious reservations as regards the compliance of the contested tax ruling with the state aid principle. First, Luxembourg did not submit to the Commission any transfer pricing report prepared by Amazon in support of the arrangement in the ruling. Although there was reference to an economic analysis presented by Amazon to the Luxembourgish tax authorities, this was not made available to the Commission. ­Therefore, it was

243 

Ibid, p 2. Ibid, p 3. 245 State aid SA.38944 (2014/C)—Luxembourg, Brussels, 7 October 2014 C(2014) 7156 final (­henceforth, the Amazon case). For commentary, see William Hoke and David D Stewart, ‘European Commission Details Challenge to Luxembourg’s Amazon Ruling’, 2015 WTD 12-4 (20 January 2015); Lee A S­ heppard, ‘EU Amazon Case: Is Transfer Pricing Really the Issue?’ (2015) 77 Tax Notes International 291 (26 January 2015). Also see Lee A Sheppard, ‘Accounting for State Aid and BEPS’ (2015) 77 Tax Notes International 842 (9 March 2015). 244 

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‘not clear whether that analysis, to the extent that it exists, constitutes a ­transfer pricing report with a comparability analysis for the purposes of ­determining arm’s length pricing’.246 In the absence of such a transfer pricing report, the Commission doubted ‘whether the Luxembourgish tax authorities properly confirmed by the contested tax ruling that the transfer pricing arrangement presented in ­Amazon’s ruling request reflected what a prudent independent operator acting under ­normal market conditions would have accepted’.247 The Commission further noted that the ruling request by Amazon was assessed within 11 working days from the receipt of the first letter making the ruling request. This was a very short period of time, had a transfer pricing report been submitted and assessed.248 In addition, the Commission found that the method proposed by Amazon’s tax advisor in the ruling request and accepted by the Luxembourgish tax authorities in the tax ruling did not seem to correspond to any of the methods listed in the OECD Transfer Pricing Guidelines. While those methods were not exhaustive, the Commission was doubtful, particularly in the absence of a transfer pricing report, whether the Luxembourgish tax authorities properly confirmed that the transfer pricing arrangement was in line with market conditions.249 Crucially, the Commission thought that the royalty rate might not be in line with market conditions. Referring to paragraph 6.16 of the OECD Transfer ­Pricing Guidelines ‘a royalty would ordinarily be a recurrent payment based on the user’s output, sales, or in some rare circumstances, profits’. Here, it was alleged that the royalty payment approved by the contested tax ruling was not related to output, sales, or profit. Although the royalty rate was expressed as a percentage of all revenues, the royalty payment was only presented and not calculated in the form of a royalty rate over revenue.250 Instead, the royalty was calculated as a residual profit and not on the basis of the arm’s length principle.251 Amazon had a financial incentive to exaggerate the amount of the royalty when applying the transfer pricing arrangement approved.252 ‘[I]f the royalty is exaggerated, it would unduly reduce the tax paid by Amazon in Luxembourg by shifting profits to an untaxed entity from the perspective of corporate taxation’.253 Another issue was that Amazon EU Sàrl’s profit was capped in a range of four to six per cent of operating expenses, despite having taken numerous responsibilities. This seemed to be based on the TNMM.254 The Commission argued that the level of that margin appeared to constitute only a part of an arm’s length r­ emuneration

246 

Amazon case, n 245 above, para 63. Ibid. Ibid. 249  Ibid, para 64. 250  Ibid, para 65. 251  Ibid, para 66. 252  Ibid, para 71. 253  Ibid, para 71. 254  Ibid, para 72. 247  248 

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in comparison to previous cases such as Apple and Starbucks.255 In those cases, the Commission expressed doubts as to the level of ­remuneration accepted by the respective tax authorities. In both cases, the TNMM was applied using the operating costs for the pricing of activities presented as ­routine activities with limited risk. Nevertheless, in both cases the margin considered as arm’s length by the respective tax authorities was more than double the margin accepted by the Luxembourgish tax authorities in relation to Amazon. Levels of arm’s length remuneration could vary across markets and depend on economic circumstances. In this case, it could not be concluded in the absence of a complete functional analysis that the remuneration was too low. Yet, the functions of Amazon performed and the risks assumed by Amazon EU Sàrl seemed complex. They were presented as central and strategic commercial decisions concentrating the business risk of the entire European market. Therefore, the method approved (the residual profit method), did not seem appropriate, whereas the level of margin accepted seemed relatively low.256 The Commission also had trouble with the cap and floor mechanism, as this effectively overrode the pricing method based on operating expenses. The cap was 0.55 per cent and the floor was 0.45 per cent. This ensured Amazon EU Sàrl would only be taxed within a fixed range, no matter what it earned. The cap was also too low.257 Similarly to the other cases, the Commission challenged the duration of the contested tax ruling which was more than 10 years. Even if the transfer pricing arrangement was considered to comply with the arm’s length principle at the time, the appropriateness of the remuneration over the years should have been called into question, given the changes to the economic environment and the required remuneration levels. Here, the ruling continued to be accepted without any revision. It was noted that the duration was much longer than the length of tax rulings currently concluded by other Member States.258 On the basis of these observations, the Commission found that the Amazon ruling did not comply with the arm’s length principle and as such, the Luxembourgish tax authorities had conferred an advantage on Amazon.259 That advantage was also granted in a selective manner. ‘To the extent the Luxembourgish

255 

Ibid, para 74. Ibid. 257  See, para 75: ‘There is no explanation as to why such a combination of methods would be appropriate. It appears that the floor and the cap are used to ensure a relatively predictable level of taxable profit; they do not seem to be based on any arm’s length reasoning. Moreover, if the overall profit of the EU business is lower than the level of the floor, the floor of 0.45% of turnover no longer applies … Therefore, the transfer pricing arrangement put in place by Amazon and accepted by the contested tax ruling effectively contains a cap on a remuneration which seems too low’. 258  Ibid, para 76. 259  Ibid, para 77. 256 

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authorities have deviated from the arm’s length principle as regards the contested tax ruling, the measure should also be considered selective’.260 Arguably, in all of the above cases, the Commission appears to reject the ­economic rationale underlying the APAs. It also appears to be fairly confident of the way the arm’s length principle and the various comparability methods ought to have applied. The Commission shows preference for some methods of finding comparables and, slightly too willingly, substitutes its own judgment and calculations. Rather worryingly, it takes today’s OECD transfer pricing practice and applies it retroactively to arrangements existing and rulings given more than two decades ago. Using the state aid prohibition this way leads to the undermining of the OECD Transfer Pricing Guidelines and the various methods for finding comparables.261 What is remarkable is that, by introducing the concept of the prudent market operator in all these cases, the Commission seems to have created its own transfer pricing standards. The prudent independent market operator is the personification of the arm’s length method. The hypothetical actor would never accept the lower possible return or price for a good or service. So a tax authority may have granted state aid when it accepted a multinational’s intra-group pricing that deviated from market practices of prudent independent market operators.262

If the Court of Justice, in its judgments, follows the concept of the prudent ­market operator as an autonomous concept,263 whatever the outcome of these cases, another layer of complexity would have been added for multinationals with tax structures in the European Union. Adopting a price that is within an acceptable range under the OECD Transfer Pricing Guidelines may no longer be enough. As was made clear in the Amazon case, even though the OECD Guidelines provide some flexibility with respect to the application of the arm’s length principle, that flexibility is limited by the principle that the remuneration arrived at should reflect what a prudent independent operator acting under normal market conditions would have accepted.264

In these cases, the Commission appeared to be particularly troubled with the application of the transactional net margin method. Furthermore, what is most disconcerting is that the Commission does not actually satisfy the five-prong test for finding state aid, and more specifically,

260 

Ibid, para 78. Also see Herzfeld who argues that the state aid cases may be setting up a collision course between the Commission and the OECD, which could jeopardise the future of the arm’s length pricing principle. Herzfeld, ‘The Case Against Starbucks’, n 237 above. 262  Sheppard, ‘EU Amazon Case: Is Transfer Pricing Really the Issue?’, n 245 above, p 293. 263  See also Anna Gunn and Joris Luts, ‘Tax Rulings, APAs and State Aid: Legal Issues’ (2015) 24 EC Tax Review 119, at 124. 264  Amazon case, n 245 above, para 61. 261 

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the ­selectivity test. It fails to examine the system of reference (ie the domestic transfer pricing rules) at the time of the relevant rulings and whether the measure derogates from the system ‘insofar as it differentiates between economic ­operations who, in light of the objectives intrinsic to the system, are in a comparable f­actual and legal situation’, as stipulated as recently as in the 2014 Draft Notice.265 Rather, the OECD Transfer Pricing Guidelines seem to be treated as part of or akin to a national tax system,266 when in fact not all Member States had adopted or f­ollowed these Guidelines (or their latest version) at the time of the relevant rulings. Also, the Commission fails to examine whether the derogation was justified by the nature or the general scheme of that specific reference system and not the general OECD Transfer Pricing Guidelines. In other words, a crucial element in the analysis is missing: have these MNEs been treated by discretion more favourably than other taxpayers in a similar factual and legal situation in those specific Member States?267 For this, there needs to be a comparison of tax rulings given to other undertakings at that time to ascertain whether there have been derogations from the reference framework. The recent Spanish amortisation case268 suggests strict adherence to the original test. Whilst the (alleged) non-compliance with the arm’s length principle may be enough to show deviation from the internationally accepted OECD standard, it does not necessarily mean deviation from the reference framework, upon which the transfer pricing analysis is premised or should be premised. This point was made clear in the 2014 Draft Notice, which substantially elaborated on the link between discretionary practices and selectivity—something also mentioned in the 1998 Notice on state aid.269 As was noted, treating taxpayers on a discretionary basis may indicate selectivity where the exercise of the discretionary power goes beyond the simple management of tax revenue by reference to

265 

Ibid, para 128. Gunn and Luts (2015), n 263 above, pp 122–23. 267  See also para 177 of the 2014 Draft Notice, n 20 above: ‘Advance administrative rulings could be selective where the tax authorities have discretion in granting administrative rulings; the rulings are not available to undertakings in a similar legal and factual situation; the administration appears to apply a more “favourable” discretionary tax treatment compared with other taxpayers in a similar factual and legal situation; the ruling has been issued in contradiction to the applicable tax provisions and has resulted in a lower amount of tax’. 268  See Spanish amortisation case, analysed in section 7.7.3 above. 269  See paras 21–22 of the 1998 Notice, n 15 above. ‘The discretionary practices of some tax authorities may also give rise to measures that are caught by [ex-]Article 92 … in particular where exercise of the discretionary power goes beyond the simple management of tax revenue by reference to objective criteria … If in daily practice tax rules need to be interpreted, they cannot leave room for a discretionary treatment of undertakings. Every decision of the administration that departs from the general tax rules to the benefit of individual undertakings in principle leads to a presumption of State aid and must be analysed in detail. As far as administrative rulings merely contain an interpretation of general rules, they do not give rise to a presumption of aid. However, the opacity of the decisions taken by the authorities and the room for manoeuvre which they sometimes enjoy support the presumption that such is at any rate their effect in some instances. This does not make Member States any less able to provide their taxpayers with legal certainty and predictability on the application of general tax rules’. 266 

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­objective criteria.270 Tax settlements might also entail state aid, in particular, where it appears that the amount of taxes due has been significantly reduced without clear justification or in a disproportionate manner to the benefit of the taxpayer.271 There is special reference to ‘prior administrative rulings’ in the 2014 Draft Notice.272 Administrative rulings that merely contain an interpretation of the relevant tax provisions without deviating from the case law and administrative practice do not give rise to a presumption of aid.273 While it is acknowledged that the absence of publication of tax rulings and the room for manoeuvre which tax authorities sometimes enjoy support the presumption of aid,274 this is a mere presumption. It still has to be proved. As advised in the 2014 Draft Notice, tax rulings should only aim to provide legal certainty to the fiscal treatment of certain transactions and should not have the effect of granting the undertakings concerned lower taxation than other undertakings in a similar legal and factual situation (but which were not granted such rulings).275 Read in the context of the Commission’s recent state aid actions, this is likely to lead to very vague and general tax rulings being given out, which may not be of much use to MNEs in the future. It is worth pointing out that there may be factual errors in the Commission’s description of the national tax rulings impugned. For example, Irish tax authorities (as well as the UK’s HMRC) have no power to give binding rulings but can merely give non-binding guidance. Of course, this by itself, does not absolve the Irish government. As noted, the only difference between an undertaking that did obtain a tax ruling and one that did not, is that the tax administration has looked into and accepted its tax position, whether without a challenge or following an audit.276 What is important is not whether an advantage is embedded in a tax ruling obtained by an undertaking but whether ‘this undertaking is treated selectively better than other undertakings who are in a comparable legal and factual situation’.277

270 

2014 Draft Notice, n 20 above, para 170. Ibid, para 172. 272  Ibid, para 174. 273  Ibid, para 175. 274  Ibid. 275  Ibid, para 176. There is reference to the Commission’s decisional practice which shows that rulings allowing taxpayers to use alternative methods for calculating taxable profits, eg the use of fixed margins for a cost-plus or resale-minus method for determining an appropriate transfer pricing, may involve state aid. The following Commission Decisions and cases are cited: Commission Decision 2003/438/EC of 16 October 2002 on State aid C50/2001, Luxembourg Finance Companies, [2003] OJ L153/40, 20 June 2003, recitals 43 and 44; Commission Decision 2003/501/EC of 16 October 2002 on State aid C49/2001, Luxembourg Coordination centres, [2003] OJ L170/20, 9 July 2003, recitals 46–47 and 50; Commission Decision 2003/755/EC of 17 February 2003, Belgian Coordination centres, [2003] OJ L282/55, 30 October 2003, recitals 89 to 95 and the related Joined Cases C-182/03 and C-217/03 Belgium and Forum 187 v Commission [2006] ECR I-5479, paras 96 and 97; Commission Decision 2004/76/EC of 13 May 2003, French Headquarters and Logistic Centres, [2004] OJ L23/1, 28 January 2004, recitals 50 and 53. 276  See Gunn and Luts (2015), n 263 above, p 122. 277  Ibid. 271 

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Another question raised from these investigations is the following: is the ­ ommission simply applying the state aid prohibition, albeit zealously, or is it in C fact pushing a political agenda? Is the Commission trying to reverse the impact of the Court of Justice’s decisions which promote economic freedoms with arguably little concern for tax avoidance? Or is it trying to extend the scope of state aid into the BEPS arena? The latter appeared to be foreshadowed by Mr Pierpaolo RossiMaccanico from the European Commission’s Legal Services department, in his article ‘Fiscal Aid, Tax Competition, and BEPS’, which was published on Tax Notes International on 8 September 2014.278 He argued that state aid review should be viewed as the appropriate instrument to remedy most of the situations giving rise to inappropriate low taxation that results from the exploitation of legal or regulatory mismatches in member states’ taxation of cross-border transactions, including those resulting from the application of income tax treaties.279

At a subsequent article,280 the same author argued that the state aid prohibition could be used with respect to measures favouring tax arbitrage of MNEs mainly on the basis of the Gibraltar judgment.281 This proposition has been challenged in that, while it might be tempting to use the state aid provision in this way and also try to address issues which effectively fall in the scope of harmful tax competition, as has been argued, ‘in the absence of comparable regimes abroad, the EU might be tying its hands when some of its main trading partners are not’.282 Although the opening of formal state aid investigations could serve to (further) promote the BEPS project within the European Union, Article 107 TFEU is not well suited to dealing with large parts of tax avoidance in the international arena.283 There are increased concerns among the legal community that the EU state aid investigations are going too far. To restore legal certainty for Member States and taxpayers, it has been suggested that the Commission should adopt a directive on the basis of Article 106(3) TFEU which would define the framework and procedural rules for Member State competent authorities to examine and grant tax rulings to MNEs.284 Whilst this could help with future tax rulings and stave off a wave of Member State notifications of tax rulings, it would not reduce the uncertainty as regards existing ones. In any case, whatever the legal conclusion of the current investigations will be, the momentum is certainly unabated. Since June 2013, the Commission has been investigating the tax ruling practices of seven Member States.285 ­Information was 278  Pierpaolo Rossi-Maccanico, ‘Fiscal Aid, Tax Competition, and BEPS’ (2014) 75 Tax Notes International 857 (8 September 2014). 279  Ibid, p 868. 280  See Pierpaolo Rossi-Maccanico, ‘Fiscal State Aids, Tax Base Erosion and Profit Shifting’ (2015) 24 EC Tax Review 63–77. 281  Commission v Gibraltar and UK (2011) n 146 above. 282  Raymond Luja, ‘EU State Aid Rules and Their Limits’ (2014) 76 Tax Notes International 353 (27 October 2014). 283  Ibid. 284  Rossi-Maccanico (2015), n 280 above, at pp 75–77. 285  Information was requested from Cyprus, Ireland, Luxembourg, Malta, the Netherlands and the UK. Information was also requested from Belgium including on certain specific tax rulings.

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also requested about intellectual property taxation regimes from 10 Member States which had such a regime at the time.286 In December 2014, it was announced that the Commission had enlarged the enquiry on tax ruling practices to cover all Member States.287 It was announced that all Member States would be asked to provide information about their tax ruling practices, in particular to confirm whether they provide tax rulings, and if so, to request a list of all companies that had received a tax ruling from 2010 to 2013. It was later on reported that obtaining information from Member States on tax rulings had proved to be both challenging and time-consuming.288 Recently, the Commission has also announced its intention to propose a new directive on the automatic exchange of information on tax rulings between EU Member States. Such exchange of rulings would certainly permit tax authorities to monitor each other’s behaviour. As discussed in Chapter five, in March 2015, the Commission made several proposals in its Tax Transparency Package, including the amendment of the Mutual Assistance Directive 2011/16/EU to ensure automatic exchange of information on tax rulings. What is certain is that many investigations are likely to be launched in Member State tax ruling regimes.289 Also, the proposal for automatic exchange of information on tax rulings is likely to lead to some de facto peer reviewing of tax ruling practices by Member States. It could also lead to tax competition, as within the bounds of the state aid prohibition, Member States would strive not to offer comparatively disadvantageous rulings. These are very interesting times for state aid and tax lawyers.

286  The countries were Belgium, Cyprus, France, Hungary, Luxembourg, Malta, the Netherlands, Portugal, Spain, and United Kingdom. For an excellent overview of the state aid issues arising with intellectual property taxation regimes, see Joris Luts, ‘Compatibility of IP Box Regimes with EU State Aid Rules and Code of Conduct’ (2014) 23 EC Tax Review 258–83 and Begoña Pérez Bernabeu, ‘R&D&I Tax Incentives in the European Union and State Aid Rules’ (2014) 5 European Taxation 178–91. 287  See Press Release IP/14/2742, dated 17 December 2014. The Commission is also examining Gibraltar’s tax rulings practice. For commentary, see William Hoke, ‘European Commission Expands State Aid Inquiries’, 2014 WTD 243-2 (18 December 2014). 288  See Stephanie Soong Johnston, ‘EU Delays Deadline for State Aid Tax Ruling Probes’, 2015 WTD 87-1 (6 May 2015). It appeared at the time that the Czech Republic, Estonia and Poland were yet to comply with the Commission’s information requests. 289  See also Commission announcement IP/15/4080 on 3 February 2015, that the Commission has opened an in-depth investigation into Belgian tax rulings that allowed MNEs to reduce their Belgian taxes by claiming a deduction for excess profits that purportedly resulted from the advantage of being part of a multinational group. The deductions granted through the excess profit ruling system usually amounted to more than 50% of the profits covered by the tax ruling and could sometimes reach 90%. Benefits were only available to a limited number of MNEs and not stand-alone companies. The Commission expressed doubts that the Belgian legislation was following the OECD’s arm’s length principle. Also see reports that the Commission is inquiring into Luxembourg’s tax ruling to McDonald’s. It has been claimed that McDonald’s is paying an effective tax rate of 0.48% in Europe and it has underpaid its tax obligations to European countries by more than one billion between 2009 and 2013. For commentary, see William Hoke, ‘EU Begins State Aid Investigation of Belgian Excess Profits Rulings’, 2015 WTD 23-2 (4 February 2015); William Hoke, ‘EU Launches Inquiry Into Luxembourg’s Tax Rulings for McDonald’s’, 2015 WTD 63-1 (2 April 2015).

8 Unanimity, Enhanced Cooperation and the Financial Transaction Tax: Challenging the European Union’s Tax Traditions Up until now, much of the analysis in this book has focused on BEPS and the efforts made by the international community and the European Union to tackle aggressive tax planning. This chapter explores another angle—the ongoing efforts by the Commission and some Member States to introduce the Financial Transaction Tax (FTT), in an attempt to make the financial sector pay its fair share for its role in the origins of the economic crisis.1 To a large extent, this proposal fits in well with the Commission’s and the EU’s overall efforts to address some of the causes and effects of the financial crisis. The focus of this chapter is on the Commission’s proposal for an FTT and the current efforts to adopt it through enhanced cooperation. Before considering the development of the proposal and the suitability of the enhanced cooperation mechanism in adopting it, it is important first to understand how this mechanism works.

8.1.  The Enhanced Cooperation Procedure The existence of the fiscal veto has always been blamed for the scarcity of EU tax legislation. This is because all legislative bases used to enact direct tax legislation require unanimity in Council.2 Overall, the fiscal veto, ie the power of even one Member State to object to a harmonising measure in direct tax law, is a fiercely

1  European Commission—Press release, Financial Transaction Tax: Making the financial sector pay its fair share, IP/11/1085. 2  The fact that Member States have retained competence in direct tax matters is a known mantra. As there is no explicit legislative base for the harmonisation of direct taxes, general legislative bases under Arts 115 and 352 TFEU have been used for direct tax legislation. These legislative bases focus on the attainment of the internal market and their use is strictly policed by the Court of Justice. Both ­legislative bases require unanimity by Member States.

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guarded prerogative which has survived successive Treaty amendments and attempts to move to qualified majority voting. As a result, the Union has l­ egislated in a number of limited areas, where it was deemed expedient for the proper functioning of the internal market. Therefore, ‘positive integration’, that is integration through proper legislative routes, does exist but it is scarce compared to the growing volume of case law.3 Recently, efforts are being made to use alternative methods to approve legislative instruments—one being the enhanced cooperation mechanism. The precursors of the enhanced cooperation rules were the closer cooperation rules introduced in the Treaty of Amsterdam,4 which were introduced as a hybrid solution between the classical (and scarce) Community harmonisation process and intergovernmental agreements.5 These rules enabled closer cooperation to be established amongst subsets of Member States in the framework of EU law. The procedural rules for closer cooperation were very strict and were never used in practice.6 The rules were revised in the Treaty of Nice and renamed the enhanced cooperation rules.7 The rules were further simplified following the ratification of the Lisbon Treaty and the procedure is now set out in Article 20 TEU and Articles 326–334 TFEU. Currently, for enhanced cooperation to be enabled, a minimum of nine8 ­Member States is needed. Under the EU Treaties, enhanced cooperation can only be used as a measure of last resort.9 Although all Member States can participate in the Council deliberations, only participating Member States can vote on it.10 Unanimity of the participating Member States is required.11 Enhanced cooperation has to comply with EU law and must not undermine the internal market, create barriers in trade or discriminate between Member States or distort competition.12 The competences, rights and obligations of 3  See ch 2 in Christiana HJI Panayi, European Union Corporate Tax Law (Cambridge University Press, 2013). 4  Consolidated version of the Treaty on European Union (TEU) [1997] OJ C340/145; Consolidated version of the Treaty establishing the European Community (TEC) [1997] OJ C340/173. See TEU Arts 43 to 45 and TEC Art 11. 5  Joachim Englisch, John Vella and Anzhela Yevgenyeva, ‘The Financial Transaction Tax Proposal Under the Enhanced Cooperation Procedure: Legal and Practical Considerations’ [2013] British Tax Review 221, 243. 6  See Alexander Stubb, Negotiating Flexibility in the European Union: Amsterdam, Nice and Beyond (Palgrave 2002); Steve Weatherill, ‘“If I’d wanted you to understand I would have explained it better”: What is the purpose of the provisions on closer cooperation introduced by the Treaty of Amsterdam?’ in David O’Keeffe and Patrick Twomey, Legal Issues of the Amsterdam Treaty (Hart Publishing, 1999) p 21. 7  The revised rules were set out in Articles 11 and 11A of the EC Treaty and Articles 40, 43–45 of the Treaty on the European Union. See Jo Shaw, ‘Enhancing Cooperation After Nice: Will the Treaty do the Trick?’ in Mads Andenas and John Usher (eds), The Treaty of Nice and Beyond: Enlargement and Constitutional Reform (Hart Publishing, 2003) p 207; José María de Areilza, ‘The Reform of Enhanced Cooperation Rules: Towards Less Flexibility’ in Bruno de Witte et al (eds), The Many Faces of Differentiation in EU Law (Intersentia, 2001) p 27. 8  Prior to the Lisbon Treaty, eight Member States were needed to trigger enhanced cooperation. 9  It is only considered a last resort when the Council has established that the objectives of such cooperation cannot be attained within a reasonable period by the Union as a whole. See Art 20(2) TEU. 10  Art 20(3) TEU and Art 330 TFEU. 11  Art 330 TFEU. 12  Art 326 TFEU.

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non-­participating Member States are to be respected.13 Acts adopted in the framework of this procedure only bind participating Member States.14 At the same time, non-participating Member States are under an obligation not to impede the implementation of the legislation under enhanced cooperation.15 Therefore, even though acts adopted within the framework of enhanced cooperation do not become part of EU law and cannot affect non-participating Member States, nevertheless these Member States are under an obligation not to impede the implementation of these acts. The extent of this obligation may not always be clear, or reciprocal. It should also be borne in mind that expenditure incurred from the implementation of enhanced cooperation, other than administrative costs of the institutions, is to be borne by participating Member States, unless all members of the Council acting unanimously and consulting the European Parliament, decide otherwise.16 Enhanced cooperation is open to all Member States satisfying the conditions of participation and, at a later time, subject to compliance with acts adopted in the framework.17 The Commission and the participating Member States have to promote participation by as many Member States as possible.18 The authorising decision is adopted by the Council as a measure of last resort when the objectives of cooperation cannot be attained within a reasonable period by the Union. Member States wanting to adopt legislation through enhanced cooperation have to send the request to the Commission, specifying the scope and objectives of the enhanced cooperation proposed.19 The Commission may submit the proposal to the Council to authorise enhanced cooperation.20 Authorisation shall be granted by the Council after a proposal is made by the Commission and consent is obtained from the European ­Parliament.21 All Member States can take part in the deliberations in Council but only those participating in enhanced cooperation can vote.22 It is stipulated in Article 330 TFEU that unanimity has to be constituted by the votes of the participating Member States. This provision is slightly confusing. The article does not really specify what unanimity is required for. Presumably, at least nine Member States have to agree to proceed to enhanced cooperation for the proposal to be considered; otherwise it cannot be adopted. Perhaps one should interpret this provision as saying that even if the legal base used to enact legislation requires 13 

Art 327 TFEU. Art 20(4) TEU. In the same paragraph, it is stated that the acts shall not be regarded as part of the acquis which is to be accepted by candidate states for accession to the Union. However, it is not specified if they are part of the acquis for other purposes. 15  Art 327 TFEU. 16  Art 332 TFEU. 17  Art 328 TFEU. 18  Ibid. 19  Art 329(1) TFEU. 20  Ibid. 21  Ibid. 22  Art 330 TFEU. 14 

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unanimity, if adoption is through the process of enhanced cooperation, then this requirement is modified. In other words, a possible majority of non-participating Member States cannot block the minority at authorisation stage. The provision should also be read in light of Article 333 TFEU which provides that where the Treaty provision which may be applied in the context of enhanced cooperation requires unanimity, the Council acting unanimously may adopt a decision stipulating that it will act by qualified majority. Therefore, technically, the participating Member States only have to agree between themselves on the contents of the request made to the Commission and subsequently to vote in Council for the Commission’s proposal based on their request. Arguably, following the Treaty of Lisbon, it has become easier to use enhanced cooperation, as it is more flexible and depends more on participating Member States. It is obvious that the new provisions on enhanced cooperation confer on participating Member States more autonomy, both at deliberation and the subsequent implementation phase. This, however, raises potential problems in managing diversity among Member States while still preserving core values of the EU legal order.23 So far,24 enhanced cooperation has been used to adopt conflict of laws rules in relation to divorce proceedings in 201025 and to establish the unitary patent protection system in 2012.26 As far as the latter is concerned, the two non-­ participating Member States (Italy and Spain) had applied for annulment of the enhanced cooperation27 but both the Advocate General and the Court of Justice dismissed the challenge. Notably, the Court of Justice adopted a technical, and to an extent minimalist, interpretation of the Treaty provisions on enhanced cooperation. ­Perhaps had it done otherwise, it would have been accused of getting embroiled in political controversies. What was interesting in the unitary patents challenge was the Court’s ­relative permissiveness as to the contents of the Council’s authorising decision. 23  See Editorial comments, ‘Enhanced cooperation: A Union à taille réduite or à porte tournante?’ (2011) 48 Common Market Law Review 317–27. 24  An attempt was made in 2007 to enact rules on criminal suspects’ procedural rights but there was insufficient support to go forward with the proposal on the basis of enhanced cooperation. See Framework Decision on Criminal Suspects’ Procedural Rights, COM(2004) 328, 28 April 2004. Also see Steve Peers, ‘Divorce, European Style: The First Authorization of Enhanced Cooperation’ (2010) 6 European Constitutional Law Review 339–58, 342. 25  See Council Decision of 12 July 2010 authorising enhanced cooperation in the area of the law applicable to divorce and legal separation [2010] OJ L189/12. For commentary, see Peers (2010), n 24 above. 26 See Council Decision of 10 March 2011 authorising enhanced cooperation in the area of the creation of unitary patent protection [2011] OJ L76/53. The unitary patent system established under enhanced cooperation endeavoured to minimise complexities for the protection of patents within the European Union. It ensured that only one application would be necessary to protect a patent in the participating Member States. The patents could only be validated in one of the following languages: English, French and German. Spain and Italy objected to the use of enhanced cooperation by the other Member States on a number of grounds, all of which were rejected in the Court of Justice. For commentary, see Steve Peers, ‘The Constitutional Implications of the EU Patent’ (2011) 7 European Constitutional Law Review 229–66. 27  See Joined Cases C-295/11 Italy v Council of the European Union and C-274/11 Spain v Council of the European Union. The Court delivered its decision on 16 April 2013. Also see Advocate General Bot’s opinion delivered on 11 December 2012.

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The ­applicants had complained that the Council disregarded the judicial system of the Union by authorising enhanced cooperation without specifying what the judicial system should be.28 The Court of Justice noted that under Article 329(1) TFEU, Member States’ requests for enhanced cooperation had to specify the scope and objectives of the enhanced cooperation proposed. According to the Court of Justice, this was done as shown in the request and the Commission proposal. The Council was not obliged to provide further information with regard to the possible content of the system adopted by the participants in the enhanced cooperation in question. The sole purpose of the decision was to authorise the request of the Member States.29 This judgment suggests that the amount of information that has to be provided by Member States proposing enhanced cooperation to potentially non-­participating Member States does not have to be extensive, even at Council stage where enhanced cooperation is to be authorised. It is, therefore, unclear how much consultation is needed before or after making the request for enhanced cooperation. Especially as regards non-participating Member States, the lack of consultation and of opportunities to give representations, as well as the lack of clarity as to the obligations of non-participating Member States may infringe their rights and competences. This is, in fact, something that the UK complained of vis-à-vis the FTT, as explained in section 8.3 below. It is obvious from the unitary patent case that the Court of Justice was reluctant to make any general statements or give general guidelines on the parameters of reviewing compliance with the conditions for authorising enhanced cooperation. Its analysis was limited to the technical issues raised. A similarly lenient approach is apparent in the Court’s dismissal of the UK action against the FTT enhanced cooperation decision, again discussed in section 8.3. Overall, as far as taxes are concerned, although the FTT proposal is the most prominent and often mentioned example, the first time the question of enhanced cooperation was in fact raised was in the context of the proposed Common Consolidated Corporate Tax Base (CCCTB). Even before the publication of the Commission’s draft CCCTB Directive,30 it was thought that unanimity in Council was unlikely to be attained and there were suggestions to allow a few Member States to adopt the CCCTB under the enhanced cooperation procedure.31 In fact,

28  Under the unitary patents system, it was envisaged that a unitary patent court would be set up to decide disputes. Spain had complained that although it was not necessary to create in every instrument of secondary legislation a set of judicial rules, here, the judicial rules had to be specified in a measure authorising the creation of a new European intellectual property right. See, ibid, para 87. 29  Ibid, paras 87–92. 30 Brussels, COM(2011) 121/4, 2011/0058 (CNS); SEC(2011) 316 final. For more information, see Christiana HJI Panayi, The Common Consolidated Corporate Tax Base and the UK System (IFS, 2011) and HJI Panayi (2013), n 3 above. 31 See HJI Panayi (2011), n 30 above, especially parts 1, 2 and 5. Also see Luca Cerioni, ‘The Possible Introduction of Common Consolidated Base Taxation via Enhanced Cooperation: Some Open Issues’ (2006) 46 European Taxation 187; Christiana HJI Panayi, ‘The Common Consolidated Corporate Tax Base: Issues for Third Countries and Member States opting out’ (2008) 48 European Taxation 114–23. The possibility of enhanced cooperation was referred to, inter alios, by Philip Baker and Ioanna Mitroyanni, ‘The CCCTB Rules and Tax Treaties’, and Malcolm Gammie and Christiana

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in a European Parliament resolution,32 the Commission’s efforts to establish the CCCTB were supported33 and the intention to launch it even in the framework of enhanced cooperation was welcomed.34 It was, however, pointed out that this was ‘a second-best solution as, in the absence of a comprehensive EU-wide system, the benefits of transparency and lower administrative costs may be partly mitigated’.35 Although the adoption of the CCCTB has been brought to light once again following the Commission’s launch of the Tax Transparency Package,36 this is likely to take time as there is still no unanimity among Member States and not sufficient Member States to trigger the enhanced cooperation mechanism. Furthermore, if the proposal is to be adopted through enhanced cooperation, there needs to be sufficient consultation with non-participating Member States as to aspects of the proposal that have to be clarified or amended to cater for the rights and obligations of these Member States. There is general concurrence that the draft CCCTB Directive, as produced by the Commission in 2011, cannot be used in case of enhanced cooperation, as a number of issues have to be resolved first.37 By contrast, the proposal for an FTT, although it rose to prominence much later that the CCCTB,38 was nevertheless fast-tracked in the last few years. Following the initiatives of mainly France and Germany, it is currently being proposed to Member States via enhanced cooperation. This is examined next.

8.2.  The Financial Transaction Tax There has long been a general discussion to introduce a financial transaction tax.39 ­Arguments in favour of such tax increased with the advent of the banking crisis in HJI Panayi, ‘Inbound Investment and Thin Capitalization’ in Michael Lang, Pasquale Pistone, Josef Schuch and Claus Staringer, Common Consolidated Corporate Tax Base (Linde, 2008). For an economic analysis, see Leon Bettendorf, Albert van der Horst, Ruud A de Mooij, Handrik Vrijburg, Corporate tax consolidation and enhanced cooperation in the European Union (2009) Oxford University Centre for Business Taxation WP 10/01. 32 See Resolution of 15 January 2008 on Tax Treatment of Losses in Cross-Border Situations 2007/2144(INI), P6_TA(2008)0008, published in Official Journal of the European Union, C 41 E, 19 February 2009. 33  Ibid, paras 24–25. 34  Ibid, para 27. 35  Ibid, para 27. 36  See analysis in section 5.4 in Ch 5 of this volume. 37  The author has done extensive research which considers the possible impact of the CCCTB on non-participating Member States and the matters that ought to be resolved for enhanced cooperation to be successfully applied. These issues were explored by the author in a report commissioned by the Institute for Fiscal Studies. See HJI Panayi (2011), n 30 above. 38  The Commission had been working on the CCCTB Directive ever since the necessity for such legislation was raised in the Commission Company Tax Study published in 2001 (‘Company Taxation in the Internal Market’, SEC(2001) 1681). See ch 1 in HJI Panayi (2013), n 3 above. 39  See proposal for currency exchange aimed at stabilising financial markets by Nobel Laureate economics Professor James Tobin (Tobin tax). James Tobin, ‘A Proposal for International Monetary Reform’ (1978) 4 Eastern Economic Journal 153–59. Professor Tobin acknowledged the influence of

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late 2007 and its impact on the world economy.40 The ongoing discussion at the level of the G20 and the IMF41 intensified the debate within the European Union. On 28 September 2011, the Commission published a proposal for a Council Directive introducing a common system of a Financial Transaction Tax.42 Although the initial intention was to work towards the introduction of an FTT on a worldwide basis,43 it was decided to attempt an EU-FTT. The proposal was accompanied by an impact assessment.44 Being a Directive on indirect taxes, the harmonisation base was Article 113 TFEU. The FTT was not, according to the Directive, meant to affect citizens and business. It would only apply to financial transactions between financial i­nstitutions, when at least one party to the transaction was established in a Member State and a financial institution was established in a Member State.45 A tax of 0.1 per cent for most financial transactions other than derivatives and 0.01 per cent for derivative contracts was envisaged, as explained below.46 These were minimum rates and participating Member States were entitled to apply higher rates.

the writings of John Maynard Keynes on his proposal. See JM Keynes, General Theory of Employment, Interest Rates and Money (New York, Harcourt Brace & World, 1936). For a brief overview of the proposals and subsequent developments, see, inter alios, Thornton Matheson, Taxing Financial Transactions: Issues and Evidence, IMF WP/11/54 (IMF, 2011); Anthony Seely, ‘The Tobin tax: earlier debates’, House of Commons Library Standard Note, Standard Notes SN01346, dated 16 January 2012, available on: www.parliament.uk/briefing-papers/SN01346); Pablo A Hernández González-Barreda, ‘On the European Way to a Financial Transaction Tax under Enhanced Cooperation: Multi-Speed Europe or Shortcut?’ (2013) 41 Intertax 208–9; Gerard TK Meussen, ‘A New Tax Strategy for the European Union: FTT and FAT, Realistic or a Bridge too Far’ (2011) 52 European Taxation 101–4. 40  See Antony Seely, ‘The Tobin Tax: Recent Developments’, House of Commons Library, Standard Notes SN6184, dated 29 April 2013. Available on: www.parliament.uk/briefing-papers/SN06184. 41  See G20 Saint Andrews Communique, Meeting of Finance Ministers and Central Bank Governors, para 6 (7/11/2009) and IMF, A Fair and Substantial Contribution by the Financial Sector: Final Report for the G-20 (2010), cited in González-Barreda, n 39 above, p 298. 42  Proposal for a Council Directive on a common system of financial transaction tax and amending Directive 2008/7/EC, COM(2011) 594 final, Brussels, 28 September 2011 (henceforth, the 2011 FTT Proposal). For a critical overview, see John Vella, Clemens Fuest and Tim Schmidt-Eisenlohr, ‘The EU Commission’s Proposal for a Financial Transaction Tax’ [2011] British Tax Review 607; Thorsten Vogel and Benjamin Cortez, ‘The Commission’s Proposal to Introduce an EU Financial Transaction Tax’ (2012) 52 European Taxation 77; Oskar Henkow, ‘The Commission’s Proposal for a Common System of Financial Transaction Tax: A Legal Appraisal’ (2012) 21 EC Tax Review 5; Géry Bombeke and Evert Bleus, ‘Financial Transaction Tax’ (2013) 41 Intertax 553–56. 43  See conclusions of European Council in its meeting on 17 June 2010 with regard to the G20 Toronto Summit that ‘[t]he EU should lead efforts to set a global approach for introducing systems for levies and taxes on financial institutions with a view to maintaining a world-wide level playing field and will strongly defend this position with its G-20 partners. The introduction of a global financial transaction tax should be explored and developed further in that context’. Also see the Commission’s follow-up work on this: Commission Staff Working Document, Financial Sector Taxation, accompanying the communication from the Commission to the European Parliament, the Council, the European Economic and Social Committee and the Committee of the Regions (COM(2010) 549 final). 44  See Commission Staff Working Paper Impact Assessment accompanying the document Proposal for a Council Directive on a common system of financial transaction tax and amending Directive 2008/7/EC (28/09/2011), SEC(2011) 1102 final (henceforth, the 2011 Impact Assessment). 45  See Art 1(2) of the 2011 FTT Proposal, n 42 above. 46  Ibid, Art 8(2).

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The FTT proposal was described as a levy which would ensure that the financial sector contributes to the covering of the costs of the crisis and that it would be taxed in a fair way vis-à-vis other sectors in the future. It was also argued that a coordinated framework at EU level would help to strengthen the EU single market. At the time of the 2011 FTT proposal, 10 Member States had a type of a financial transaction tax in place. The proposal would introduce new minimum tax rates and harmonise different existing taxes on financial transactions in the European Union. This would help to reduce competitive distortions in the single market. The FTT was also meant to dis-incentivise excessively risky activities by financial institutions, to complement regulatory measures aimed at avoiding future crises and to generate additional revenue for general budgets or specific policy purposes. The FTT would only apply if one of the two parties was a financial institution and if one of the two parties—whether the financial institution or the non-­ financial institution—was established in a Member State.47 Therefore, direct transactions between non-financial institutions were not technically subject to FTT and the place where the transaction took place was not relevant. The term ‘financial transactions’48 was defined broadly, as the close substitutability of financial transactions and instruments would increase opportunities for tax avoidance.49 The term included the sale or purchase of financial instruments,50 money-market instruments (with the exception of instruments of payment), units or shares in collective investment undertakings,51 transfers of financial instruments between group entities, which are not a purchase and sale, and the conclusion or modification of derivatives (eg forwards, futures, options, swaps and financial contracts for difference). The FTT would be levied irrespective of whether or not the transaction took place through a stock exchange or over the counter. Transactions on the primary market were exempt from the scope of the FTT.52 Some other transactions were not included, for example, spot currency transactions, ‘consumer transactions’ (eg concluding insurance contracts, granting consumer credit, mortgage lending, credit card transactions, payment services,

47  Ibid, Art 1(2). The financial institution may be acting either for its own account or for account of another person, or is acting in the name of a party to the transaction. 48  Ibid, Art 2(1)(1). 49  See Vella et al (2011), n 42 above, p 609. 50  This is before netting and settlement, including repurchase and reverse repurchase and securities lending and borrowing agreements. See Art 2(1)(1)(a). 51  See references in Art 2(3)–(6) to the definition of financial instruments in Annex I to Directive 2004/39/EC [2004] OJ L145/1, 30.4.2004. This definition covers units in collective investment undertakings. Shares and units of undertakings for collective investment in transferable securities (UCITS) as defined in Art 1(2) of Directive 2009/65/EC ([2009] OJ L302/32, 17.11.2009) and alternative investment funds (AIF) as defined in Article 4(1)(a) of Directive 2011/61/EU ([2011] OJ L174/1, 1.7.2011) are financial instruments. The subscription and redemption of these instruments are also considered financial transactions. See Explanatory Memorandum to the Proposal, p 6, fn 8. Therefore, concepts found in internal market regulation of financial services would now require a tax interpretation. 52  Art 1(4)(a) of the 2011 FTT Proposal, n 42 above. Also excluded are Central Counter Parties (CCPs) where exercising the function of a CCP, Central Securities Depositories (CSDs) and International Central Securities Depositories (ICSDs) where exercising the function of a CSD or ICSD.

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deposits), issuing of government bonds and transactions with certain bodies (eg transactions with the central banks of Member States). ‘Financial institutions’53 were broadly defined and comprised all financial institutions and SPVs, as well as certain non-financial companies where a significant part of their overall activities was financial.54 Financial institutions would have to collect the tax and file a monthly FTT declaration. Some institutions (eg the ­European Financial Stability Facility and national Central Banks) were excluded from being financial institutions for the purposes of the proposed Directive.55 The exclusion of the Central Banks was intended to guarantee that the proposed Directive would not affect the refinancing possibilities of financial institutions or the instruments of monetary policy.56 A financial institution would be deemed to be established in a Member State under a number of criteria set out in Article 3.57 As a result of the rules, under certain circumstances, non-EU financial institutions would also be deemed EUestablished. There was an escape clause in that no FTT would be levied where there was no link between the economic substance of the transaction and the ­territory of any Member State.58 Financial transactions other than derivatives would be taxed at 0.1 per cent and for the conclusion or modification of derivatives the tax rate would be 0.01 per cent.59 As mentioned, both are minimum rates and Member States may increase them but cannot differentiate between financial transactions falling under the two categories. This was to mitigate the risk of tax-driven product selection of these highly mobile instruments.

53 

Ibid, Art 2(7). Eg credit institutions, regulated markets, investment firms, insurance/reinsurance undertakings, pension funds etc. 55  See Art 1(3) of the 2011 FTT Proposal, n 42 above. 56  See Explanatory Memorandum to the Proposal, p 5 and Vogel and Cortez (2012), n 42 above, p 136. 57  Where the financial institution has been authorised to act as a financial institution, in respect of transactions covered by the authorisation (Art 3(1)(a)); where it has its registered seat (Art 3(1)(b)); where it has its permanent address or usual residence (Art 3(1)(c)); where it has a branch, in respect of transactions carried out by the branch (Art 3(1)(d)); where it is a party, acting either for its own account or for the account of another person, or is acting in the name of a party to the transaction, to a financial transaction with another financial institution established in that Member State pursuant to points (a), (b), (c) or (d), or with a party established in the territory of that Member State and which is not a financial institution (Art 3(1)(e)). This list is hierarchical so if more than one of the conditions are met, the first one takes priority. See Art 3(2) of the 2011 FTT Proposal, n 42 above. Englisch et al (2013), n 5 above, discuss the ‘contagion effect’ of the rules in that when a financial institution fulfils none of the criteria set out, it shall nevertheless become liable to the FTT if the other party involved in the transaction is (or is deemed to be) established in a participating Member State under the tests. See pp 236 and 240. Although the argument is made in the context of the 2013 FTT Proposal, the same applies under the 2011 FTT Proposal (see Art 3(1)(e)). However, Englisch et al point out that in the 2011 Impact Assessment, n 44 above, p 5, the Commission appears to interpret the rules as not requiring the taxation of the part of a trade that is undertaken by a non-resident buyer or seller: see Englisch et al p 240. 58  Art 3(3) of the 2011 FTT Proposal, n 42 above. 59  Ibid, Art 8(2). 54 

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The FTT liability would arise when the transaction occurred and would be payable immediately (in case of electronic transactions) or within three working days.60 Each financial institution that was a party to the financial transaction would pay FTT61 and there would be joint and several liability.62 Transfers of financial instruments within a corporate group would also be subject to FTT, even if the transaction could not be characterised as a purchase or sale (cascading effect). It was stipulated that Member States would lay down obligations as to the registration of financial institutions, accounting, reporting and other obligations to ensure effective payment, verification of correct payment of the tax, and prevention of tax evasion, avoidance and abuse.63 The administration was left for the Member States to determine but Member States had to make use of administrative cooperation tools. It was obvious that under the proposed Directive, there would be limited coordination proposed at an EU level. If adopted, the proposed directive would become effective on 1 January 2014. In the 2011 Impact Assessment,64 the Commission estimated revenues of approximately €57 billion annually depending on market reactions and the effectiveness of tax collection. It was not certain how the revenue would be used. Some of it could be allocated to the EU Budget, thus reducing the contributions of Member States. To achieve harmonisation within the European Union, all Member States which already had such tax would have to abolish it and replace it with the FTT. In March 2012, the Commission proposed to split the revenues 2/3 to the EU Budget and 1/3 to Member States. The proposed FTT Directive was not favourably seen by a number of Member States and especially the UK, Sweden, Bulgaria, the Czech Republic, Cyprus, Malta and Denmark.65 It was criticised for having a broad field of application, potentially catching non-financial and non-EU undertakings. In February 2012, only nine Member States (Austria, Belgium, Finland, France, Germany, Greece, Italy, Portugal and Spain) had indicated their support for an EU-wide FTT. In its opinion on the Commission’s proposal, the European Parliament voted in favour of the proposal.66 The European Parliament recommended the addition of an issuance principle to the Commission’s proposal whereby non-EU financial institutions would pay the FTT if the securities traded were originally issued within

60 

Ibid, Arts 4 and 10(4). Ibid, Art 9. Ibid, Art 9(3). 63  Ibid, Art 10. 64  2011 Impact Assessment, n 44 above. 65  Thorsten Vogel and Benjamin Cortez, ‘Recent Development and Resulting Implications Regarding a Financial Transaction Tax in Europe’ (2013) 53 European Taxation 135. Also see Rebecca Christie and Jim Brunsden ‘EU Transaction Tax Debate Highlights Euro-Area Disagreement’ in Bloomberg, Businessweek (8 November 2011). Vella et al (2011), n 42 above, at p 609 describe the UK as being bitterly opposed to an FTT unless it was adopted by other G20 countries. Also see Brooke Masters, Jeremy Grant and Chris Bryant, ‘Warning of unintended outcomes of Tobin tax’, Financial Times (5/10/2011). 66  European Parliament legislative resolution of 23 May 2012 on the proposal for a Council Directive on a common system of financial transaction tax. 61  62 

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the European Union. The European Parliament also stated that the FTT should be adopted even by some Member States.67 By June 2012 at the ECOFIN meeting, it was clear that the Commission’s proposal for an EU FTT had not amassed the necessary support to be unanimously adopted by all Member States. Given that unanimity was required for the proposal to be adopted as a directive under Article 113 TFEU, interested Member States had to look for alternative ways. The only option seemed to be adoption through the enhanced cooperation mechanism. Indeed, on 28 September 2012, in a joint letter sent to the Commission and the Finance Ministers of other Member States, the German and French Finance ­Ministers stated their strong support in favour of the FTT and urged the Commission to trigger the enhanced cooperation mechanism in order to implement the FTT in a subset of Member States. Although France and Germany encouraged and invited other Member States to join this initiative, the letter was vague as to the detail of the actual FTT proposal, stating that it would be based on the Commission’s initial proposal. As argued, this stance suggested that the ‘design of the FTT is therefore still a moving target and the scope and objectives remain unclear’.68 Shortly thereafter, on 23 October 2012, the Commission gave the green light for the use of enhanced cooperation to adopt the FTT69 and advised the Council to approve this. The Commission argued that enhanced cooperation on an FTT would support the EU’s objective and reinforce the integration process. A common FTT system, shared by 11(+) Member States, would reduce the number of divergent national approaches to financial sector taxation. In doing so, it would lead to less competitive distortions, fewer tax avoidance opportunities, more transparency and information exchange amongst those taking part, and less compliance costs for ­businesses and operators across the EU.70

The Commission argued that the FTT would lead to fewer barriers and ­competitive distortions, as a ‘common system of taxing the financial sector, even if not applied by all Member States, is preferable to the fragmentation that would result from 27 different national systems’.71 The Commission also stated that this proposal would respect the competences and rights of non-participating Member States, giving as an example the fact that non-participating Member States would not be precluded from having their own national FTTs if they wanted to.72 This proposal, supported by 10 Member States at the time and eventually 11 Member States73 was approved by the European Parliament in December

67 

See ‘EU Update’ (2012) 52 European Taxation 25–26. See PwC EU Tax Direct Group Newsflashes (Oct 2012): ‘Germany and France push for EU financial transactions tax’. Available at: www.pwc.com/gx/en/tax/newsletters/eu-direct-tax-newsflashes/ eudtg-newsflash-2012-4okt.jhtml. 69  See Press Release, Commission proposes green light for enhanced cooperation on financial transactions tax (IP/12/1138 dated 23/10/2012). 70  See European Commission, Enhanced Cooperation on Financial Transaction Tax—Questions and Answers (MEMO/12/799 dated 23/10/2012). 71  Ibid. 72  Ibid. 73  Austria, Belgium, Finland, France, Germany, Greece, Italy, Portugal, Spain, Slovenia and Slovakia. 68 

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2012.74 In the January 2013 ECOFIN Council, the adoption of the FTT through enhanced cooperation was eventually approved by qualified majority.75 However, the UK, Luxemburg, Malta and the Czech Republic raised concerns that the Commission had not provided any analysis of the impacts that an enhanced cooperation FTT would have on individual Member States, both participating and non-­participating ones. Furthermore, the UK tabled a minute statement76 stating that it could not support the proposal as it could not take a view whether the conditions of enhanced cooperation were met.77 The dissenting Member States abstained from voting. Notwithstanding the disagreement of the UK and some other Member States, on 14 February 2013, the Commission published a new proposal for a Council directive implementing enhanced cooperation in the area of financial transaction tax,78 accompanied by another Impact Assessment.79 The main change and perhaps the most important one compared to the 2011 FTT proposal was the issuance principle, whereby financial instruments issued in the participating Member States would be taxed when traded, even if the parties trading them were not established in FTT Member States. This principle was added as an anti-avoidance measure against the relocation of activities or establishments outside participating Member States and served as a last resort as regards the establishment of tax liability.80 The issuance principle complimented the principle of establishment which remained the main principle. It is thought to be the most contentious recommendation as in certain circumstances it could

74  See European Parliament/News, ‘Eleven EU countries get Parliament’s all clear for a financial transaction tax’, Plenary Session Economic and monetary affairs—12.12.2012. Available at: www. europarl.europa.eu/news/en/pressroom/content/20121207IPR04408/html/Eleven-EU-countriesget-Parliament%27s-all-clear-for-a-financial-transaction-tax. 75  See Council of the European Union, ‘Financial transaction tax: Council agrees to enhanced cooperation’, Brussels, 22 January 2013, 5555/13, PRESSE 23. Available at: register.consilium.europa.eu/pdf/ en/13/st05/st05555.en13.pdf (last accessed 2 March 2013). 76  See Written Ministerial Statement, ECOFIN 22 January 2013, www.parliament.uk/documents/ commons-vote-office/January_2013/30-01-13/2.CHANCELLOR-ECOFIN-22-January.pdf. 77  These conditions included the following: any such cooperation shall not undermine the internal market or economic, social and territorial cohesion; such cooperation shall not constitute a barrier to or discrimination in trade between Member States, nor distort competition between them; and any enhanced cooperation shall respect the competences, rights and obligations of those Member States which do not participate in it. Also see analysis of enhanced cooperation in section 8.1 above. 78  Proposal for a Council Directive implementing enhanced cooperation in the area of financial transaction tax, COM(2013) 71 final (henceforth, the 2013 FTT Proposal). With this, the Commission withdrew the original proposal. For commentary, see Joachim Englisch et al (2013), n 5 above, p 243; Vogel and Cortez, n 65 above; Nicolas de Boynes, Andrew Thomson & Pierre-Antoine Bachellerie, ‘European Commission’s Revised Draft Directive on the Financial Transaction Tax’ (2013) 70 Tax Notes International 353 (22 April 2013); Raymond Adema, ‘Financial Transaction Tax: Pan-European Market for Master-Feeder Structures—or Part of It—Smothered?’ (2010) 42 Intertax 653–61. 79  See Commission Staff Working Document, Impact Assessment accompanying the document Proposal for a Council Directive implementing enhanced cooperation in the area of financial transaction tax: analysis of policy options and impacts’, SWD(2013) 28 final of 14 February 2013 (henceforth, the 2013 Impact Assessment). This was meant to be read together with the impact assessment accompanying the 2011 proposal. 80  See 2013 FTT Proposal, n 78 above, p 5.

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have e­ xtraterritorial effects. For example, FTT would be due when a bank established in the USA bought shares originally issued in Germany from a bank in Singapore. Both banks would be subject to FTT as the shares had been issued in Germany.81 Another change was that, in the management of public debt, Member States and other public bodies were excluded from the scope of the directive.82 Also, the European Central Bank, the European Financial Stability Facility and the European Stability Mechanism were explicitly referred to as being exempt from the FTT.83 The issuance of shares and units in collective investment funds and restructuring operations were also excluded from the scope of taxation.84 Also, exchanges of financial instruments were regarded as two transactions for tax purposes but repurchase and reverse agreements and securities lending and borrowing were regarded as only one transaction, as they were considered to be economically equivalent to a single credit operation.85 Furthermore, a general anti-abuse rule was inserted whereby an artificial arrangement or an artificial series of arrangements which had been put into place for the essential purpose of avoiding taxation and led to a tax benefit would be ignored.86 Furthermore, the revenue estimate was adjusted and the Commission expected about €30–35 billion per year. Part of this would be added to the EU Budget directly as an own resource, reducing the contributions of participating Member States accordingly. On 2 July 2013, the European Parliament discussed the FTT proposal, along with amendments recommended by its Committee on Economic and Monetary Affairs.87 Opponents and supporters of the FTT aired their views.88 The following day, the European Parliament approved the 2013 FTT Proposal.89 However, its role in the process was only advisory. The Commission and the participating Member States were free to accept or reject any changes. 81  For more examples, see Boynes et al (2013), n 78 above, pp 356–58; Englisch et al (2013), n 5 above. 82  See Art 3(2)(c) of the 2013 FTT Proposal, n 78 above. 83  Ibid, Art 3(4). 84  Ibid, Art 3(4)(a). 85  Ibid, Art 2(2). 86  Ibid, Art 13(1). Pursuant to this provision, participating Member States shall treat these arrangements for tax purposes by reference to their economic substance. An arrangement was defined widely and may comprise more than one step or part (Art 13(2)). An arrangement was artificial if it lacked commercial substance. See Art 13(3). A number of situations listed were to be taken into account. The purpose of an arrangement was to avoid taxation ‘where, regardless of any subjective intentions of the taxpayer, it defeats the object, spirit and purpose of the tax provisions that would otherwise apply’ (see Art 13(4)). 87 See Committee on Economic and Monetary Affairs, Report on the proposal for a Council directive implementing enhanced cooperation in the area of financial transaction tax, 24 June 2013 (COM(201)0071—C7, 0049/2013—2013/0045(CNS), A7-0230/2013). 88  David D Stewart, ‘FTT Opponents Air Concerns as European Parliament Takes Up Amended Proposal’, 2013 WTD 128-1 (3 July 2013). 89  David D Stewart, ‘European Parliament Approves Amended FTT Proposal’, 2013 WTD 129-2 (5 July 2013).

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In September 2013, an internal legal opinion prepared by the EU Council Legal Service raised concerns that the proposed FTT would have an extraterritorial reach that would infringe upon the taxing rights of non-participating Member States.90 It was also concluded that the proposed FTT breached international law norms which had to be respected under EU law, that it was discriminatory and it led to distortion of competition. However, the Commission continued to support the FTT unabated. Indicatively, on 4 February 2014, at a plenary debate at the European Parliament, EU Tax Commissioner Algirdas Šemeta spoke of the impact and future goals of the FTT. He noted: ‘Europe needs to reconnect with its citizens. And the FTT is a prime example of a project which can help to achieve this’.91 Quite how this is case—when all costs to financial institutions are expected to eventually be passed on to the consumers/citizens—is not explained. As already mentioned, a number of Member States were against the initial proposal for the FTT and the subsequently revised proposal. The most vocal and proactive opponent has been the UK, which eventually challenged the Commission’s actions at the Court of Justice. The UK Government’s reaction to the FTT is ­considered in the next section.

8.3.  The Financial Transaction Tax and Enhanced Cooperation: The UK Reaction Broadly indicative of the UK’s stance on the FTT, on 26 March 2013 the House of Lords European Union Committee published a letter that it had sent to the Financial Secretary of HM Treasury, Mr Greg Clark, urging the UK to challenge the authorising decision.92 In this letter, the Committee criticised the ‘paucity of thinking’ in the FTT proposal and the lack of action by the UK Government.93 One criticism levied against the Commission’s proposal was the lack of ­information given on how the tax would be collected and the costs that might 90  David D Stewart and Stephanie Soong Johnston, ‘EU Council Opinion Casts Doubt on Legality of Financial Transaction Tax’, 2013 WTD 176-1 (11 September 2013); Adrian Cloer and Stefan Trencsik, ‘Alive and Deadly—The European Financial Transaction Tax through Enhanced Cooperation: Current Progress’ (2014) 54 European Taxation 307–12. Some authors have also expressed concerns that the FTT is in breach of the fundamental freedoms and more specifically, Art 63 TFEU. See Pablo A Hernández González-Barreda, ‘On the European Way to a Financial Transaction Tax under Enhanced Cooperation: Multi-Speed Europe or Shortcut?’, n 39 above; George Dietlein, ‘National Approaches Towards a Financial Transaction Tax and their Compatibility with European Law’ (2012) 21 EC Tax Review 207–11. 91 See Financial Transaction Tax: Time to engage, compromise and deliver—Plenary debate in Parliament, available on Tax Analysts, 2014 WTD 24-10 (5 February 2014). 92  See House of Lords, European Union Committee Letter dated 16 April 2013, p 4, available on www.parliament.uk/documents/lords-committees/eu-sub-com-a/FTTEnhancedScrutiny/260313FTT. pdf. 93  See Stephanie Soong Johnston, ‘Legal Action Possible Against EU Financial Transaction Tax, UK Lawmakers say’, 2013 WTD 60-2 (28 March 2013).

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accrue to non-participating Member States. The Committee asked for clarifications on the obligation of the UK authorities to collect the tax. Even though the UK had opted not to adopt the FTT and would not benefit from the collection of revenue, UK financial institutions entering into financial transactions with financial institutions in participating Member States would still be liable for the FTT. The FTT levy could be collected through the Mutual Assistance Directive for the Recovery of Taxes94 or as a result of the provisions on joint and several liability set out in the proposal.95 This is notwithstanding the fact that the Commission representative giving oral evidence to the Committee, Mr Manfred Bergmann, had said that there would be no legal obligation on UK tax authorities to collect the FTT—no greater obligation than that of non-UK financial institutions under the UK stamp duty.96 This argument was also raised in the Commission’s 2013 Impact Assessment and has been criticised. The comparison of the FTT with the Stamp Duty Reserve Tax regime is not very accurate, as the former is a tax on the financial sector rather than capital investment, which is entirely unrelated to the location of the companies whose shares are traded.97

94  Council Directive 2010/24/EU of 16 March 2010 Concerning Mutual Assistance for the Recovery of Claims Relating to Taxes, Duties and Other Measures, repealing Council Directive 76/308/EEC of 15 March 1976 on Mutual Assistance for the Recovery of Claims Resulting from Operations ­Forming Part of the System of Financing the European Agricultural Guidance and Guarantee Fund and of Agricultural Levies and Customs Duties and in Respect of Value Added Tax and Certain Excise Duties. 95  See House of Lords letter, n 92 above, p 2. 96  Ibid. More correctly, it is the Stamp Duty Reserve Tax that the Commission representative should have mentioned. In any case, the comparison is not correct, as discussed immediately below. 97  See Englisch et al (2013), n 5 above, pp 243–44. It is pointed out by the authors that the UK Stamp Duty has evolved historically as a tax upon the use of certain instruments needed to give effect to an agreed change in (share) ownership and its eventual registration. The Stamp Duty Reserve Tax is a tax on electronic (paperless) share transactions and was introduced when electronic settlement of share transactions began to take place in the London stock market. As explained on the HMRC website, you pay Stamp Duty Reserve Tax on paperless transactions when you buy shares in a UK company, shares in a foreign company with a share register in the UK, an option to buy shares, rights arising from shares already owned, an interest in shares, like an interest in the money made from selling them and units in unit trusts or shares in open-ended investment companies. Most paperless share transactions subject to this tax are carried out electronically through CREST, the electronic settlement and registration system administered by Euroclear. The amount of Stamp Duty Reserve Tax payable is worked out at a flat rate of 0.5 per cent (rounded up or down to the nearest penny) based on what you give for the shares, not what the shares are worth. See www.hmrc.gov.uk/sdrt/intro/basics.htm. This tax is automatically collected by CREST and sent to HMRC. Therefore, it is not collected by financial institutions or other parties trading the shares. Also, there are a number of exemptions for overseas exchange traded funds, though some foreign ‘off-market’ transactions of shares in UK corporations are also caught by the Stamp Duty Reserve Tax. Englisch et al (2013), n 5 above, argue that ‘[a] tax on capital levied by the country where the intangible representing the capital investment is “located”, as determined by the issuance principle, can possibly be defended in the light of the territoriality principle, at least to the extent that it can reasonably be expected to be collected by institutions and intermediaries (e.g. stockbrokers) which are established domestically’: ibid, pp 243–44. For more information on the UK’s Stamp Duty Reserve Tax, see, inter alios, Reginald S Nock, Monroe & Nock on the Law of Stamp Duties (Sweet & Maxwell, loose-leaf last updated in 2012), James Mirrlees et al, Tax By Design: The Mirrlees Review (Oxford University Press, 2011) and John A Kay and Mervyn A King, The British Tax System, 5th edn (Oxford University Press, 1990).

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The House of Lords Committee was of the opinion that under the FTT ­proposal, the UK financial institutions would be burdened with the obligation to pay the FTT tax, even if the UK was a non-participating Member State. Even more ­far-reaching consequences would apply in relation to the FTT tax imposed on the basis of the issuance principle. The Committee gave the example of a financial transaction involving German shares between a US and a UK financial institution. Under the issuance principle, this would give rise to an FTT on both parties which would be payable to the German tax authorities but the collection of this tax from the US financial institution might be difficult. The Committee believed that ‘the proposal would enable the German tax authorities to impose joint and several liability for both instances of the FTT upon the UK financial institution and recover the whole amount using the EU mutual assistance regime’.98 Such consequences would be serious and must be resisted, the Committee thought, especially if account is taken of the fact that a portion of the revenue would constitute a new own resource for the EU Budget.99 This would raise ‘the spectre that an FTT imposed on a financial institution resident in a non-participating Member State such as the UK would reduce the national contribution of a participating Member State’.100 A related argument was that the issuance principle often triggered extraterritorial effects and this risked being non-compliant with customary international law. Although the UK stamp duty was based on the issuance ­principle, it had a much narrower scope.101 The uncertainty as regards the use of potential revenue from the FTT was highlighted by the House of Lords Committee. The fact that revenue collected could be used as a new own resource for the EU Budget, resulting in a corresponding reduction of the national contributions of participating Member States, would raise ‘the deeply unpalatable prospect that an FTT imposed on a financial institution resident in a non-participating Member State such as the UK would reduce the national contribution of a participating Member State’.102 There was in fact a great concern even under the original proposal in 2011 that, given London’s strength as a financial centre, a disproportionate majority of the revenues would be coming from the UK, rendering a European FTT ‘more of a tax on London than on the EU’.103 A European-FTT might not even raise any additional money for the UK, as

98 

House of Lords letter, n 92 above, pp 4–5. Ibid, p 5. Ibid. 101  See analysis in n 97 above. 102  House of Lords letter, n 92 above, p 2. 103  For example, the UK would lose about £3 billion per year in stamp duty, as under the 2011 FTT Proposal the UK stamp duty would be replaced by the FTT. Furthermore, there would be a reduction of corporation tax receipts from the financial sector due to the impact of the tax and a reduction of income tax receipts from the possible loss of jobs of financial sector employees etc. See letter by Stuart Fraser, Policy Chairman at the City of London Corporation, in ‘Letters: How can you tax transactions that are no longer there?’, Financial Times, 7 October 2011. Also see House of Lords EU Economic and Financial Affairs and International Trade Sub-Committee, Financial Transaction Tax: Oral and Written Evidence, 28 November 2011, pp 190–91 and Seely (2013), n 40 above, pp 14–17. 99 

100 

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any gains would be offset by losses in other taxes due to the impact of the tax.104 It is unfortunate that neither the 2011 FTT Proposal nor the provisions suggested under the 2013 FTT Proposal addressed these concerns. The House of Lords Committee also commented on the fact that the Commission had not given much information about the implications of the proposal for non-participating Member States. There was no detailed analysis of the impact of the FTT on non-participating Member States in the 2013 Impact Assessment. We find this to be an unacceptable omission, suggesting that the Commission has failed in its duty to the 16 Member States who have thus far chosen not to participate in the tax, yet may be significantly affected by it.105

Moreover, the UK Government was accused of complacency and was criticised for not keeping the House of Lords Committee duly informed. It was warned that just because the UK will not participate in the FTT, this does not mean that ‘the reverberations of an FTT would not be felt here’.106 The Committee urged the government to cooperate with the other non-participating Member States to try and avert the worse consequences of this proposal.107 The Committee also voiced concerns that the 2013 Impact Assessment did not adequately address the potentially deleterious effect of the FTT on economic growth.108 It was questioned whether the FTT would have a negative impact on economic growth and it was argued that ‘at a time of ongoing financial crisis and at best fragile economic growth across the entire EU, a new tax which could have a substantial detrimental impact on EU GDP should be resisted’.109 The Committee was also unconvinced that the FTT would curb irresponsible trading and enhance the efficiency of financial markets, an avowed purpose of the FTT proposal.110 Given the continuous US hostility to the proposal, the Committee also remained unconvinced that an EU-wide FTT would pave the way for the introduction of a global tax. Finally, the House of Lords Committee criticised the way the UK Government had handled the use of the enhanced cooperation procedure and emphasised the need to create alliances with non-participating Member States.111 It was questioned whether the proposal met the criteria for the enhanced cooperation to be used and especially whether it would create a distortion of competition.112 The Committee thought that it was ‘particularly unacceptable that a full analysis of 104  See Letter from Rt Hon George Osborne to Rt Hon Andrew Tyrie MP, Chairman, House of Commons Treasury Committee, 12 December 2011, cited by Seely (2013), n 40 above, p 17. 105  House of Lords letter, n 92 above, p 3. 106  Ibid, p 5. 107  Ibid, p 5. 108  Ibid, p 6. 109  Ibid. 110  Ibid, p 7. 111  Ibid, p 8. 112  The possibility of double taxation was conceded by the Commission. The Commission did not go into this in much detail in the 2013 Impact Assessment: House of Lords letter, n 92 above, p 8.

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the impact of the proposal on non-participating Member States was not made ­available before the vote on enhanced cooperation took place’.113 This highly critical letter must have had some influence on the UK ­Government’s policy as shortly thereafter, on 18 April 2014, an application was lodged to the Court of Justice to challenge the authorising decision to adopt the FTT through enhanced cooperation.114 An HM Treasury spokesman emphasised that the UK was not against the principle of a global financial transactions tax, ‘but think that a European-only tax would hit people’s savings and pensions and hit jobs and growth’.115 While the UK would not participate in a Europe-only tax, ‘we have also said we will not stand in the way of other countries, but only if the rights of countries not taking part are respected’.116 The UK lodged the challenge as it believed that the proposal on the table did not meet these requirements. More specifically, the UK was concerned with the extraterritorial impact of the FTT.117 The UK Government’s challenge was welcomed by the House of Lords European Union Committee.118 Since then, more stakeholders have expressed their support for the UK Government and disapproval of the FTT. On 17 February 2014, the Law Society commented that its chief executive had written to key European finance ministers to raise the Society’s concerns that the proposal would not sufficiently respect the rights and competences of the countries that have chosen not to participate. He argued that the effects of the proposed tax would ‘force a degree of participation’ on countries that choose not to participate.119 Similarly, the City of London has issued a special interest paper examining how the proposed FTT would affect European households’ savings, specifically with regard to Germany, Italy, Spain, Slovakia, Luxembourg and the UK.120 On 30 April 2014, the Court of Justice rejected the UK’s challenge to the Commission’s decision to authorise the use of enhanced cooperation.121 The request to annul the Commission’s decision was rejected on the basis that its arguments were founded on the draft Directive (ie the 2013 FTT Proposal), which was not part of the decision to authorise the use of enhanced cooperation. The review of the Court of Justice was limited to the issue of whether that decision was valid as such in light of Article 20 TEU and Articles 326–334 TFEU, which defined the s­ ubstantive and 113 

Ibid, p 9. See Case C-209/13 United Kingdom v Council [2015] ECR I-0000. 115  The comments were reported in Tax Analysts on 23 April 2013. Stephanie Soong Johnston (2013) n 93 above. Also see Christiana HJI Panayi, ‘The EU’s Financial Transaction Tax, Enhanced Cooperation and the UK’s challenge’ (2013) 53 European Taxation 358–67. 116  Stephanie Soong Johnston (2013) n 93 above. 117  See statements made by the Chancellor of the Exchequer George Osborne in the press, available at: www.independent.co.uk/news/uk/politics/osborne-in-legal-challenge-to-european-commissionover-financial-transaction-tax-8581165.html. 118  Also see Christiana HJ1 Panayi, ‘The EU’s Financial Transaction Tax, Enhanced cooperation and the UK’s challenge’, n 115 above. 119  See Tax Analysts, Doc 2014-3586 (18 February 2014). 120 See The Effect of a Financial Transaction Tax on European Households’ Savings, published in Tax Analysts on 17 February 2014. See 2014 WTD 33-16. 121  Case C-209/13 United Kingdom v Council, n 114 above. 114 

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procedural conditions relating to the granting of such authorisation. ‘That review should not be confused with the review which may be undertaken, in the context of a subsequent action for annulment, of a measure adopted for the purposes of the implementation of the authorised enhanced cooperation’.122 Therefore, the challenge was premature. As far as the UK Government’s specific arguments were concerned, the Court of Justice did not consider them. Furthermore, the Court noted that the contested decision contained no provisions relating to the issue of expenditure.123 As such, it was obvious that the question of the possible effects of the future FTT on the administrative costs of the non-participating Member States cannot be examined for as long as the principles of taxation in respect of that tax have not been definitively established as part of the implementation of the enhanced cooperation authorised by the contested decision.124

The overtone of the Court’s decision was that if and when an FTT is adopted under enhanced cooperation, it may be possible to challenge the substance of the measures at that point. Therefore, a subsequent challenge could be admissible, depending on the form and scope of any FTT.

8.4.  The Future of the Financial Transaction Tax At the May 2014 ECOFIN meeting, finance ministers from 10 of the participating Member States125 reiterated their commitment to the FTT by issuing a joint statement. In the press release, the intention of participating Member States to work on a progressive implementation of the FTT, focusing initially on the taxation of shares and certain derivatives, was noted.126 It was also noted that the first steps would be implemented at the latest on 1 January 2016. Following this joint statement, it was thought that the FTT might initially involve a tax on equities and equity derivatives only, with a possible wider scoped tax at a later stage. The participating Member States would be permitted to maintain taxation of instruments that were not within the scope of the tax levied under the initial launch. Much remained to be agreed, particularly on further phases of the tax and the position of smaller Member States. 122 

Ibid, para 34. Ibid, para 37. 124  Ibid, para 38. 125  Slovakia, which was among the 11 participating Member States, did not sign the joint statement as at the time it was considering whether to withdraw from the initiative. See Stephanie Soong Johnston, ‘EU Financial Transaction Tax to Take Effect in 2016 Despite Strong Opposition’, 2014 WTD 88-1 (7 May 2014). Also see PwC bulletin available at pwc.to/1xIckFn and Ernst & Young bulletin available at: bit.ly/1zwbWtU. 126  Press Release (PRESSE 242, PR CO 22) 3310th Council meeting, ECOFIN 6 May 2014, p 9. Available at: bit.ly/1qOX84f. 123 

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On 7 November 2014, the French Finance Minister, Michel Sapin, presented a revised, scaled-down version of the FTT to ECOFIN ministers to address concerns of smaller countries that they would be negatively affected by the FTT. Under his proposal, only transfers of shares of companies domiciled in one of the 11 participating Member States that had agreed in principle to the FTT would be subject to the tax. The FTT would not apply to all activities but credit default swaps not handled by clearinghouses would be taxed.127 Subsequently, a document prepared by the Italian government for an ambassadors’ meeting on 10 December 2014 revealed that several of the participating Member States might not be able to meet their self-imposed deadline to agree on the scope and rates of the tax by the end of 2014. More work was needed especially on the scope of the derivatives that would be taxed, how the tax would be collected, and how far-reaching the tax would be.128 At the ECOFIN meeting in January 2015, in another joint statement, ministers from 10 Member States reiterated their commitment to implementing the FTT in stages, adding that the tax should be based on the principle of the widest possible base and low rates.129 It was announced that progress had been made on the scope of the FTT for transactions in shares, while the taxation of transactions in derivatives remained a key open question. Further reflection was necessary on the taxation principles to be applied for the FTT (residence principle, issuance principle) as well as on the mechanism to be used for collecting the FTT. Therefore, despite the continuous opposition by some Member States and numerous lobbying bodies,130 the participating Member States as well as the Commission have not abandoned the idea of launching the FTT. There were reports that the participating131 Member States are likely to come to an agreement on the FTT by the June 2015 ECOFIN meeting, though the instrument is unlikely to be ready by 2016.132 While there is still quite a lot of confusion as to when the FTT will be launched, what it will eventually encompass, whether it will eventually restore public confidence in the financial sector or whether it will have the opposite effect with widespread relocation from the European Union to third countries,

127  William Hoke, ‘France Proposes Scaled Down Version of Financial Transaction Tax’, 2014 WTD 214-3 (5 November 2014). 128  Stephanie Soong Johnston, ‘EU Countries Might Miss Deadline for FTT Deal’, 2014 WTD 234-1 (5 December 2014). 129  Outcomes of the Meeting, 3356th Council meeting Economic and Financial Affairs, Brussels, 9 December 2014, 16603/14 (OR. en) Presse 68 PR CO 632. For commentary, see Margaret Burow, ‘EU Finance Ministers Offer Up New Financial Transaction Tax Proposals’, 2015 WTD 15-3 (23 January 2015). 130  See, for example, the letter sent by the European Association of Cooperative Banks (EACB), the European Association of Public Banks (EAPB) and the European Banking Federation (EBF), published in Tax Analysts on 23 January 2015 (see 2015 WTD 21-19). 131  Slovenia has since said it may withdraw from the initiative, reportedly because of its dissatisfaction with the tax in its current form. See Stephanie Soong Johnston, ‘EU Financial Transaction Tax to Take Effect in 2016 Despite Strong Opposition’, 2014 WTD 88-1 (7 May 2015). 132  Stephanie Soong Johnston, ‘EU FTT by 2016 Unlikely, Austrian Finance Minister Says’, 2015 WTD 95-3 (18 May 2015).

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and whether in general that is the right legislative instrument for the European Union,133 the proposal still features high on the agenda of many Member States. Nevertheless, it should be emphasised that linking tax legislation with enhanced cooperation could have broader constitutional implications. While the existence of the fiscal veto has always been criticised for stifling further tax integration in the EU, especially in the area of direct taxation, the perils of partial integration should not be underestimated. The developments surrounding the FTT are a good illustration of this. They show the potential of enhanced cooperation leading to a situation where non-participating Member States bear the burdens of deeper tax integration without reaping the benefits. Furthermore, as the use of the enhanced cooperation procedure is still at an embryonic stage and experience from it is almost non-existent, there are still concerns as to how it should be conducted overall—eg the level of consultation that should be undertaken during the process, how much protection should be given to non-participating Member States and built into the instrument, the cost implications, the resolution of disputes etc. It is one thing to allow flexible and coordinated action between Member States to promote further (tax) integration between them; it is another to circumvent principles of natural justice and good governance in the European Union under this pretext. Although as argued,134 the limits of the European Union’s legislative competence are in practice imprecisely defined by the Treaty itself, enabling legislative institutions to enjoy wide discretion, as far as taxation is concerned, there is a strong and entrenched tradition of deference to Member States’ sovereignty. If this is to be eroded, whether permanently or occasionally or as a one-off situation, then, arguably, this should be done gradually and in a transparent way. The FTT proposal is undeniably a very bold and controversial project. It would have been preferable if it was not introduced through enhanced cooperation—a process highly contentious itself. This combination is unlikely to yield the best possible results. It might also set a dangerous precedent as it would enable Member States pushing for more tax harmonisation to fast-track legislative proposals on the pretext of tackling aggressive tax planning.

133  There have been arguments that a Financial Activities Tax might be a preferable option. See Josephine Kaiding, ‘The Financial Transaction Tax: The Way Forward for the European Union?’ (2014) 23 EC Tax Review 30–42, and studies cited at p 41 et seq. 134  See, for example, Stephen Weatherill, ‘The Limit of Legislative Harmonisation Ten Years after Tobacco Advertising: How the Court’s Case Law has become a “Drafting Guide”’ (2011) 12 German Law Journal 827. He explains that the Court of Justice has produced broad guidelines and EU legislature follows and adopts similar vague vocabulary, which is unlikely to be challenged in Court.

9 International and European Union Tax Law in the Post-BEPS World This book set out to provide an overview of recent developments in the field of international taxation as well as in the field of EU tax law. Most of the developments were centred around the polemic against aggressive tax planning and the momentum that has been developed both internationally and in the European Union. At the beginning of the book, there was an overview of the various factors and events that led to the launch of the BEPS project. What became apparent was that there was some sort of continuum of efforts to address the same or a similar problem, which seems to be rebranded and/or reconfigured every few years. The rhetoric against harmful tax competition and tax havens seems now to have been reconfigured to the rhetoric against aggressive tax planning. This has attracted a lot of attention by advocacy groups and NGOs, and lately the media. All these bodies have had an important role in raising public awareness on the topic. It is often claimed that the existence of tax havens has contributed to the financial crisis and has had an impact on the fiscal sustainability of countries, although there is no concrete evidence to this effect. On the other hand, the offensive against tax havens could be perceived as merely a populist measure to deflect the peoples’ (essentially voters’) attention from the real problems and factors that led to the financial crisis. The strategies used by some large MNEs to benefit from low effective tax rates and/or create stateless income were then examined, mostly in light of several investigations by source states and residence states. The underlying tone of the various investigations and hearings considered was that multinationals should follow the spirit and not just the letter of the law—and pay taxes according to that. This seems to be buttressed by an overriding concept of tax morality or tax justice which trumps black-letter law. What seems to be emerging is that due to the inadequacy of existing principles of international tax law, vague concepts of morality and fairness are increasingly becoming prevalent, to the detriment of legal certainty. The perception of ­taxpayers in many countries is that the system is unfair or broken—this is worsened by the global financial crisis and heightened by media scrutiny into the taxation of MNEs. It was argued in Chapter one that the injection of notions of morality into the debate has added further complexity and uncertainty to an

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already ­complicated area. It was also questioned whether standards of morality and fairness have a place in corporate taxation. The notions of corporate social responsibility (CSR) and good governance in tax matters were analysed, with emphasis on the former. The link between CSR and aggressive tax planning was considered, both internationally and within the European Union. It was argued that it was a slippery slope for a country to expect to raise or increase corporate tax revenues from CSR. The international tax system is all about choices. A company should not be deemed socially irresponsible for benefitting from certain choices if those choices are available and there are no rules against them, either as hard law or soft law. It was questioned whether companies that engage in aggressive tax planning are indeed socially irresponsible. While it might be difficult to justify why the payment of full (or higher) taxes is a significant act of social responsibility and even of patriotism, it was recognised that there could be business reasons for avoiding aggressive tax planning. Therefore, notwithstanding the lack of conclusive evidence on the point and the author’s belief that CSR should play no role on how a company conducts its tax affairs, it was conceded that CSR implications are likely to become predominant in the whole debate. Combined with the launch of the OECD/G20 BEPS project and the uncertainties surrounding the deliverables, it would seem that tax arrangements are being assessed on an increasingly ill-defined set of criteria. In Chapters two to four, the reports under the BEPS project published up until 1 June 2015 were considered in greater detail. From the launch of the BEPS project, the OECD declared that it would not carry out a holistic review of the international tax regime. It was stated in the Action Plan that the project was not directly aimed at changing the existing international standards on the allocation of taxing rights on cross-border income. What it sought to do was to restore both source and residence taxation where cross-border income would otherwise go untaxed or would be taxed at very low rates. For most of the deliverables, the OECD did not make drastic recommendations but was rather limited to realistic compromises that had more chances of success and consensus. In the Digital Economy discussion drafts produced for the purposes of Action 1, the OECD acknowledged that it would be impossible to ring-fence the digital economy for the purposes of creating separate tax rules, as the digital economy was increasingly becoming the economy itself. Some options for reform to address the broader tax challenges raised by the digital economy were made, though nothing specific recommended. As the digital economy is in a continuous state of evolution, future developments would need to be monitored to evaluate their impact on tax systems. For the time being, the tensions and disagreements remain unresolved and the fate of the digital economy deliverables remains uncertain. Several proposals were made in the context of the rest of the Action items. As far as hybrids were concerned under Action 2, inter alia, linking rules were suggested to ensure there is no double non-taxation. The CFC discussion draft under Action 3 was not a consensus document and followed a best practices approach.

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The d ­ iscussion draft on interest deductibility under Action 4 also adopted a best practices approach but there were two main suggestions: a group-wide approach and a fixed ratio approach. As far as Action 5 was concerned (countering harmful tax practices more effectively), a proposal for a modified nexus approach was made as well as a proposal for compulsory spontaneous exchange of taxpayer-specific rulings related to preferential regimes. Concrete recommendations were also made in the Treaty Abuse deliverables produced under Action 6. It was recommended to include in the title and preamble of tax treaties a clear statement that the Contracting States, when entering into a treaty, wish to prevent tax avoidance and intend to avoid creating opportunities for double non-taxation and treaty shopping. An LOB (limitation on benefits) and a PPT (principal purpose test) were also recommended as a minimum standard of protection through a flexible approach. There was a refinement of this flexible approach in follow-up discussion drafts. In the original discussion draft under Action 7, proposals were made for changes to prevent abuse of the permanent establishment threshold through commissionaire arrangements. Several alternative options were given setting out variations in the wording of suggested paragraphs 5 and 6 of Article 5 of the OECD Model, with the aim of tackling commissionaire arrangements. Suggestions were also made as regards the specific activity exemption of the permanent establishment definition. Rules on the fragmentation of activities between related parties and on the splitting up of contracts were suggested. In the Revised PE Discussion Draft, the OECD explained which options should be followed. The OECD’s work on intangibles, under Action 8, is at the heart of the BEPS project. Taxation of intangibles has long been considered as one of the most challenging aspects of transfer pricing. The mantra used in the BEPS project is that taxable profits (and here taxable intangible returns) should correspond to value creation. There is a lot of vagueness as to what that entails and in general it is quite hard to design rules that correctly allocate intangible-related returns. The focus of the discussion drafts under Action 8 was on value-creating functions, rather than the bearing of risk through contractual arrangements, or the implications of legal rights on remuneration. Rules would be developed for risk and capital allocation to match returns with activities rather than contractual arrangements. It was suggested that the legal owner of an intangible should be entitled to all returns attributable to the intangible only if, in substance, it performed and controlled all of the important functions related to the development, enhancement, maintenance and protection of the intangibles; it controlled other functions outsourced to independent enterprises or associated enterprises and compensated those functions on an arm’s length basis; it provided all assets necessary to the development, enhancement, maintenance, and protection of the intangibles; and bore and controlled all of the risks and costs related to the development, enhancement, maintenance and protection of the intangible. To the extent that one or more members of the MNE group other than the legal owner performed the above functions, returns attributable to the intangible had to accrue to such

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other m ­ embers through arm’s length compensation reflecting their anticipated contribution to the intangible value. This could, depending on the facts and circumstances, constitute all or a substantial part of the return attributable to the intangible. Follow-up reports led to a proposal for the whole of Chapter VI of the OECD Transfer Pricing Guidelines to be redrafted in line with these recommendations and be entitled ‘Special Considerations for Intangible Property’. Similarly, the CCA Discussion Draft, again in the context of Action 8, acknowledged the need to simplify the measurement of contributions and to ensure that contributions were commensurate with the benefits received under a CCA. It reinforced the notion that the contribution of each participant to a CCA should be reflective of value contribution. The suggested revisions to the OECD Transfer Pricing Guidelines on CCAs would similarly support the use of value contributed over the costs incurred. The rest of the transfer pricing deliverables produced guidelines in different areas. A discussion draft on low value-adding intra-group services made proposals which would fully rewrite Chapter VII of the OECD’s Transfer Pricing Guidelines on intercompany services and would include an elective simplified approach. The Profit Split Discussion Draft examined several key issues related to the application of transactional profit split methods, gave illustrative scenarios for discussion purposes and posed some questions for public discussion. A proposal for clarification of the guidance in Chapter II of the OECD Transfer Pricing Guidelines was made in the Commodities Discussion Draft, as well as other suggestions. Very importantly, the Risk and Re-characterisation Discussion Draft reduced the importance of contractual allocations of risk while raising the importance of functions such as managing and controlling risks. The draft focused on identifying the actual conduct of the parties for the purposes of delineating a controlled transaction. Attention was to be paid to the contractual terms of the transaction, the functions performed, the characteristics of the property transferred, the economic circumstances of the parties and their business strategies. The Risk and Re-characterisation Discussion Draft also added a substantially new section on non-recognition and introduced the concept of fundamental economic attributes of arrangements between unrelated parties. Under Action 11, the discussion document sought to set out options to establish methodologies to collect and analyse data on BEPS. The options included in this discussion draft did not represent conclusions on the assessments or proposed measures, but were intended to provide stakeholders with substantive options for analysis and comment. The Mandatory Disclosure Discussion Document produced under Action 12, examined the usefulness of disclosure initiatives in addressing the lack of comprehensive and relevant information on tax planning strategies available to tax authorities. It provided an overview of mandatory disclosure regimes, based on the experiences of countries that had such regimes, and set out recommendations for a modular design of a mandatory disclosure regime.

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The country-by-country template produced under Action 13 is perhaps the proposal most likely to be followed by countries internationally without much dissent. In the CbC Revised Discussion Draft, the OECD moved from a two-tier to a three-tier approach. The three-tier approach comprised a master file, a local file, and a separate country-by-country template that had been proposed in the OECD’s earlier work on this topic. The country-by-country information was to be reported to tax authorities at a very high level and for risk assessment purposes only. The amount of information being requested for risk assessment purposes was significantly curtailed. The CbC Revised Discussion Draft contained revised standards for transfer pricing documentation and a template for country-bycountry reporting. In the follow-up report on Action 13, guidance was given on the implementation of country-by-country reporting, such as the timing of preparation and filing of the country-by-country report, which MNE groups should be required to file such report, etc. In the Dispute Resolution Discussion Draft produced under Action 14, the obstacles to effective dispute resolution were discussed and various options for improving these issues with MAP (mutual agreement procedure) processes explored. However, there were no effective recommendations. The solutions proposed were primarily in the form of suggestions for amending the treaty commentary or statements regarding what different tax administrations could commit to, in order to advance dispute resolution procedures. A monitoring process within an appropriate forum was also considered. No mandatory binding arbitration was recommended, to the dissatisfaction of some stakeholders. Overall, the Dispute Resolution Discussion Draft did not recommend specific dispute resolution measures but merely outlined possibilities. As a result, the existing strained dispute resolution system is likely to come under additional pressure in the post-BEPS world. The Multilateral Instrument Discussion Draft produced pursuant to Action 15 explored the feasibility of producing a multilateral instrument to address BEPSrelated issues. It analysed the tax and public international law issues related to the development of such an instrument without infringing sovereign autonomy in tax matters. It was conceded that a multilateral instrument posed several challenges, although the OECD was positive in that legal mechanisms existed to address these challenges. The most promising approach was to have a multilateral instrument that would co-exist with bilateral tax treaties. It was emphasised that the multilateral instrument should be highly targeted, efficient but also flexible. In Chapter four, there was also a review of the OECD’s engagement with developing countries. Although the importance of developing countries in the BEPS project was mentioned many times by leading OECD figures, it was questioned whether the interests of developing countries were properly reflected in the Action Plan. In fact, there have been complaints that some of the proposals might even prejudice developing countries. The next chapters examined the measures taken in the European Union to tackle international tax avoidance and aggressive tax planning. There was a consideration of the judicial response to the concept of tax abuse by the Court of

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Justice. It was argued that, overall, recent case law suggests that EU law does not provide a ­general ­principle of abuse of rights in the field of direct taxation. Whilst a principle of abuse of rights may be deduced from some cases in the area of VAT, it does not apply in a non-harmonised area. It was noted that in the current state of the Court’s jurisprudence, it was difficult to conclude that the concept of tax abuse has been de-nationalised and that there is now an EU principle of tax abuse. The quasi-official policy of the European Union on tax abuse and aggressive tax planning that was formed in the past decade was reviewed in Chapter five. It was noted that initially, emphasis was on making sure that domestic anti-abuse rules did not restrict EU nationals from exercising their fundamental freedoms, such as the freedom of establishment and the free movement of capital. Then there was some focus on preventing double non-taxation, eventually leading to the EU Action Plan to Strengthen the Fight against Tax Fraud and Tax Evasion and the Recommendations on Aggressive Tax Planning and Good Governance. These Commission initiatives and the follow-up measures seem to form the ‘new’ ­Commission policy on international tax avoidance. The main developments that have taken place up to the launch of the Tax Transparency Package are reviewed. What seems apparent is that the pendulum has swung and now the European Union places much more emphasis on tackling tax evasion and aggressive tax planning than it did a decade ago. What is also apparent is that the Commission has seized on this unique political momentum and, as a result, many legislative proposals or amendments that had been lurking for some time have now been fast-tracked at Council level. However, the author argued that some of the measures adopted, or aspects of them, may be incompatible with EU law, as interpreted by the Court of Justice in important cases. This chapter set the background against which in the following chapter, there was an analysis of the compatibility of the various items of the BEPS Action Plan with EU law. In Chapter six, the analysis showed that quite a few of the BEPS Action items dealt with rules on the determination or allocation of taxing rights and were thus within the scope of Member State competences. However, most of the suggested anti-abuse rules had defects, mainly because they did not target wholly artificial arrangements or because they were applied mechanically in a way that would likely be deemed disproportional by the Court of Justice. Furthermore, proposals that were dependent on taking into account the tax treatment in another Member State might not pass muster at the Court of Justice. Concerns were also raised as regards the OECD’s and the Code of Conduct Group’s endorsement of a strictly territorial nexus test as regards substance. A comparison between the EU transfer pricing documentation requirements and the OECD’s CbC proposal was also made, as well as a comparison of the regimes for dispute resolution. Lastly, the proposal for a multilateral instrument was reviewed and the obligations of Member States in that respect considered. In Chapter seven, there was a detailed analysis of the state aid provision and its application to fiscal state aids. Following a comprehensive overview of the state aid prohibition and selected recent case law, there was an examination of the use of the

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prohibition in tackling some forms of aggressive tax planning. The C ­ ommission’s state aid investigations into Apple, Fiat, Starbucks and Amazon were critically reviewed. Thoughts were offered as to the legality of the Commission’s ‘prudent independent market operator’ test and the overall appropriateness of using the state aid prohibition in this area. Chapter eight explored another angle of the debate by considering the ongoing efforts to introduce the Financial Transaction Tax, so as to make the financial sector pay for its role in the origins of the economic crisis. The original Commission proposal and the subsequent proposal to be adopted through enhanced cooperation were analysed. The development of the proposal and the suitability of using the enhanced cooperation procedure to adopt it were reviewed. The constitutional implications of using the enhance cooperation mechanism to promote tax legislation were also considered. In general, the analysis suggests that while some developments were very much anticipated and long overdue, others were unexpected and took many by surprise. In fact, the developments in the European Union are short of ground-breaking. It has been questioned1 whether the BEPS project will be the starting point for the development of new principles of international tax law or whether it will be the final failure of the OECD to gain consensus on topics, notwithstanding the unprecedented level of political support. It is widely acknowledged that BEPS is a political commitment of the OECD and the G20 countries, though as has been argued it would appear that it is a commitment to the agenda and ‘not a commitment to accept whatever solutions come out of the process’.2 It may prove impossible to reach consensus on solutions to some problems and/or some solutions agreed upon by the majority might not be implemented by all countries.3 The need for coordination is crucial. It is not just the survival of the international tax regime at stake here but also ‘the relevance of the OECD and its dominant members as the key players in the international tax world’.4 A review of the rules at play in the current international tax system has been long overdue. The arbitrary allocation of taxing rights, relying on a source/­ residence dichotomy and an active/passive income distinction first agreed in the 1920s by the League of Nations, eventually encapsulated in the OECD Model,5 has been gravely manipulated over the years. It also proved to be ill-suited to deal with MNEs operating in today’s global business environment. This is rather unequivocal given the number of corporate tax scandals that have emerged in the last few years. Stateless income and the very low effective tax rates that some MNEs enjoyed were quite provocative, especially within the context of the European

1 

Philip Baker, ‘Is there a Cure for BEPS?’ [2013] British Tax Review 605. Ibid, p 605. 3  Ibid. 4  Yariv Brauner, ‘BEPS: An Interim Evaluation’ (2014) 6 World Tax Journal 10, 13. 5  See ch 1 in Christiana HJI Panayi, Double Taxation, Tax Treaties, Treaty Shopping and the European Community (Kluwer Law International, 2007). 2 

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Union, of which some Member States have suffered tremendously from the global financial crisis. As noted, ‘the system is manipulable, distortive, often incoherent and unprincipled and encourages countries to compete with each other’.6 Prior to the launch of the BEPS project, it was feared that unless coordinated action had been taken at international level, countries would adopt (or would continue adopting) unilateral measures—hence the strong initial support for the BEPS project by many countries. The business sector also seemed to support the project in principle. The reputation risks faced by some MNEs and the uncertainty that had been generated by the recent tax scandals was sometimes more detrimental than higher effective tax rates. However, to an extent, it now seems that legality is taking a back seat in favour of what appears to be social justice and other vague concepts such as CSR and tax morality. What is also noteworthy is that in the BEPS project, there is a break from tradition in the way that the proposals are presented. Instead of the OECD ­recommending model rules as consensus-built and definitive standards, in most discussion drafts there is a menu of options that countries may select—a series of alternative or minimum requirements. The level of support for these various options among OECD/G20 countries is not known. This is arguably attributable to the fact that the BEPS project is different from past OECD initiatives because it is not just driven by OECD countries but also non-member G20 countries. ­Furthermore, developing countries were strongly encouraged to participate in the process and have done so to an extent. Therefore, the divergent interests of all the participators may have eroded the OECD’s traditional consensus-built model. Rather than encourage uniformity, the OECD is now offering options which could lead to more non-uniformity among country laws and could exacerbate the unilaterality problem. It could also generate more opportunities for tax arbitrage (for companies) and tax competition (for countries). Another change is that the focus of the BEPS project is to protect tax bases and to fight stateless income. This is different from the focus of previous OECD ­projects which was mostly to promote trade or prevent double taxation. In any case, while the BEPS project did not exactly go back to basics in ­attempting to improve the international tax regime, it has addressed some fundamental issues, and efforts were made to update the current tax system. A consideration of the source/residence taxation question was excluded from the beginning. However, to an extent, Action 1 tries to deal with the allocation of taxing rights in the context of digital economy, which has implications for the source/residence questions. The Action items dealing with anti-abuse rules, Actions 2 to 4, mostly offer guidance in the form of best practices. In fact, most of the discussion drafts are not consensus documents. Important proposals are made in the context of Action 5—the modified nexus approach for patent boxes and the compulsory

6 Michael P Devereux and John Vella, ‘Are we Heading Towards a Corporate Tax System Fit for the 21st Century?’ (2014) 35 Fiscal Studies 449–75, 461.

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s­ pontaneous exchange of taxpayer-specific rulings related to preferential regimes. The modified nexus approach was largely anticipated, at least among EU Member States, given the hostility shown towards the UK patent box regime and similar types of regimes. As for the exchange of tax rulings, this could reasonably be considered as a by-product of instruments dealing with exchange of information which have expanded exponentially in the past few years. As for tax abuse and treaty shopping, the proposals clarify, consolidate and rationalise anti-treaty-shopping rules that are already in existence. A lot of these are optional to ensure that countries have maximum flexibility. These rather organic changes would likely have been made anyway. The same could also be said about the proposals under Action 7. They were likely to be developed in the normal course of affairs—the OECD Model is, after all, an ambulatory instrument. Perhaps the most important proposals are those taken in the context of transfer pricing. The perceived deficiencies of the regime were largely attributed to the arm’s length principle and its dominance. To an extent, the OECD is making an attempt to shift away from the mixed legal and economic approach in transfer pricing practice by placing a lot of emphasis on the principle that profits should follow value creation. Such an approach, interestingly, resembles the traditional approach of the United Nations to transfer pricing, which has not been followed by the OECD. Notwithstanding this very perceptible shift of emphasis, the OECD does not seek to replace the arm’s length principle, however much some of the BEPS discussion drafts seem to transform it from a pricing standard to a behavioural standard.7 In any case, replacing the arm’s length principle is not currently an option because even though some countries have shown some willingness to move beyond the arm’s length principle, other countries are strongly resisting it. This also partly explains the failure to obtain a complete consensus on many of the Action items. As shown in Chapter three, there is a refinement of the application of the arm’s length principle in specific areas and in very rare cases, deviations from it.8 Profit split methods are mentioned in Action 10 but there is strong resistance by some countries. The same goes for the proposals made under the Risk and Re-characterisation Discussion Draft—it remains to be seen if the final scope of this discussion draft will be limited. Nevertheless, the fact that the OECD has, for the first time, shown some willingness to divert from the exclusive application of the arm’s length principle, even in limited circumstances, could be seen as a small victory for those advocating change. What does seem to emerge from the BEPS project, though again, to an extent, this could have resulted anyway, are increased reporting requirements for MNEs. Under Action 13, the OECD recommended that MNEs prepare master files and 7  See Jens Wittendorff, ‘More Black Smoke From the OECD’s Chimney—Third Draft on Intangibles’ (2015) 77 Tax Notes International 167 (12 January 2015) p 172. 8 Yariv Brauner, ‘Transfer Pricing in BEPS: First Round—Business Interests Win (But, Not in Knock-Out’ (2015) 43 Intertax 72–84, 73–74.

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local files for transfer pricing documentation purposes, as well as the country-bycountry report. Action 11 raises the possibility that tax authorities may require MNEs to provide additional firm-level information to assist authorities in analysing the extent of base erosion and profit shifting. Action 12 makes several recommendations for mandatory disclosure rules. Action 5 provides for spontaneous exchange of taxpayer-specific rulings related to preferential regimes. All these are in addition to the US-led FATCA reporting system and its accompanying intergovernmental agreements, as well as in addition to the OECD’s Common ­Reporting Standard for automatic exchange of financial account information, aimed ­primarily at financial institutions. Moreover, for MNEs doing business in the European Union, there are likely to be additional reporting standards, on the basis of other corporate transparency initiatives discussed in Chapter five. Which begs the question—if the OECD refuses to properly address the basics such as the source/residence dichotomy or the role of tax competition in generating stateless income, does the BEPS project have any chances of success? Or will it also lead to a reconfiguration of the old solutions? Can there be any rational evolution of the transfer pricing rules without a clearer articulation of the principle of value creation? Can the anti-abuse rules in the problematic areas considered in the BEPS project be improved and streamlined without some sort of uniformity of standards? One could argue that some of the proposals shaping up the BEPS deliverables are likely to generate more tax competition rather than less. It is not, therefore, surprising, that some countries that have been at the core of nations leading the BEPS project are actually considering taking unilateral action or have already done so. The UK’s Diverted Profits Tax (DPT) is the best example.9 The DPT, also misleadingly called the Google Tax, seems to be based on the idea that the volume of sales of an entity in a particular country should determine the tax paid in that country, ie it should be a connecting factor for exercising tax jurisdiction.10 The DPT was introduced in the UK Finance Act 2015.11 It was intended to apply to large MNEs with business activities in the UK who entered into contrived arrangements to divert profits from the UK by avoiding a UK taxable permanent establishment and/or by other contrived arrangements between connected entities. Broadly, the DPT applies in two situations: when a foreign company ­artificially 9  For commentary, see Sol Picciotto, ‘The UK’s Diverted Profits Tax: Admission of Defeat or PreEmptive Strike?’, 2015 WTD 12-12 (20 January 2015); David Stewart and Stephanie Soong Johnston, ‘The UK Government reveals Details of Diverted Profits Tax’, 2014 WTD 238-1 (11 December 2014); Amanda Athanasiou, ‘U.K. Diverted Profits Tax Remains a Work in Progress’, 2015 WTD 29-4 (12 February 2015); Heather Self, ‘Diverted Profits Tax: Give BEPS a chance’, Tax Journal, Issue 1244 (15 December 2014). 10  Luca Cerioni, ‘The New “Google Tax”: The “Beginning of the End” for Tax Residence as a Connecting Factor for Tax Jurisdiction?’ (2015) 55 European Taxation 185–95. For a criticism of the DPT and the haste with which the UK government had adopted it, see Heather Self, ‘The UK’s New Diverted Profits Tax: Compliance with EU Law’ (2015) 43 Intertax 333–36. 11  See Kristen A Parillo, ‘UK Diverted Profits Tax Legislation Both Narrowed and Broadened’, 2015 WTD 57-2 (25 March 2015).

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avoids having a UK permanent establishment (essentially where a person is carrying on activity in the UK in connection with the supply of goods and services by a non-UK resident company to customers in the UK) and when a UK company, or a foreign company with a UK permanent establishment, creates a tax advantage by using entities or transactions that lack economic substance. The tax is at a rate of 25 per cent of the diverted profits relating to the UK activity. The DPT is unlikely to arise where there is sufficient substance in offshore asset-owning companies, or arm’s length transfer pricing through the international value chain, or a taxable presence in the UK eg through a permanent establishment. There are also exemptions for small and medium sized enterprises. Under the DPT legislation, non-resident companies have a duty to notify HMRC under rather vague and subjective circumstances. Broadly, a non-resident company must notify HMRC within three months of the end of an accounting period if it was reasonable for the company to assume that diverted profits might arise for that period (ie if it is potentially within the scope of the DPT legislation).12 Where the designated HMRC officer determines that the DPT should apply, a preliminary notice is issued.13 As a policy choice, the DPT arguably reduces the pressure on the OECD to adopt a more wholesale change to global permanent establishment and transfer pricing rules in the BEPS project. The DPT is a more targeted approach than that so far proposed by the OECD. It also appears to address one of the main criticisms on the OECD proposals on Action 7, namely, that they would create a huge number of permanent establishments and associated compliance burden but no significant additional tax in many circumstances. From that perspective, the DPT could be viewed as a more attractive option. Nevertheless, there is concern that the DPT is likely to give rise to considerable uncertainty in its application in the short-term. Although the intention is for the DPT to only narrowly target cases of ‘contrived’ avoidance of UK tax, the drafting of the provisions is very broad. The DPT applies to a large range of transactions across all industry sectors, even though it has been widely reported as targeting the digital sector. There are also concerns in how the DPT would be applied and whether it would give rise to double taxation if more jurisdictions implement a similar tax. It has been announced that HMRC is sharing information with five other tax a­ uthorities

12  There is no duty to notify if HMRC has confirmed there is no need to do so or if it is reasonable for the company to assume that it has provided sufficient information to HMRC to enable the agency to decide whether to give a preliminary notice for that period and that HMRC has examined that information (either as part of an inquiry into a return or otherwise); or if it is reasonable for the company to conclude that no DPT charge will arise. 13  The recipient of the notice has 30 days to make representations and the designated HMRC officer may consider certain specified matters within a further 30 day period before either issuing a charging notice on the original or a revised amount, or confirming that no charge arises. The charging notice requires the payment of the DPT within 30 days. Penalties apply for late payment.

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on how digital multinationals might be shifting their profits to tax havens.14 This is the E6 project which started in August 2013 and is expected to feed into the DPT regime. The Australian government has also recently announced that it would set up a joint working party with the UK to further consider and develop initiatives in relation to diverted profits by MNEs.15 Australia is expected to pursue a similar measure as the DPT and other countries may follow suit. In fact on 11 May 2015, the Australian government announced that it would propose a 100 per cent penalty on multinational companies engaging in tax avoidance. This has been coined as the ‘Netflix tax’.16 Incidentally, it has been recently reported that Amazon has changed its EU business structure so that from 1 May 2015 it would record retail sales made to customers in the UK and some other EU jurisdictions in those jurisdictions rather than Luxembourg.17 With this move, Amazon might also avoid the UK’s DPT which is higher than the normal tax due. To the extent that the UK is the only country to have a diverted profits tax so far, this seems logical and appropriate. It may prove more problematic for MNEs once other countries adopt their own overlapping versions of a diverted profits tax, leading to a need for coordination as with the current BEPS Action Plan. The OECD/G20’s BEPS project is certainly not panacea. There is a risk that the compliance costs generated from some of the actions might be out of line with any additional revenue that the governments might collect. In fact, the BEPS project may not even help reduce unilateral actions, as the enactment of the UK’s DPT and other initiatives suggest. According to data compiled by PwC, more than 30 unilateral BEPS-focused measures were introduced by at least 19 countries in 2014 alone.18 The measures included guidance and legislation or proposed legislation on hybrids, interest deductibility, CFC rules, harmful tax practices, ­artificial avoidance of permanent establishments etc. It is obvious that several countries are not waiting for a consensus approach.19 In fact, it would seem that countries have started using BEPS as an excuse for unilateral actions. There is definitely political pressure to take swift action. However, the unilateral actions of developing countries and BRICS countries such as

14 See HMRC Press Release of 25 March 2015, available on: www.gov.uk/government/news/ government-ramps-up-efforts-to-tackle-digital-multinational-tax-risks. 15  Also see Teri Sprackland, ‘Australia to Work with UK on its Own Diverted Profits Solution’, 2015 WTD 76-3 (21 April 2015). 16  See William Hoke, ‘Australian Budget to Include 100 Percent Tax Avoidance Fine, “Netflix Tax”’, 2015 WTD 91-2 (12 May 2015). 17  Stephanie Soong Johnston, ‘Amazon Changes EU Structure to Book Profits in Local Countries’, 2015 WTD 101-1 (27 May 2015). 18  PwC TaxTalk Monthly, ‘The forces and tensions shaping BEPS’, 1 April 2014. Available on: www. pwc.com.au/tax/taxtalk/assets/alerts/TaxTalk-Alert-BEPS-Apr14.pdf. 19  See Amanda Athanasiou, ‘Jumping the Gate on BEPS: Unilateral Actions Weaken OECD’s Plan’, 2015 WTD 49-2 (13 March 2015); Amanda Athanasiou, ‘The Cost of BEPS’, 2015 WTD 9-1 (14 January 2015); Margaret Burow, ‘Countries Aren’t Waiting on OECD to Implement BEPS’, 2014 WTD 218-2 (12 November, 2014).

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India and China might be more radical than the unilateral actions of the UK or Australia, given their wider divergence of interests from the traditional OECD paradigm. In any case, it is likely to be harder to gain consensus if countries have already locked in their positions though unilateral actions. Furthermore, even post-BEPS there is likely to be unilateral action by some countries, mostly in the areas where the deliverables offered a menu of options rather than made specific recommendations for amendments to the OECD Model, the Commentary or the Transfer Pricing Guidelines. There may well be dissentients to the final product. US Treasury officials have expressed their frustration with the direction of some parts of the BEPS project. It was emphasised that the US would not commit to substantive changes in existing laws without a commitment from other countries. The US Congress is likely to be hostile to the idea of new transfer pricing documentation requirements that would subject US companies to greater foreign taxation, while limiting the ability of the US to tax their profits.20 There is an overall feeling that in committing to the BEPS project, the US is effectively signing up to provide indirect aid to other jurisdictions by reallocating its rights to tax global profits.21 It has even been argued that the primary objective of the US involvement in the BEPS project is not to avoid double non-taxation but to minimise the impact of the project on the US and its MNEs and to ensure that if any double non-taxed income of US MNEs is to be taxed, then it should be taxed by the US Government.22 Nevertheless, there are reports that the next US Model Tax Treaty, which is expected to be released by the end of 2015, reflects some of the BEPS policy concerns such as double non-taxation, stateless income via treaty shopping, etc.23 In fact, some of the recommendations expressed by the US delegates in the BEPS consultation process—thought to be based on the forthcoming version of the US Model Tax Treaty—have been incorporated in the latest version of the Treaty Abuse discussion draft (the Treaty Abuse Second Revised Discussion Draft), examined in Chapter three. Therefore, notwithstanding the initial and to an extent on-going US recalcitrance on some of the BEPS proposals, there has been cross-fertilisation of ideas and confluence of actions. The status quo is unlikely to remain the same. In any case, the OECD is moving fast to keep whatever level of consensus has been preserved among countries and to prevent them from acting unilaterally to tackle BEPS, as much as possible.24 There is also a hurry to benefit from the 20 Mindy Herzfeld, ‘Making Bets on CbC Reporting’ (2015) 78 Tax Notes International 595 (18 May 2015). 21 Ibid. 22  Antony Ting, ‘The Politics of BEPS—Apple’s International Tax Structure and the US attitude towards BEPS’ (2015) 69 Bulletin for International Taxation 410–15. Also see Manal Corwin, Sense and Sensibility: The Policy and Politics of BEPS, 19th Annual Tillinghast Lecture (30 September, 2014). 23 See Kristen A Parillo, ‘Model Treaty Proposals Reflect Dramatic Change in US Policy’, 2015 WTD 99-1 (22 May 2015). 24  See Stephanie Soong Johnston, ‘Pascal Saint-Amans—the Face of BEPS’ (2014) 76 Tax Notes International 1051 (22 December 2014).

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political momentum. This is certainly the case in the European Union, where a lot of emphasis was placed on tackling tax avoidance, tax evasion and aggressive tax planning. The Commission has fast-tracked many legislative proposals or amendments at Council level, which are questionable from an EU law perspective. It has also launched state aid investigations on tax rulings enjoyed by several high-profile MNEs, which are again dubious from a pure state aid perspective. And more behind the scenes, it has been facilitating the adoption of an important tax instrument—the Financial Transaction Tax—through enhanced cooperation, without really addressing the serious and detrimental impact of this instrument on non-participating Member States. These concerns were examined in greater detail throughout the book. There certainly needs to be coordination with the principles set out by the Court of Justice in established case law, otherwise legal certainty is being jeopardised. Nevertheless, one should question whether in the absence of harmonisation the European Union is currently going too far by restricting options for tax competition. To an extent, much of the criticism directed at MNEs or their legal advisors or accountants might be misdirected because individual countries themselves engage in tax competition, offering a wide choice of alternative strategies from which to choose.25 This type of forum shopping was until recently condoned and to an extent protected under EU law. Attempts for harmonisation were very much resisted by Member States. A good example is the proposal for the Common Consolidated Corporate Tax Base, which is still pending since it was released in 2011. Furthermore, Member States such as Ireland and Luxembourg have long been associated with some of the low-substance aggressive tax planning practices now criticised (but previously partly copied) by other Member States and attacked by the Commission in its state aid investigations. In fact, the current president of the Commission, Jean-Claude Juncker, who is so fervently pushing for reform to fight tax evasion and to instil ‘some morality, some ethics, into the European tax landscape’,26 was the Prime Minister of Luxembourg at the time these practices thrived and has been accused of turning Luxembourg into a major European centre of corporate tax avoidance during his premiership. Following the Luxembourg leaks considered in Chapter one, Juncker was embroiled in political controversy but still survived a vote of confidence in the European Parliament in November 2014. In any case, this traditionalist anti-harmonisation mindset is likely to change as BEPS is not just about the loss of revenue for countries—it also affects tax competition between countries and the ability to confer tax incentives to attract capital. The European Union is likely to adopt some BEPS policies, or variations of them, in the near future. In fact, it has already adopted elements of the BEPS proposals such as the amendments to the Parent-Subsidiary Directive considered in 25  William Hoke, ‘Big 4 Defend MNE Tax Advice to EU Parliament and Urge Reform’, 2015 WTD 88-2 (7 May 2015). 26 See speech in Brussels, in July 2014, reported by several media outlets. See, eg www. theguardian.com/business/2014/nov/05/-sp-luxembourg-tax-files-tax-avoidance-industrial-scale.

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­ hapter five. These measures are binding on Member States, irrespective of their C stance on the BEPS project, their attitudes and expectations. Therefore, the BEPS deliverables are likely to have an impact on EU law, whether directly or indirectly. In any case, the widely anticipated Action Plan on Corporate Taxation is expected to change the EU tax landscape in a more defined way than some of the mosaic of proposals under BEPS. Nevertheless, an EU strategy focusing only on the fight against tax avoidance and aggressive tax planning runs the risk of hindering the single market and reducing its efficiency and potential.27 In the absence of a single fiscal market, such an ad hoc strategy can only do more damage than good in the long term. The recent state aid litigation on tax rulings shows the problematic nature of an ad hoc approach. Whilst the enthusiasm to grasp the opportunity to increase tax revenues by closing some loopholes and to ‘punish’ MNEs for their aggressive tax planning is understandable, a holistic approach to tax reform and an acceptance of the absolute necessity for some partial tax harmonisation are essential if the EU efforts are to succeed. It is undeniable that the international tax community and especially the EU tax community are moving to a new direction. There are many unresolved issues and the post-BEPS tax world is likely to be very challenging. The abundance of vague concepts embedded in the pre-BEPS discourse, such as CSR, good tax governance, morality and fairness, are likely to remain and as such amplify the legal uncertainty. How will this story end? None knows but at least from a European Union perspective, a new and possibly irreversible era has begun with much wider implications than originally thought.

27 

Michel Aujean, ‘Plea for a New Tax Package’ (2015) 24 EC Tax Review 60–62, 61.

318

INDEX

accountability  23, 29, 31–2 accountancy firms code of conduct, proposal for HM Treasury to produce  15–17, 38 professional social responsibility  38 Public Accounts Committee (PAC) (UK)  15–17, 38 reputation  15–16 sale of tax planning schemes  17 accounting see also accountancy firms Accounting Directive  182 Action Aid  9 Action Plan on Corporate Taxation (­Commission)  191 Action Plan to Strengthen the Fight against Tax Fraud and Tax Evasion (Commission)  2, 162, 175–88 aftermath of Action Plan  180–8 Aggressive Tax Planning Recommendation  176, 178–81 BEPS project  1, 183–4 Code of Conduct Group for Business Taxation  176, 195–200 corporate social responsibility  32 digital economy  176, 192–5 double non-taxation  91, 176, 178, 184, 308 exchange of information  176, 181, 187–8 GAAR  91, 178–9 Good Governance Recommendation  176–8, 180–1 harmful business taxation  176–7, 179 long-term measures  177 medium-term measures  177 money laundering  182–3 Mutual Assistance Directive, amendment to  182, 187 Parent-Subsidiary Directive  184–6, 317 Platform for Tax Good Governance (­Commission)  176, 180–1 Pre-Action Plan Communication  173–5 recommendations  176–81 short-term measures  177 standards, improving  180–3 terrorist financing  182 transparency  181–3, 187–8, 312 Action Plans see Action Plan to Strengthen the Fight against Tax Fraud and Tax Evasion (Commission); Base Erosion and Profit ­Shifting (BEPS) project Action Plan

active business/trade test  231 active/passive income distinction  218, 309 activist vigilantism  12–13 administration burdens  67, 73, 83, 144, 232 capacity  174 controlled foreign companies  67 cooperation  180 costs  131, 133, 136, 232, 284, 287 country-by-country reporting  232 disclosure of aggressive tax planning arrangements  137 Financial Transaction Tax, proposal for  291 Forum on Tax Administration (OECD)  134 good administration, right to  247 good governance  23 multilateral instruments, development of  156 treaty abuse, prevention of  89 advance pricing arrangements (APAs)  189–90, 268–77 advance tax rulings  189–90 advocacy groups  9, 141, 303 Aer Arann  248–9 Aer Lingus  248–9 agents  99–100, 104 aggressive tax planning see also Base Erosion and Profit Shifting (BEPS) project; state aid and aggressive tax planning advocacy groups  303 Aggressive Tax Planning Recommendation (Commission)  176, 178–81, 207, 220, 228–30 consumer backlashes  46 corporate social responsibility  29–40, 303–4 disclosure  51, 130, 133–8, 306 EU policy on abuse and aggressive tax planning  2, 162, 167–79 factors leading to launch of BEPS project  1, 4–5, 11–22, 46 media  46, 303 politics of debate  11–22, 38, 303–4, 310 subject-to-tax approach  207 tax avoidance distinguished  34, 37 tax havens  7, 303 terminology  303 Amazon  2, 11, 13, 17, 267–8, 274–8, 309, 314 annulment actions  243, 249, 265, 300 Apple  2, 19–21, 267–72, 276–7, 279, 309

320

Index

arbitration  147, 150–2 Convention (EU)  171, 233–5 double tax treaties  171, 233–4 GAAR disputes  152 Joint Transfer Pricing Forum  234–5 mandatory arbitration  147, 150–2, 307 three-stage procedure for eliminating double taxation  234 transfer pricing documentation  234–5 Argentina  145 arm’s length principle arbitration  233–4 behavioural standard  311 BEPS project  46 Commodities Discussion Draft (OECD)  124 cost contribution arrangements  115–17 developing countries  159–61 excessive loan interest payments  211 intangibles  107–13, 115–17, 305 interest  74, 76, 206, 212 Intra-Group Services Discussion Draft (OECD)  118–19 pricing standard  311 profit split method  120, 122, 311 proportionality  209 replacement of principle  311 Risk and Re-characterisation Discussion Draft  125–9, 311 risk-return trade-off  126 state aid  268–77 transactional net margin method (TNMM)  274 value creation  159–61 arrangements, definition of  179 artificial arrangements see wholly or partly artificial arrangements  38, 149 Australia ‘Netflix tax’  314 Austria  291 avoidance see tax avoidance banks Central Banks  290, 294 European Central Bank  294 Financial Transaction Tax, proposal for  290, 294 Revised Capital Requirements Directive  182 transparency  7, 290, 294 Base Erosion and Profit Shifting (BEPS) project see also Base Erosion and Profit ­Shifting (BEPS) project Action Plan; Base Erosion and Profit Shifting (BEPS) project with EU law, compatibility of Addressing Base Erosion and Profit Shifting. OECD  48–50 best practices  310–11 boardroom, tax in the  35, 41–5

Code of Conduct Group for Business Taxation (EU)  199–200 consensus  49–50, 309–11, 314–16 controlled foreign companies  70–1 corporate loss utilisation  47 corporate social responsibility  1–2, 28–40 data, methodologies for analysis and ­collection of  130–3, 306 declaration on BEPS (OECD)  48 definition of BEPS  48 developing countries  2, 151–2, 157–61, 307, 310, 314–15 digital economy  193–5 disclosure  51, 130, 133–8, 306 dispute resolution  51, 147–53, 233–5, 307–8 Diverted Profits Tax (UK)  313–14 double non-taxation  49, 219–20, 314–15 double taxation  85, 88, 90, 95, 157, 235–6, 308, 310–11 economic analysis of scale and impact of BEPS  131–3 fairness  1, 22, 317 globalisation  4, 48, 159 good governance  1, 22–8, 31, 34 harmful tax competition  5–8, 45 hybrid mis-match arrangements  47, 50, 59–66, 304 intangibles  106–17, 305–6 launch  1–2, 4–46, 303–4 linking rules  185 multilateral instruments, development of  51, 130, 153–7, 307 permanent establishments  99–106 politics  11–22, 47, 50, 309, 314–16 principles of international tax law  1, 50 procedural reforms  51, 130–61 residence/source dichotomy  49–50, 303–4, 309–10, 312 Risk and Re-characterisation Discussion Draft (OECD)  129 risks and capital and other high-risk ­transactions  105, 117–29 state aid  268–77 stateless income  106, 310 tax havens  1, 5–6, 7–10, 19, 45–6 transfer pricing  49, 51, 105–30, 138–47, 305–6, 311, 314 transparency  49, 232–3 treaty abuse, prevention of  85–99 unilateral measures, concerns over  310, 314–16 value creation  305, 312 Base Erosion and Profit Shifting (BEPS) ­project Action Plan  2, 47–161 Action Plan (Commission), interaction with  1, 183–4 Actions 1–5  2, 47–84, 201–19

Index Actions 6–9  2, 50–1, 85–129, 201–3, 219–31 Actions 10–15  2, 50–1, 130–61, 201–3, 231–6 controlled foreign companies  50–1, 66–72, 304–5 digital economy  47, 49–50, 51–8, 304, 310 dispute settlement  233–5, 308 double non-taxation  50–1, 219–31 economic substance criteria  213–19, 308, 310–11 group-wide rules and comparability ­issues  211–13 harmful tax practices, countering  51, 76–84, 305 hybrid mismatch arrangements, neutralisation of effects of (Action 2)  50, 59–66, 304 interest payments  48–9, 72–6, 305 Intra-Group Services Discussion Draft (OECD)  120 Limitation-on-Benefits provisions  220–5 linking rules  203–8 modified nexus approach  213–19, 308, 310–11 permanent establishment status, avoidance of  50, 305 residence/source dichotomy  50 taxing rights, rules on determination and/or allocation of  1, 7–10, 201–3 transfer pricing of intangibles  50 treaty abuse, prevention of  51, 85, 88, 311 wholly or partly artificial arrangements, rules targeting  208–11, 308 Base Erosion and Profit Shifting (BEPS) ­project with EU law, compatibility of  2, 201–36 country-by-country reporting  231–3, 308 Court of Justice, case law of  220–1, 236 dispute resolution  233–5, 308 double non-taxation  219–27 forum shopping  222–3, 316 group-wide rules and comparability ­issues  211–13 Limitation-on-Benefits provisions  220–9 linking rules, unilaterally-imposed and ­mechanical  203–8 modified nexus approach and economic substance  213–19 multilateralisation of tax treaties  235–6, 308 principal purposes test  220, 228–31 taxing rights, rules on determination and/or allocation of  201–3 wholly or partly artificial arrangements, rules targeting  208–11, 308 Belgium  9, 65–6, 291 beneficial ownership, central registers of  182–3 BEPS Monitoring Group controlled foreign companies  70–1

321

data, methodologies for analysis and ­collection of  131 developing countries  160 disclosure  138 dispute resolution  150–1 harmful tax practices  79, 84 hybrid loans and mis-matches  63–6 intangibles  113 permanent establishments  103–4 Profit Split Discussion Draft (OECD)  122 research and development  79 Risk and Re-characterisation Discussion Draft (OECD)  129 treaty abuse, prevention of  90, 95 BEPS project see Base Erosion and Profit ­Shifting (BEPS) project Bermuda, use of companies in  14 best practices Anti-Abuse Communication (­Commission)  169 BEPS project  310–11 Commission  25–6, 169 controlled foreign companies  70, 304 Platform for Tax Good Governance  180–1 transfer pricing  129 bilateral/double tax treaties Court of Justice  227 hybrid loans and mis-matches  208 Limitation-on-Benefits provisions  97, 226 multilateral treaties  153–6, 235, 307 subject-to-tax requirements  178 treaty shopping  226–7 blacklists  8, 178, 181 boardroom, tax in the  35, 41–5 Brazil BRICS  160–1, 314–15 bribery and corruption  31 BRICS  160–1, 314–15 Bulgaria  291 business secrets  190–1 capacity-building  23, 157–9 capital asset pricing model (CAPM)  272 Caterpillar  19 Central Banks  290, 294 CFCs see controlled foreign companies (CFCs) Charter of Fundamental Rights of the EU  247 check-the-box regime  20, 70 China BRICS  160–1, 314–15 Christian Aid  9–10 civil society  9, 23, 26, 28, 45–6, 157 cloud computing  54, 58 Code of Conduct Group for Business Taxation (EU)  195–200

322

Index

design of standards  195 economic/commercial reality, transactions reflecting  218–19 economic substance criteria  198 good governance  25 harmful tax measures  195 hybrid loans and mis-matches  197–8, 208 international tax avoidance  195 IP boxes  198–200, 213, 219 nexus approach  198–200 Parent-Subsidiary Directive, amendment of  197–8 Subgroup  197 transparency  189, 191, 196–8 codes of conduct see also Code of Conduct Group for Business Taxation (EU) accountancy firms  15–17, 38 Arbitration Convention  235 double taxation  171 commercial reality see economic and ­commercial reality Commission (EU) adjustments, guidance on  168–9 aggressive tax planning abuse, policy on  2, 162, 167–70 Recommendation  176, 178–81, 207, 220, 228–30 Anti-Abuse Communication  167–70 best practices  27 Common Consolidated Corporate Tax Base  71 corporate social responsibility  29–32, 37 digital economy  192 double non-taxation  220–1 double taxation  170–3 enhanced cooperation procedure  284–7 European Taxpayer’s Code, proposal for  27 exchange of information  37, 81 Financial Transaction Tax, proposal for  2–3, 282, 288, 291–6, 309 good governance  24–7, 37 investigations  2, 240, 247, 249, 267–81, 309, 316 IP boxes  199–200, 213 Platform for Tax Good Governance  26, 176, 180–1 policy on abuse and aggressive tax ­planning  2, 162, 167–70 Pre-Action Plan Communication  173–5 state aid  236–55, 263–81, 308–9, 316 approval  240, 242–5, 250 Communication on State Aid ­Modernisation  242 Draft Notice  240, 243, 250–1, 253–5, 264–5, 278–9 guidance  239, 244–5, 253–6 investigations  2, 240, 247, 249, 267–81, 309, 316

Notice on enforcement of state aid by national courts  248 Notice on the application of the State aid rules  250–1, 253–4, 260–1, 278 transparency  37, 81, 187–92, 195, 287, 308 commissionaire arrangements  99–100, 104, 194, 203, 305 Committee of the Regions  242 Commodities Discussion Draft (OECD)  117, 122–4 Common Consolidated Corporate Tax Base (CCCTB) controlled foreign companies  71–2 directive, proposal for a  286–7 double taxation  171–2 exchange of information  187–8 group-wide rules and comparability ­issues  212 harmonisation  316 Tax Transparency Package (­Commission)  191, 287 comparability issues see group-wide rules and comparability issues competition see also state aid and aggressive tax planning distortion of competition  283–4, 292, 295, 298–9 economic/commercial reality, transactions reflecting  218 Financial Transaction Tax, proposal for  283–4, 292, 295, 298–9 harmful tax competition  5–8, 45, 220, 261, 280 compliance costs BEPS project  45, 232, 314 corporate social responsibility  36 country-by-country reporting  232 hybrid loans and mis-matches  60, 63 Intra-Group Services Discussion Draft (OECD)  120 Pre-Action Plan Communication (EU)  175 transfer pricing documentation, re-examination of  140 Confederation of British Industry (CBI)  1, 18–19 Confederation of Dutch Industry and Employers  83 confidentiality  140–1, 144–6, 232 contracts, splitting up of  93, 101–2, 105, 305 controlled foreign companies (CFCs)  50–1, 66–72 Anti-Abuse Communication (­Commission)  169 base stripping, scope of  67 best practice  70, 304 building blocks  66, 68–9 Common Consolidated Corporate Tax Base  71–2

Index control definition of  68 direct control  68 economic control  68 indirect control  68 legal control  68 level of control  68–9 minimum control  69 related parties  68 definition  66, 68 design of rules  67 discrimination against non-residents  67 double taxation  67, 69 economic substance criteria  71, 216–17 entity approach to attribution of income  68 EU law  67, 71–2, 206, 208 freedom of establishment  67, 206, 208 full inclusion approach  71 hybrid loans and mis-matches  65, 68 modified nexus approach  217–18 non-resident subsidiaries  67 subsidiaries  67, 71 Tax Transparency Package (Commission)  72 transaction approach to attribution of ­income  68 transfer pricing  67, 70 unitary approach  71 wholly or partly artificial arrangements, rules targeting  67, 206, 208, 210–11 consumption tax  55 cooperation see also enhanced cooperation procedure boardroom, tax in the  42–5 corporate citizenship  42–3 developing countries  160 dispute resolution  149 enhanced cooperation  44–5 Financial Transaction Tax, proposal for  291, 298 international cooperation  6, 24, 181–2 Pre-Action Plan Communication (EU)  173–4 cooperative societies  261–5 corporate citizenship  40, 42–3 corporate governance  42–4 corporate social responsibility (CSR) accountability  29, 31–2 aggressive tax planning  1–2, 176, 303–4 benefits/advantages  38–40 BEPS project  1–2, 28–40 bribery and corruption  31 citizenship behaviour  28 Commission  29–32, 37 compliance costs  36 country-by-country reporting  232–3 definition  29–32 directors  33–5, 40, 44 environment  29–31

323

EU law  39, 304 exchange of information  31, 37 fair tax competition  31, 37 fiduciary duties  33, 37 good governance  28, 31, 34 guidelines  39 litigation costs  36 morality  29–31 professional social responsibility  38 profit maximization  29, 31–3 reputation  35–7 shareholders  32–3 soft law  39 stakeholders  29–32 standards  31–2 tax avoidance  28–9, 32–4, 37, 39 tax havens  31, 35, 38 transparency  29, 31–2, 37, 40, 232–3 under-sheltering puzzle  36 view of the corporation  32 voluntary nature  29–30, 38 corporate tax responsibility, development of  22 corporation, view of the see view of the ­corporation corruption  24, 31 cost contribution arrangements (CCAs) and intangibles  113–17 arm’s length principle  115–17 benefits/advantages  113–16 BEPS project  306 buy-in and buy-out payments  116 definition  114 design and administration  117 Intra-Group Services Discussion Draft (OECD)  119 joint development, ­enhancement, ­maintenance, protection or ­exploitation  114 OECD CCA Discussion Draft  113–15, 306 Intra-Group Services Discussion Draft  119 Risk and Re-characterisation Discussion Draft  113 Transfer Pricing Guidelines  113–15, 306 re-characterisation  113, 116–17 residence/source dichotomy  20 risks, capacity to control  114, 116 service CCAs  114–15 transfer pricing  113–17, 306 value contribution  113–14, 306 Costa Rica  131 costs see alsocompliance costs administration  131, 133, 136, 232, 284, 287 arbitration  152 country-by-country reporting  142 digital economy  192

324

Index

intangibles  108, 305 intellectual property, acquisition of  82–3, 213 litigation costs  36 payroll  71 rental costs  12 reputation  36 research and development  82, 214–15 service costs  119–20 transparency  191 countermeasures  132 country-by-country reporting Accounting Directive  182 BEPS project with EU law, compatibility of  231–3, 308 Code of Conduct on transfer p ­ ricing ­documentation for associated ­enterprises  231–3 conditions  145–6 corporate social responsibility  232–3 developing countries  147, 157 disclosure of aggressive tax planning ­arrangements  134 double reporting  147 government-to-government mechanisms, framework for  145 guidance  231 implementation  307 low-value-adding intra-group services  231 OECD Common Reporting Standard  182, 312 royalties  145 templates  138, 157, 231–3 timing  145 transfer pricing documentation  138–47, 231–3, 307, 312 transparency  232–3 Court of Justice (CJEU) BEPS project with EU law, compatibility of  236 development of principle of abuse  162–7 double non-taxation  220–1 economic substance criteria  214–18 enhanced cooperation procedure  285–6 Financial Transaction Tax, proposal for  295, 299–300, 308 forum shopping  222–3 fundamental freedoms  162, 308 GAAR  166 group-wide rules and comparability ­issues  211–12 Limitation-on-Benefits provisions  222–6 linking rules  204 modified nexus approach  214–18 principal purposes test  228–30 proportionality  209–10 Risk and Re-characterisation Discussion Draft (OECD)  165

state aid  2, 240–1, 243, 246, 249–50, 254–77, 280, 308 treaty shopping  222–7 VAT  163–6, 186, 308 wholly artificial arrangements  206, 208–10, 308 customary international law  297 Cyprus  230–1, 291 Czech Republic  9, 291, 293 data, methodologies for analysis and ­ collection of  130–3 BEPS project  130–3, 306 countermeasures, scale and impact of  132 digital economy  54 economic analysis of scale and impact of BEPS  131–3 data protection  191 deduction/no inclusion outcomes (D/NI)  60 Denmark  9, 291 derivative benefits clause  86, 92–4, 97–8, 227–9 derivatives  288, 300–1 developing countries aid  10, 23 arm’s length principle  159–61 BEPS project  2, 151–2, 157–61, 307, 310, 314–15 capacity-building  157–9 Code of Conduct on Business Taxation (EU)  25 country-by-country reporting  146, 157 dispute resolution  151–2 Doha Declaration on Financing for ­Development (UN)  24 double taxation  95, 154, 157, 159 EU law  161 Eurasian BEPS meeting  159 Global Financial Integrity  10 good governance  23–4, 26 IMF, guidance from  158–9 intangibles  111 Intra-Group Services Discussion Draft (OECD)  120 Monterey Consensus  24 multilateral instruments, development of  154 NGOs  9 permanent establishments  104 poverty  10 prejudice against developing countries  2 profit split method  160 tax havens  8–10, 45 technical assistance  24 transfer pricing  111, 159 treaty abuse  95, 157 UN, guidance from  159 unilateral measures, concerns over  314–15

Index value creation  159–61 World Bank, guidance from  158–9 digital economy  51–8 Action Plan (Commission)  176, 192–5 base creation, absence of  52–3 benefits/advantages  57 BEPS project  47, 49–50, 51–8, 193–5, 304, 310 challenges  50, 51–8 cloud computing  54, 58 Common Consolidated Corporate Tax Base  194–5 consumption tax  55 Diverted Profits Tax (UK)  314 EU law  58, 192–5 exemptions  55 Group on Digital Economy (EU)  58 High-Level Expert Group on Taxation of the Digital Economy (EU)  192–5 intangibles  57 internal market  192, 195 market country  54 market jurisdiction  54 Mini One Stop Shop (MOSS)  193–5 neutrality  53 nexus approach  54–6 OECD Committee on Fiscal Affairs  53 Digital Economy Discussion Draft (March 2014)  52–3, 54–7 Digital Economy Revised Discussion Draft (Sept 2014)  56–8 International VAT/GST Guidelines  58 Task Force on Digital Economy  54 Technical Advisory Group (TAG)  53 One Stop Shop (OSS)  193–4 Ottawa Taxation Framework Conditions (OECD)  52 payments in the context of new business models, characterisation of  54 permanent establishments  55, 57, 194 residence/source dichotomy  49–50, 53, 56 small and medium-sized enterprises  192 specific activity exemptions  100 Tax Transparency Package (Commission)  195 transfer pricing  57 value, attribution of  54 value creation  194 VAT  54, 57–8, 192–5 withholding tax  55 direct tax Court of Justice, development of principle of abuse by  163–4, 166, 307–8 directives, amendments to  183–8 Financial Transaction Tax, proposal for  302 state aid  250–1, 253–5, 260–1, 278 directives see also Parent-Subsidiary Directive Accounting Directive  182

325

Action Plan (Commission)  176, 183–8 Common Consolidated Corporate Tax Base  286–7 direct tax directives, amendments to  183–8 double non-taxation  176 exchange of information  281 Financial Transaction Tax, proposal for  288–94 GAAR  91 Interest and Royalties Directive  74, 171, 211–12 Merger Directive  166 Revised Capital Requirements Directive  182 Savings Directive  25, 181, 184, 186–7, 190 VAT  166, 218–19 directors boardroom, tax in the  35, 41–5 cooperation  42–5 corporate social responsibility  33–5, 40, 44 positive duty to avoid tax  33–4 reputation  41–2, 44 shareholders, duty to  41–2 success of company, promotion of  33–4 disclosure of aggressive tax planning ­arrangements  51, 130, 133–8 administration  137 benefits/advantages  135, 137 BEPS project  51, 130, 133–8, 306 compliance  134–5, 137–8 cooperative compliance  134, 138 country-by-country reporting  134 country specific risks  134 design  134 deterrence  135 domestic laws  137–8 exchange of information  134 financial penalties  137 Forum on Tax Administration (OECD)  134 generic hallmarks  136 identification of schemes  135 legal professional privilege  136 mandatory disclosure  134–8, 306 multi-step approach  136 Mutual Assistance Directive  190 OECD Discussion Document  134–7 promoter-based approach  135 recommendations  134, 137, 306 reportable schemes  135–7 risk assessment  134–5 single-step approach  136 small and medium-sized enterprises  138 specific hallmarks  136 standards for reporting  138 threshold approach  136–7 timeframe  137 transaction-based approach  135 transparency  134, 138 what must be reported  136–7 who must report  135–6

326 discrimination  27, 67, 83 see also nationality discrimination dispute resolution  51, 147–53 see also ­arbitration BEPS project  51, 147–53, 233–5, 307–8 certainty and predictability  147 cooperation  149 developing countries  151–2 double taxation  151–2, 171 EU law, compatibility of BEPS project with  233–5, 308 Forum on Tax Administration  152 good faith  148 interpretation  150 monitoring mechanism  148, 150–3, 307 Mutual Agreement Procedure (MAP)  147–53, 155, 307 OECD Discussion Draft  147–52, 307 follow-up draft  152 Manual on Effective Mutual Agreement Procedures (MEMAP)  147 Model Commentary  148 peer reviews  152–3 penalties  149 publication of decisions  150 recommendations  150, 307 transfer pricing  148, 152 transparency  149–50 treaty disputes  147–51 dividends  93 Diverted Profits Tax (DPT) (‘Google Tax’) (UK)  312–14 connected entities  312–13 digital economy  314 double taxation  313–14 E6 project  314 economic substance criteria  313 Finance Act 2015  312–13 information sharing  313–14 legal certainty  313 notification of HMRC  313 permanent establishment, artificial avoidance of  312–13 small and medium-sized enterprises, ­exemption for  313 targeted approach, as  313 documentation see transfer pricing documentation, re-examination of domestic laws Court of Justice, development of principle of abuse by  162 developing countries  157 disclosure of aggressive tax planning arrangements  137–8 double non-taxation  220 European Taxpayer Identification Number  180

Index GAAR  178 hybrid loans and mis-matches  59–66 recommendations  6 treaty abuse, prevention of  98 double deductions—DD outcome  60, 64 double non-taxation Action Plan (Commission)  176, 178, 308 Aggressive Tax Planning Recommendation  220 BEPS project  49–51, 219–29 Court of Justice, case law of  220–1 double taxation to double non-taxation, from  170–3 EU law compatibility of BEPS project with  219–27 policy on abuse and aggressive tax planning  170–3 Parent-Subsidiary Directive  184, 220 state aid  220 treaty abuse, prevention of  86, 88–9, 94, 220, 305 unintentional double non-taxation  169–70 double taxation see also double non-taxation; double tax treaties arbitration  171, 233–4 BEPS project  310 code of conduct, proposal for  171 Commission  170–3 Common Consolidated Corporate Tax Base  171–2 cost contribution arrangements  117 developing countries  154, 159 dispute resolution  147–52, 171 Diverted Profits Tax (UK)  313–14 double non-taxation, from double taxation to  170–3 group-wide approach  76 hybrid loans and mis-matches  59–63, 65, 68, 172, 208 intangibles  117 interest  72, 76, 171 Joint Transfer Pricing Forum (JTPF)  173 juridical double taxation  170, 220 League of Nations  309 Limitation-on-Benefits provisions  97, 225–6 multilateral treaties  153–6, 235, 307 nationality discrimination  220 peer review process  8 principal purposes test  230 residence  87, 93–5, 202, 226, 229 Risk and Re-characterisation Discussion Draft (OECD)  128 state aid  266–7 subject-to-tax requirements  178 subsidiarity  172 three-stage procedure for eliminating double taxation  234

Index double tax treaties see also OECD Model Tax Treaty Aggressive Tax Planning Recommendation (Commission)  178 arbitration  233–4 benefits, use of treaty  85, 88, 311 BEPS project  85, 88, 90, 95, 157, 235–6, 308, 310–11 bilateral treaties  62, 153–7 hybrid loans and mis-matches  208 Limitation-on-Benefits provisions  97, 226 multilateral treaties  153–6, 235, 307 subject-to-tax requirements  178 treaty shopping  226–7 contracts, splitting of  93 Court of Justice, case law of  222–7 derivative benefits clause  227–9 developing countries  95, 154, 157, 159 dispute resolution  147–51 dividends  93 double non-taxation  86, 88–9, 94, 171, 305 EU law  92, 97 exchange of information  95 forum shopping  222–3, 316 free movement of capital  221–3, 225 freedom of establishment  221–3, 225–6 GAAR  86–91, 93 hybrid loans and mis-matches  62, 207–8 interpretation and application  88, 95 Limitation-on-Benefits provisions  86–7, 89, 92–8, 225–6, 305 main purpose test  86–7, 89, 92–3 multilateral instruments, development of  153–7, 235–6, 307–8 nationality discrimination  226, 236 peer review process  8 permanent establishments  55, 98 prevention of abuse  85–99, 305, 311 principal purposes test  92–8, 230, 305 proportionality  223–4 savings clauses  88, 94 small countries  95–6 sole or dominant purpose  87 state aid  266–7 tax credits  204, 207 taxing rights, rules on determination and/or allocation of  202 third countries  235–6 treaty shopping  51, 220–8 forum shopping  222–3, 316 free movement of capital  221–3, 225 freedom of establishment  221–3, 225–6 prevention of abuse  86, 88–9, 91–2, 95, 305, 311 wholly artificial arrangements  224 withholding tax  87, 89, 93 due diligence  18

327

E6 project  314 economic and commercial reality see also economic substance criteria Code of Conduct Group for Business Taxation (EU)  218–19 competition law  218 freedom of establishment  217–18 group-wide rules and comparability issues  211–12 interest deductibility  212 linking rules  206–7 modified nexus approach  217–19 objectivity  208 Parent-Subsidiary Directive  229 real and genuine economic activity  217 sole purpose test  210 subject-to-tax approach  207 wholly or partly artificial arrangements, rules targeting  206–7, 208–10 economic crisis see global economic crisis economic substance criteria BEPS Action Plan  213–19, 308, 310–11 Code of Conduct Group for Business Taxation (EU)  198 controlled foreign companies  71 Diverted Profits Tax (UK)  313 EU law, compatibility with  213–19, 308, 310–11 Limitation-on-Benefits provisions  221–2 EEA Agreement  216–17 electronic commerce see digital economy employment  30, 79, 144, 204 enhanced cooperation procedure closer cooperation procedure  283 Commission  284–7 Common Consolidated Corporate Tax Base  286–7 Council  282–6 Court of Justice, interpretation by  285–6 European Parliament  284, 286–7 Financial Transaction Tax, proposal for  2–3, 282–7, 292–3, 295–302, 309 fiscal veto  282–3, 302 harmonisation  282–3 information, provision of  286 internal market  283–4 last resort, as measure of  283–4 nationality discrimination  283 non-participating member states, ­competences, rights and obligations of  283–7, 293 positive integration  283 qualified majority voting (QMV)  283, 293 transparency  287 unanimity  282–7 unitary patents, challenges to  285–6 use of procedure  285 environment  29–31

328

Index

ethics see morality EU law see also Action Plan to Strengthen the Fight against Tax Fraud and Tax ­Evasion (Commission); Base Erosion and Profit ­Shifting (BEPS) project with EU law, ­compatibility of; Commission (EU); ­Common Consolidated Corporate Tax Base (CCCTB) (EU); Court of Justice (CJEU); directives; fundamental freedoms; ­harmonisation of EU law; state aid and ­aggressive tax planning adjustments, guidance on  168–9 arbitration  233–5 Charter of Fundamental Rights of the EU  247 Code of Conduct Group for Business ­Taxation  25, 175–6, 195–200, 213, 218–19 confidentiality  146 controlled foreign companies  67, 71–2, 169 corporate social responsibility  39, 304 developing countries  26, 161 digital economy  58 double taxation non-double taxation, from  170–3 treaty abuse, prevention of  92, 97 enhanced cooperation procedure  283–7, 293 European Taxpayer’s Code, proposal for  27 Financial Transaction Tax, proposal for  2–3, 282–302, 308–9, 316 good governance  22, 24–7 Intra-Group Services Discussion Draft (OECD)  118 Limitation-on-Benefits  97 Neighbourhood Policy instruments  26 Platform for Tax Good Governance  26 policy on abuse and aggressive tax ­planning  2, 162, 167–79 pre-accession process  26 Pre-Action Plan Communication  173–5 public interest  167–8 subsidiarity  27 tax evasion and avoidance  25–7 terrorism, financing of  24 transfer pricing documentation  141, 146 transparency  25, 26–7 treaty abuse, prevention of  92, 97 wholly artificial arrangements  168–9 European Economic Area (EEA) ­Agreement  216–17 European Central Bank (ECB)  294 European Financial Stability Facility (EFSF)  294 European Multistakeholder Forum  30 European Parliament Action Plan (Commission)  181 Committee on Economic and Monetary ­Affairs  294

corporate social responsibility  39 country-by-country reporting  233 enhanced cooperation procedure  284, 286–7 Financial Transaction Tax, proposal for  291–5 Foreign Account Tax Compliance Act  181 good governance  25 OECD Transfer Pricing Guidelines  181 Pre-Action Plan Communication  173 Report on Tax Fraud, Tax Evasion, and Tax Havens  181 Savings Directive  181 European Stability Mechanism (ESM)  294 European Taxpayer Identification Number (EU TIN)  180 European Taxpayer’s Code, proposal for  27, 180 evasion see tax evasion evidence  8, 206, 246–7 exchange of information Action Plan (Commission)  176, 181, 187–8 automatic exchange Action Plan (Commission)  180–1, 187–8 BEPS project, factors leading to launch of  6–7 harmful tax practices, countering  81 state aid  281 transfer pricing documentation  146 transparency  187–91, 228 BEPS project, factors leading to launch of  6–7 Common Consolidated Corporate Tax Base  187–8 corporate social responsibility  31, 37 directive, proposal for a  281 disclosure of aggressive tax planning ­arrangements  134 Diverted Profits Tax (UK)  313–14 effective exchange of information  6–7 European Taxpayer Identification ­Number  180 filter approach  80 Foreign Account Tax Compliance Act  181 Global Forum on Transparency and Exchange of Information  6–8, 175, 181 good governance  24, 26 harmful tax competition, countering  6, 11, 81, 305 multilateral instruments, development of  156 Mutual Assistance Directive  187, 281 OECD Common Reporting Standard  182, 312 Pre-Action Plan Communication (EU)  174–5 preferential tax regimes  6, 79–81 reciprocity  181

Index spontaneous exchange  76, 79–81, 95, 134, 188–9, 305 state aid  281 tax havens  11 Tax Information Exchange Agreements  7 tax rulings  311 transfer pricing documentation  140, 144–6 transparency  187–91, 228 treaty abuse, prevention of  95 excessive loan interest payments  211 Extractive Industries Transparency Initiative (EITI)  182 extraterritoriality  294–5, 297, 299 fairness BEPS project  1, 22, 317 corporate social responsibility  37 dispute resolution  150 double taxation  170–3 good governance  24, 26–7 legal certainty  303–4 Pre-Action Plan Communication (EU)  173–5 Fiat  2, 267–8, 271–2, 277, 309 fiduciary duties  33–4, 37 financial crisis see global economic crisis financial penalties  137 Financial Transaction Tax (FTT), proposal for  2–3, 282–302 administration  291 annulment actions  300 Central Banks, exclusion of  290, 294 Commission  2–3, 282, 288, 291–6, 309 compatibility with EU law  308 competition, distortion of  283–4, 292, 295, 298–9 constitutional implications  302 cooperation  291, 298 Court of Justice  295, 299–300, 308 customary international law  297 definition of financial transaction  289 derivatives  288, 300–1 directive, proposal for a  288–94 ECOFIN meetings  292–3, 301 economic substance and territory, no link between  290 enhanced cooperation procedure  2–3, 282–7, 292–3, 295–302, 309 escape clause  290 European Parliament  291–5 exchanges of financial instruments  294 exemptions/exclusions  289–90, 294 extraterritoriality  294–5, 297, 299 financial institutions, definition of  290 Finance Ministers  292, 299, 301 future of tax  300–2 global economic crisis  282, 287–9, 309 good governance  302

329

harmonisation  288–9, 291 House of Lords EU Committee  295–9 impact assessment  288, 291, 293, 296, 298 implementation  300–2 issuance principle  293–4, 297, 301 non-participating Member States  292, 295–302, 316 over-the-counter transactions  289 primary markets  289–90 residence principle  301 stock exchange transactions  289 third countries, relocation to  302 transfers within groups  291 transparency  302 unanimity  292 Finland  9, 291 Fiscalis Working Group  27 fixed-debt-to-equity ratio test  74 fixed-ratio approach  74–6, 305 Foreign Account Tax Compliance Act (FATCA) (US)  181–2, 312 Forum on Harmful Tax Practices (OECD)  5–7, 76–7, 80–2, 84 Forum on Tax Administration (OECD)  134, 152 forum shopping  185, 222–3, 229, 316 fragmentation of activities  101–2, 105, 305 France digital economy  56 Financial Transaction Tax, proposal for  287, 291–2, 301 multilateral exchange facility, cooperation on a pilot  182 Stop Tax Dodging initiative  9 fraud  24, 166, 181, 183 see also Action Plan to Strengthen the Fight against Tax Fraud and Tax Evasion (Commission) free movement of capital  169, 209–10, 214–16, 221–5, 308 free movement of goods  250 free movement of services  251–2 free movement of workers  204 freedom of establishment Anti-Abuse Communication (­Commission)  169 comparability, lack of  225 controlled foreign companies  67, 206, 208 Court of Justice, development of principle of abuse by  308 economic/commercial reality, transactions reflecting  217–18 economic substance criteria  214–18, 221–2 issuance principle  293–4 Limitation-on-Benefits provisions  221–6 modified nexus approach  214–18 proportionality  223–4 treaty shopping  221–3, 225–6 wholly artificial arrangements  206

330

Index

fundamental freedoms see also freedom of ­establishment Code of Conduct Group for Business ­Taxation  199 Court of Justice, development of principle of abuse by  162, 308 double non-taxation  221 double taxation  170 economic substance criteria  213–18 free movement of capital  169, 209–10, 214–16, 221–5, 308 free movement of goods  250 free movement of services  251–2 free movement of workers  204 IP boxes  199 modified nexus approach  213–18 taxing rights, rules on determination and/or allocation of  203 G20 see also Base Erosion and Profit Shifting (BEPS) project European Parliament  181 Financial Transaction Tax, proposal for  288 GAAR (general anti-abuse rule) Action Plan (Commission)  178–9 arbitration  152 Court of Justice, development of principle of abuse by  166 design  91 directives, draft  91 domestic laws  178 Financial Transaction Tax, proposal for  294 hybrid loans and mis-matches  63 Limitation-on-Benefits  86–7, 93 main purpose test  86–7, 89 Parent-Subsidiary Directive  91, 228–30 principal purposes test  228–30 treaty abuse, prevention of  86–91, 93 general anti-abuse rule see GAAR (general anti-abuse rule) Germany Federation of German Industries  83 Financial Transaction Tax, proposal for  287, 292, 294, 297 IP boxes  199, 213–14 multilateral exchange facility, cooperation on a pilot  182 nexus approach  81–2 global economic crisis  309–10 BEPS project, factors leading to launch of  4 double taxation  171 Financial Transaction Tax, proposal for  282, 287–9, 309 G20 Communiqué  7 tax havens  7, 8, 303 Global Financial Integrity  19 Global Forum on Transparency and ­Exchange of Information for Tax ­Purposes  (OECD)  6–8, 175, 181

globalisation  4, 22, 48, 153, 159 good faith  148, 246 good governance  22–8, 304 accountability  23, 31 Action Plan (Commission)  176–8, 180–1 BEPS project  1, 22–8, 31, 34 blacklists  178 civil society  23, 26, 28 corporate governance  40, 42–4 corporate social responsibility  28, 31, 34 corruption  24 developing countries  23–4, 26 EU law  22, 24–7 exchange of information  24, 26 fair tax competition  24, 26, 31 Financial Transaction Tax, proposal for  302 fraud  24 Good Governance Recommendation (­Commission)  26, 176–8, 180–1 minimum standards  25 money laundering  24 Mutual Assistance Directive  25 Neighbourhood Policy instruments  26 OECD  23, 27 Platform for Tax Good Governance  26, 176, 180–1 politics  23, 25, 27–8 Pre-Action Plan Communication (EU)  174–5 Principles of Corporate Governance (OECD)  40, 42 Savings Directive  25 soft law  27 standards  25, 177–8 state-building  23, 28 tax evasion and avoidance  25–7 tax havens  25–7 third countries  176, 178 transparency  24, 26–7, 31 UN  23–4, 27 Google  11, 14–16 see also Diverted Profits Tax (DPT) (‘Google Tax’) (UK) governance see good governance group-wide rules and comparability ­issues  211–13 benchmarking ratios  211 benefits/advantages  212 BEPS Action Plan  211–13, 305 Common Consolidated Corporate Tax Base, apportionment in context of  212 Court of Justice, case law of  211–12 double taxation  76 economic/commercial reality, transactions reflecting  211–12 EU law with BEPS project, compatibility of  211–13 interest  74–6, 211–13 Limitation-on-Benefits provisions  225 mechanical tests  211

Index treaty shopping  226–7 Guidelines for Multinational Enterprises (OECD)  40, 42–3 harmful tax practices, countering  51, 76–84 Action Plan (Commission)  176–7, 179 BEPS Action Plan  50–1, 76–7, 81 BEPS Monitoring Group  79, 84 Code of Conduct Group for Business ­Taxation  (EU)  195 competition  5–8, 45, 220, 261, 280 competitiveness  81, 84 discrimination  83 double non-taxation  220 exchange of information  6–7, 11, 81, 305 Forum on Harmful Tax Practices (FHTP)  5–7, 76–7, 80–2, 84 Global Forum on Taxation  6–8 intellectual property  77–9, 81–4 nexus approach  78–9, 81–4, 305 OECD  5–8, 11 Discussion Draft  77–80, 82 intellectual property (IP) regime  77–9, 82–4 nexus approach  78–9, 81–3 report  77, 80 research and development  78–9, 82–4 skilled labour pool  79 peer review process  8 preferential tax regimes  6, 77, 79–81, 305, 311 profit split method  84 progress reports  6–7 research and development  78–9, 82–4 state aid  261, 280 substantial activity requirement  77–9 tax havens  5–6, 7–8 transparency  6–7, 11, 76–7, 81 zero taxation  177 harmonisation of EU law Action Plan (Commission)  186 double non-taxation  221 enhanced cooperation procedure  282–3 European Taxpayer’s Code, proposal for  27 Financial Transaction Tax, proposal for  288–9, 291 fiscal veto  282–3 good governance  27 partial harmonisation  317 head office expenses  117 Hewlett Packard  19 High-Level Expert Group on Taxation of the Digital Economy (EU)  192–5 BEPS project  193–5 Common Consolidated Corporate Tax Base  194–5 Digital Economy Report  192 internal market  192, 195

331

Mini One Stop Shop (MOSS)  193–5 One Stop Shop (OSS)  193–4 permanent establishments  194 Tax Transparency Package  195 value creation  194 VAT  192–5 HM Revenue and Customs accountancy firms, role of  16–17 boardroom, tax in the  43–4 criticism  15–16, 18 Diverted Profits Tax (UK)  313 HM Treasury, criticism of  15–16, 18 human capital  30 human rights  31, 247 Hungary  9, 248 hybrid mismatch arrangements BEPS project  47, 50, 59–66, 304 bottom-up approach  64 Code of Conduct Group for Business ­Taxation  (EU)  197–8, 208 controlled foreign companies  65, 68 deduction/no inclusion outcomes (D/NI)  60 definition of a hybrid mismatch arrangements  59 design principles  60, 66 double deductions—DD outcome  60, 64 double taxation  59–65, 172, 208 dual resident entities  62, 65 ECOFIN meeting  184 economic/commercial reality, transactions reflecting  206–7 GAAR  63 hybrid entity payments  61 hybrid financial instruments and ­transfers  61 hybrid payments, definition of  64 impact assessments  63 interest deductibility  65–6 linking rules  61, 204–8, 304 mechanical rules  60, 63 neutralisation of effects  50, 59–66 OECD Domestic Law Discussion Draft  59–66 Hybrids Revised Discussion Draft  64–5 Model Tax Convention  59, 61–2, 65 Treaty Discussion Draft  59, 62, 65 ownership threshold for relatedness  65 Parent-Subsidiary Directive  184–5, 207–8 partnerships  62, 65 purpose/motive or intention test  60, 63–4, 206 reverse hybrid and imported mismatches  61 royalties  64 separate entity principle  64, 65 transparency  60–2 unilateral deductions granted by domestic law  60 wholly artificial arrangements  208

332 IKEA  17 India BRICS  160–1, 314–15 intangibles  111 interest, royalties, and service fees between associated enterprises, reporting  145 nexus  56 transfer pricing  111 indirect taxes  51, 54, 192, 255, 288 see also VAT information, exchange of see exchange of information information technology see digital economy insurance  70, 72, 75, 105, 197 intangibles  106–17 accounting standards  113 arm’s length principle  107–17, 305 BEPS project  106–17, 305–6 buy-in and buy-out payments  116 cost contribution arrangements  113–17 definition of intangibles  106, 110 design of rules  106–7 developing countries  111 development, enhancement, maintenance, and protection  108, 110–12, 305–6 digital economy  57 documentation  144 economic substance criteria  213 financial risk  108 funding and risk-taking  107–8 harmful tax competition  6 hard-to-value intangibles  113, 116, 120 joint development, ­enhancement, ­maintenance, protection or ­exploitation  114 marketing intangibles, definition of  110 modified nexus approach  213 mutual and proportionate benefits  114–15 OECD  106–15, 306 Intangibles Discussion Draft  107–8 Intangibles Revised Discussion Draft  107–13 Intangibles Second Revised Discussion Draft  109–13 Profit Split Discussion Draft  113 Transfer Pricing Guidelines  110, 306 ownership  110 profit split method  109, 112–13 re-characterisation  113, 116–17, 125, 126 remuneration  111–12, 305 stakeholders  110 substantial activity requirement  77 tax havens  106 taxing rights, rules on determination and/or allocation of  203 transfer pricing  57, 106–17, 120, 125–6, 144, 305–6 value creation  106–10, 305–6 withholding tax  109

Index intellectual property benefits/advantages  78, 82–4 boxes Code of Conduct Group for Business ­Taxation (EU)  198–200 harmful tax practices, countering  79, 81–4 patents  81–4, 198–200 Code of Conduct Group for Business Taxation (EU)  198–200 fundamental freedoms  199 harmful tax practices, countering  77–9, 82–4 Luxembourg tax practices  200 new entrants, closure of existing regimes to  82 nexus approach  78, 83 patents box regimes  81–4, 198–200 harmful tax practices, countering  79, 81–4 preferential tax regimes  80–1 qualifying expenditures  78 research and development  78–9, 82–4, 199 soft law  199–200 state aid  200, 281 trademarks  83 transfer pricing  199 intention purpose/motive or intention test  60, 63–4, 206 treaty abuse, prevention of  88, 90, 92, 305 interest payments and other financial ­arrangements arm’s length tax  74, 76 associated enterprises  145 base erosion, limiting  72–6 BEPS Action Plan  72–6, 305 best practice  72–3, 76, 305 carve-outs  75 de minimis threshold  73 dispute resolution  149 double taxation  72, 76 excessive loan interest payments  211 fixed-debt-to-equity ratio test  74 fixed-ratio rule  74–6, 305 general interest limitation rules  74 group-wide approach  74–6, 305 groups of companies  73–4 hybrid loans and mis-matches  65–6 Interest and Royalties Directive  74, 171, 211–12 interest deductibility rule  65–6, 73–4, 212–13, 305 Interest Expense Discussion Draft (OECD)  72–6 leverage and interest ratios  76 re-characterisation of interest  203–4, 206, 209, 212

Index reporting  145 state aid  245 targeted anti-abuse rules  74–5 third-party interest expense  72 transfer pricing documentation  145 unitary taxation  76 withholding tax  74 internal market Action Plan (Commission)  176, 178 ad hoc strategy  317 digital economy  192, 195 double taxation  171 European Taxpayer’s Code  180 Financial Transaction Tax, proposal for  289 state aid  242, 244, 271 Tax Transparency Package (Commission)  191–2 International Consortium of Investigative Journalists (ICIJ)  16–18 International Monetary Fund (IMF)  158–9, 288 Intra-Group Services Discussion Draft (OECD)  118–20 Ireland corporate residence, definition of  20 double Irish structure  14 principal purposes test (PPT)  230–1 residence/source dichotomy  19–20 state aid  2, 267–72, 276–7, 279, 309, 316 issuance principle  293–4, 297, 301 Italy multilateral exchange facility, cooperation on a pilot  182 state aid  261–5 Stop Tax Dodging initiative  9 transparency  181–2 Joint Transfer Pricing Forum (JTPF)  173, 231–5 Juncker, Jean-Claude  316 KPMG Ireland, report by  95–6 lawyers legal professional privilege  136 professional social responsibility  38 League of Nations  309 Liechtenstein  25 Limitation-on-Benefits (LOB) ­provisions  220–8 active business regime  98 BEPS project  220–8 comparability, lack of  225 Court of Justice, case law  222–6 derivative benefits clause  86, 92–4, 97–8 double tax treaties  86–7, 89, 92–8, 225–6, 305 dual-listed company arrangements  98 economic substance criteria  221–2

333

EU law  97, 220–8 forum shopping  222–3 GAAR  86–7, 93 main purpose test  86–7, 89, 92–3 mechanical test  230 nationality discrimination  225–6 OECD Model Tax Treaty  96–7 pension fund exceptions  97 principal purposes test  92–7 shams  221 transparency  228 treaty abuse, prevention of  86–7, 89, 92–8, 221–8, 305 withholding tax  225 linking rules benefits/advantages  204 BEPS project  185, 203–8 economic/commercial reality, transactions reflecting  206–7 EU law, compatibility of BEPS project with  203–8 hybrid loans and mis-matches  61, 204–8, 304 nationality discrimination  204, 207 Parent-Subsidiary Directive  185 per country approach  204–5 permanent establishment  205 primary jurisdiction  203–4 re-characterisation of interest payments  206 restriction approach  204 secondary/defensive rule  203–4, 206 subject-to-tax approach  207 unilaterally-imposed and mechanical rules  203–8 local country files  139–43, 311–12 location rents  110–11 location savings  110–11 low-value-adding intra-group services  231 Luxembourg 1929 holding regime  7 Financial Transaction Tax, proposal for  293 harmful tax competition  7 leaks  16–17, 228, 316 patent box regimes  200 Public Accounts Committee  13, 16–17 PWC, tax clearances arranged by  16–17, 138 state aid  2, 248, 267–8, 271–2, 277, 309 transparency  228 main purpose test  86–7, 89, 92–3, 186, 228–9, 231 Malta  230–1, 291, 293 management fees  117 Manual on Effective Mutual Agreement ­Procedures (MEMAP) (OECD)  147 master files  139–44, 232, 307, 311–12 media aggressive tax planning  46, 303 global economic crisis  303

334

Index

investigative journalism  16–18 politics  11, 16–17 Merger Directive  166 Microsoft  11, 19 Model Tax Treaty (OECD) see OECD Model Tax Treaty modified nexus approach agreed modified nexus approach  82–4 benefits/advantages  213, 215, 218 BEPS Action 5  213–19, 308 Code of Conduct Group for Business Taxation (EU)  198–200 controlled foreign companies  216–17 Court of Justice, case law of  214–18 de minimis rule  216 economic/commercial reality, transactions reflecting  217–19 EEA Agreement  216–17 EU law, compatibility of BEPS project with  213–19 fundamental freedoms  213–18 harmful tax practices, countering  81–4, 305 intangibles  213 intellectual property  83, 198–200, 213–14, 218–19, 310–11 research and development  82–3, 213–15 territorial nexus approach  308 transparency  213 money laundering  24, 182–3 morality boardroom, tax in the  43 corporate social responsibility  29–31, 39 politics  21–2, 303–4, 310, 316 most-favoured nation (MFN) clause  227 multilateral exchange facility, cooperation on a pilot  182 multilateral instruments, development of  51, 130, 153–7 administrative assistance  156 BEPS project  51, 130, 153–7, 235–6, 307, 308 bilateral treaties  153–7, 235, 307 developing countries  154 double tax treaties  153–7, 235–6, 307–8 EU law, compatibility of BEPS project with  235–6, 308 exchange of information  156 Mutual Agreement Procedure (MAP)  153, 155 Mutual Administrative Assistance in Tax ­Matters Convention  154, 235 nationality discrimination  236 OECD international conference 2015  153–4 Multilateral Instrument Discussion Draft  153, 155–6, 307 negotiating ad hoc group, formation of  157 procedure  156

reservations  156 targeted scope  154–5, 307 third countries  235–6 toolbox  155 treaty-related issues  153 Mutual Administrative Assistance ­Convention  154, 235 Mutual Agreement Procedure (MAP)  147–53, 155, 307 Mutual Assistance Directives amendment to  182, 187 exchange of information  187, 281 Financial Transaction Tax, proposal for  296–7 good governance  25 multilateral instruments, development of  154 Savings Directive  190 Tax Transparency Package (­Commission)  187–8, 190 national laws see domestic laws nationality discrimination double taxation  220, 226, 236 enhanced cooperation procedure  283 Financial Transaction Tax, proposal for  295 Limitation-on-Benefits provisions  225–6 linking rules  204, 207 neutralisation  204, 207 state aid  250–1, 259 taxing rights, rules on determination and/or allocation of  202–3 unilateral tax credit  204, 207 withholding tax  204 Neighbourhood Policy instruments  26 Netherlands Code of Conduct Group for Business Taxation (EU)  198 Confederation of Dutch Industry and ­Employers  83 state aid  2, 267–8, 272–4, 276–7, 309 neutrality  53 nexus approach see also modified nexus ­approach digital economy  54–6 digital presence, based on  55 harmful tax practices, countering  78–9 intellectual property  78 proportionality  78 residence of customer, place of  56 substantial activity requirement  79 non-governmental organizations (NGOs)  9–10, 38, 55, 303 OECD see also Base Erosion and Profit Shifting (BEPS) project; OECD Model Tax Treaty; Transfer Pricing Guidelines (OECD) boardroom, tax in the  42–3

Index capacity building  23 Committee on Fiscal Affairs  53 Commodities Discussion Draft (OECD)  117, 122–4 controlled foreign companies  66–70, 210–11 corporate social responsibility  39–40 cost contribution arrangements  113–15, 306 data, methodologies for analysis and ­collection of  131–3, 306 developing countries  2, 23, 157–60 digital economy  52–3, 54–8 dispute resolution  147–52, 307 European Parliament  181 Forum on Harmful Tax Practices  5–7, 76–7, 80–2, 84 Harmful Tax Competition: An Emerging Global Issue  5–6 progress reports  6–7 Forum on Tax Administration  134, 152 Global Forum on Transparency and Exchange of Information  6–8, 175, 181 good governance  23, 27 Guidelines for Multinational Enterprises  40, 42–3 intangibles  106–13, 306 intellectual property  77–9, 82–4 Intra-Group Services Discussion Draft (OECD)  118–20 multilateral instruments, development of  153, 155–7, 307 permanent establishments  99–105, 305 Pre-Action Plan Communication (EU)  175 Principles of Corporate Governance  40, 42 profit split method  113, 117, 120–2 Risk and Re-characterisation Discussion Draft (OECD)  124–9, 159–60, 165, 306–7, 311 risks and capital and other high risk ­transactions  117, 122–4, 306–7 Task Force on Digital Economy  54 Task Force on Tax and Development  158 Tax Transparency Package (­Commission)  191 taxing rights, rules on determination and/or allocation of  202–3 transfer pricing  138–45, 307, 311 OECD Model Tax Treaty abuse, prevention of  87–97, 305, 311 BEPS project  219–20, 314–15 Commentary abuse, prevention of  87–94, 97–8 dispute resolution  148 main purpose test  87 menu of options  315 partnerships  62 permanent establishments  101–2, 105 principal purposes test  228 dividends  87 League of Nations  309

335

Limitation-on-Benefits provisions  96–7 permanent establishments  55, 101–5, 305–6 place of effective management  87 place of incorporation  87 preamble  88, 95, 305 principal purposes test  228 reservations  102 taxing rights, rules on determination and/or allocation of  202 Treaty Abuse Discussion Draft (OECD)  85–94 Treaty Abuse Revised Discussion Draft (OECD)  85, 91–5 Treaty Abuse Second Revised Discussion Draft (OECD)  96–8 triangular situations involving third party PE  87 withholding tax  87 Ottawa Taxation Framework Conditions (OECD)  52 Oxfam  10 Parent-Subsidiary Directive Action Plan (Commission)  184–6, 317 amendment  184–6, 207–8 anti-abuse provisions  184, 186 BEPS project  185, 220 Code of Conduct Group for Business Taxation (EU)  197–8 double non-taxation  184, 220 double tax treaties  207–8 economic/commercial reality, transactions reflecting  229 forum shopping  185 GAAR  91, 228–30 hybrid loans and mis-matches  184–5, 207–8 main purpose test  186, 228 mechanical rules  185 VAT  166 partly artificial arrangements, rules targeting see wholly or partly artificial arrangements, rules targeting partnerships  62, 65, 68 patents box regimes  198–200, 213–14, 218–19, 310–11 Code of Conduct Group for Business Taxation (EU)  213, 219 economic substance criteria  213–14, 218–19, 310–11 European Patent Office  200 modified nexus approach  198–200, 213–14, 218–19, 310–11 research and development  213–14 unitary patents, challenges to  285–6 peer reviews  8, 152–3 Pepsi  17 permanent establishments (PEs) artificial avoidance of status  99–106, 313

336

Index

agents  99–100, 104 apportionment  104 associated enterprises  101, 104 attribution of profits  101, 105 BEPS project  50, 99–106, 305 commissionaire arrangements  99–100, 104, 305 common control  104 contracts, splitting up of  101–2, 105, 305 controlled foreign companies  68 core activities  55, 57 definition of PE  99, 103, 305 delivery, exemption for  102 design and drafting  98 developing countries  104 digital economy  55, 57, 194 Diverted Profits Tax (UK)  312–13 exemptions  55 Focus Group on the Artificial Avoidance of PE Status  99, 103 fragmentation of activities  101–2, 105, 305 linking rules  205 OECD Authorised OECD Approach  103 Model Tax Treaty  55, 101–5, 305 PE Discussion Draft  99–104 PE Revised Discussion Draft  103–5, 305 preparatory or auxiliary activities exemption, definition of  194 principal purpose test  101, 105 profit attribution rules  103 ratification by a principal  100 related parties  101–2, 105 small businesses  104 specific activity exemptions  99–101, 105, 305 storage, exemption for  102 subsidiaries, ease of establishment of  101 substantial economic activities  102 taxing rights, rules on determination and/or allocation of  201–2 transfer pricing  104 treaty abuse, prevention of  98 virtual PEs  55 Platform for Tax Good Governance (­Commission)  26, 176, 180–1 Poland  9 politics of debate  1, 11–22 aggressive tax planning  11–22 BEPS project  11–22, 47, 50, 309, 314–16 complexity of laws  15–17, 21 corporate tax responsibility, development of  22 dispute resolution  148 globalisation  22 good governance  23, 25, 27–8 HM Revenue and Customs, criticism of  15 HSBC and investigative journalism  17–18 letter of law, compliance with  12, 21–2, 303

low effective tax rates  309 media, negative coverage in the  11, 16–17 Public Accounts Committee (PAC) (UK)  11–19, 38 public opinion  21–2 reputation  14–16, 22, 310 residence/source dichotomy  11–21, 303 state aid  236 stateless income  11, 309 tax havens  11 tax morality/tax justice  21–2, 303–4, 310, 316 transfer pricing  11 transparency  11, 15–16 treaties, complexity of tax  15 Pre-Action Plan Communication (EU)  173–5 preferential tax regimes  6, 77, 79–81, 305, 311 Primarolo Report  196–7 principal purposes test (PPT) active business/trade test  231 Aggressive Tax Planning ­Recommendation  228–30 BEPS project  220, 228–31 conduit-PPT rule  98 Court of Justice, case law of  228–30 double tax treaties  230 EU law, compatibility of BEPS project with  220, 228–31 forum shopping  229 GAAR test  228–30 Ireland  230–1 legal certainty  230 Limitation-on-Benefits provisions  92–7 main purpose test  92–3, 228–9, 231 Malta  230–1 permanent establishments  101, 105 small countries  230–1 treaty abuse, prevention of  92–8, 305 wholly artificial arrangements  229 principles of international tax law  1, 22, 50, 303 procedure BEPS project  51, 130–61 reforms  51, 130–61 professional social responsibility  38 profit shifting see Base Erosion and Profit Shifting (BEPS) project profit split method arm’s length principle  120, 122, 311 developing countries  160 harmful tax practices, countering  84 intangibles  109, 112–13 OECD Profit Split Discussion Draft  117, 120–2 transfer pricing  104, 109, 112–13, 120, 129 proportionality arm’s length principle  209 controlled foreign companies  206, 208 free movement of capital  209–10, 225

Index freedom of establishment  223–4 nexus approach  78 purpose or intention test  206 state aid  261, 263 transfer pricing  209–10 treaty shopping  223–4 wholly artificial arrangements  168, 206, 208–10, 308 Public Accounts Committee (PAC) (UK)  11–19, 38 Tax Avoidance—Google (the Google R ­ eport)  14–16 public interest  167–8, 215 public opinion  21–2, 303 purpose/motive or intention test  60, 63–4, 206 PwC Public Accounts Committee (PAC)  16–17 tax clearances in Luxembourg  138 re-characterisation arm’s length approach  206 cost contribution arrangements  113, 116–17 intangibles  113 interest payments  203–4, 206, 209, 212 linking rules  203–4, 206 Risk and Re-characterisation Discussion Draft (OECD)  124–9, 159–60, 165, 306–7, 311 reporting see also country-by-country ­reporting aggregate country-wide reporting  141, 143 boardroom, tax in the  44 CBI Principles  1 disclosure of aggressive tax planning ­arrangements  135–7 dual reporting requirement  135–6 interest payments  145 Intra-Group Services Discussion Draft (OECD)  119–20 standards  138 reputation accountancy firms  15–16 boardroom, tax in the  41–2, 44 corporate social responsibility  35–7 large companies  36–7 politics  14–16, 22, 310 Public Accounts Committee (PAC)  14–15 research and development (R&D) economic substance criteria  213–15 harmful tax practices, countering  78–9, 82–4 intellectual property  78–9, 82–4, 199 nexus approach  82–3, 213–15 patent box regime  213–14 residence see residence/source dichotomy controlled foreign companies  71 double taxation  87, 93–5, 202, 226, 229 dual residence  62, 65, 155

337

exit taxes  94 Financial Transaction Tax, proposal for  301 residence/source dichotomy BEPS project  49–50, 303–4, 309–10, 312 citizenship basis  202 digital economy  49–50, 53, 56 double taxation  202 Public Accounts Committee (PAC)  11–19 stateless income  312 taxing rights, rules on determination and/or allocation of  201–3 worldwide basis  202 revenue bodies  45 see also HM Revenue and Customs Revised Capital Requirements Directive  182 risk see also risks and capital and other high risk transactions and transfer pricing risk assessment and management  45, 134–5, 139–40, 143–4, 231–2, 307 Risk and Re-characterisation Discussion Draft (OECD)  124–9, 159–60, 165, 306–7, 311 risk-return trade-offs  126 risks and capital and other high risk transactions and transfer pricing  117–29 BEPS project  105, 117–29 OECD Commodities Discussion Draft  117, 122–4, 306 Intra-Group Services Discussion Draft  118–20, 306 Profit Split Discussion Draft  117, 120–2 Risk and Re-characterisation Discussion Draft  124–9, 306–7 Transfer Pricing Guidelines  117, 118, 306 value-added intra-group services  117 roll back provisions  6 royalties  64, 74, 145, 171, 211–12, 275 RTL Group  248 Russia  160–1, 314–15 Ryanair  248–9 Saint-Amans, Pascal  152 Savings Directive  25, 181, 184, 186–7, 190 scandals  16–18, 267–79, 309–10 selectivity principle  237, 253–62, 268–71, 278–9 Šemeta, Algirdas  295 separate entity principle  64, 65, 129 separate legal personality, fiction of  122 service fees, reporting  145 shareholders accountability of managers  31–2 board of directors, duty to shareholders of  41–2 competitiveness  183 corporate social responsibility  32–3 Shareholders’ Rights Directive  183

338

Index

single market see internal market Slovenia  9 small and medium-sized enterprises (SMEs) Accounting Directive  182 data, methodologies for analysis and ­collection of  133 digital economy  192 disclosure of aggressive tax planning ­arrangements  138 Diverted Profits Tax (UK)  313 permanent establishments  104 transfer pricing documentation  142 soft law Action Plan (Commission)  180–3 Aggressive Tax Planning ­Recommendation  207 corporate social responsibility  39 good governance  27 source/residence dichotomy see residence/ source dichotomy South Africa  145 Spain amortization case  265–7 patent box regimes  200 Stop Tax Dodging initiative  9 splitting up of contracts  93, 101–2, 105, 305 stakeholders BEPS project  50 boardroom, tax in the  42 corporate social responsibility  29–32 European Multistakeholder Forum  30 intangibles  110 Stamp Duty Land Tax (SDLT)  296 standards accounting  113 Action Plan (Commission)  180–3 arm’s length principle  311 BEPS project  49 competitiveness  32 corporate social responsibility  31–2 country-by-country reporting  231–2 digital economy  176 disclosure of aggressive tax planning ­arrangements  138 European Taxpayer’s Code  180 exchange of information  7 good governance  25, 177–8 OECD Common Reporting Standard  182, 312 Pre-Action Plan Communication (EU)  173 transfer pricing documentation  140–1, 143 standstill provisions  241, 248 Starbucks  2, 11–13, 39, 267–8, 272–4, 276–7, 309 state aid and aggressive tax planning  2, 237–81 advance pricing arrangements (APAs)  268–77 affect trade, capacity to  238, 253

annulment of acts  243, 249, 265 arm’s length principle  268–77 assessment of compatibility  242, 244 autonomous powers  256–61 balancing test  241 BEPS project  220, 264–5, 267, 280 burden of proof  246 capital asset pricing model (CAPM)  272 cases, review of  2, 256–77, 308 Charter of Fundamental Rights of the EU  247 Code of Conduct Group for Business ­Taxation  261 Commission  236–55, 263–81, 308–9, 316 approval  240, 242–5, 250 Draft Notice  240, 243, 250–1, 253–5, 264–5, 278–9 guidance  239, 244–5, 253–6 investigations  2, 240, 247, 249, 267–81, 309, 316 Notice on enforcement of state aid by national courts  248 Notice on the application of the State aid rules  250–1, 253–4, 260–1, 278 role  2, 240–3 common interest objective  241 Communication on State Aid Modernisation (Commission)  242 compatible aid  238 competitors, rights of  2, 239–40 complaints  248–9 conditions for compatibility  242, 266, 268–9 consistency with logic and general scheme of a tax system, inherent  261–5 cooperative societies  261–5 Court of Justice  240–1, 243, 246, 249–50, 254, 256–67, 280 damages  245, 248 decisions prohibiting aid, actions against  243 definition of state aid  238 derogations  238, 254–5, 261–6, 278 direct effect  237, 244 direct taxation  250–1, 253–5, 260–1, 278 distortion or threats of distortion to ­competition  237–9, 253, 261, 263 domestic courts  238, 244–6, 248, 261–2 double non-taxation  220 double tax treaties  266–7 economic evaluation of aid  241 effective remedy, right to an  247 enforcement  242–8 evidence  246–7 examples of tax measures  239, 252–3 exchange of information, automatic  281 exemptions from prohibition on state aid  238, 241–2 tax  248, 261–5, 266

Index external policy objectives  263–4 failure to act  243 fair trial, right to a  247 fundamental freedoms  239, 248, 249–52 General Block Exemption Regulations (GBER)  241–2 good faith  246 harmful tax competition  261, 280 Implementation Report  253–4 individual concern  243 injunctions  244–5 institutions, credibility of EU  236 intellectual property  200, 281 interest  245 interested parties, rights of  246–7 internal market  242, 244, 271 legal certainty  236, 279 legitimate expectations  245 litigation avenues  243–6 loans  239 local/regional authorities  237, 256–8 market conditions  268–9, 275, 277 modernisation  242–3, 247 monitoring  261 national tax authorities, role of  2 nationality discrimination  250–1, 259 natural disasters  238 Notice on cooperation between national courts and Commission  243–4 notification  240–2, 258, 280 paradigm state aid  239 preliminary examinations  247 prevention of aid  244 primacy of EU law  245 proportionality  261, 263 prudent independent market operator test  2, 269–71, 275, 277, 309 public authorities  237 reciprocity  236 recovery decisions  244–5, 247 regulations, power to make  241–2 repayment  240–1, 244–5 selectivity principle  237, 253–62, 268–71, 278–9 severability test  250 social character, aid of a  238 standstill provisions  241, 248 suspension of aid  244 tax rulings  267–8, 279–81, 316–17 third parties, rights of  2, 247–8 time limits  241 transactional net margin method (TNMM)  270–2, 274–6 transfer pricing  236, 267–80 transparency  242, 247 standstill provisions  6, 196–7, 240–1, 248 state-building  23, 28

339

state sovereignty  11, 28, 48, 66, 88, 153, 172, 302, 307 stateless income  1–2, 5 BEPS project  106, 310 double Irish structure  14 politics  11, 309 residence/source dichotomy  11, 303, 309, 312 transfer pricing  106, 310 Stop Tax Dodging initiative  9 Stop Tax Haven Abuse Act (United States), proposal for  21 subject-to-tax approach  207 subsidiaries see also Parent-Subsidiary Directive controlled foreign companies  67, 71 double Irish structure  14 double tax treaties  97 ease of establishment  101 nationality discrimination  202 non-resident subsidiaries  67 permanent establishments  101 state aid  239, 268, 270, 274 wholly artificial arrangements  168 subsidiarity  27, 171 substance see economic substance criteria substantial activity requirement  77–9, 102 SustainAbility report  29 Sweden  9, 184, 291 Switzerland  17, 25 Task Force on Digital Economy (OECD)  54 Task Force on Tax and Development (OECD)  158 tax avoidance see also Base Erosion and Profit Shifting (BEPS) project aggressive tax planning distinguished  34, 37 corporate social responsibility  28–9, 32–4, 37, 39 definition  34 directors, positive duties of  33 fiduciary duties  33–4 good governance  25–7 Platform for Tax Good Governance (­Commission)  181 positive duty to avoid tax  33 tax evasion distinguished  29, 37 tax evasion see also Action Plan to ­Strengthen the Fight against Tax Fraud and Tax Evasion (Commission) European Parliament  181 good governance  25–7 Platform for Tax Good Governance (­Commission)  181 Pre-Action Plan Communication (EU)  173–5 tax avoidance distinguished  29, 37

340

Index

tax fraud see Action Plan to Strengthen the Fight against Tax Fraud and Tax Evasion (Commission); fraud tax havens advocacy groups  9 aggressive tax planning  7 BEPS project  1, 5–6, 7–10, 45–6 blacklists  181 civil society  9, 45–6 corporate social responsibility  31, 35, 38 developing countries  8–10, 45 domestic laws, recommendations for  6 double tax treaties  6 exchange of information  11 fundamental freedoms  221 global economic crisis  7, 8, 303 good governance  25–7 intangibles  106 NGOs  9–10 Norwegian study 2008  8–9 Platform for Tax Good Governance (­Commission)  181 Pre-Action Plan Communication (EU)  175 sanctions  7 standstill and roll back provisions  6 state sovereignty  11 Stop Tax Haven Abuse Act (United States), proposal for  21 terminology  8, 10 Tax Justice Network report  9, 33–4 tax rulings advance tax rulings  189–90 exchange of information  311 state aid  267–8, 279–81, 316–17 Tax Solidarity Week of Action 2013  9 Tax Transparency Package (Commission)  81, 187–92, 195, 287, 308 taxing rights, rules on determination and/or allocation of  1, 7–10, 201–3 Technical Advisory Group (TAG) (OECD)  53 terminology  8, 10, 162–3, 303 terrorism, financing of  24, 182–3 thin capitalisation  51, 169, 209, 211–12 third countries Financial Transaction Tax, proposal for  302 good governance  26, 176, 178 Good Governance Recommendation  176, 178 multilateralisation of tax treaties  235–6 Pre-Action Plan Communication (EU)  173 technology see digital economy toolbox/toolkits  155, 159, 176 trade mispricing  10 trade secrets  140 trademarks  83 transactional net margin method (TNMM)  270–2, 274–6

transfer pricing see also arm’s length ­principle; transfer pricing ­documentation, re-­examination of; Transfer Pricing ­Guidelines (OECD) associated/connected parties  46 BEPS project  49, 51, 105–30, 138–47, 305–6, 311, 314 controlled foreign companies  67, 70 cost contribution arrangements  113–17, 306 data collection and analysis, rules for  51, 130 developing countries  159 digital economy  57 dispute resolution  149–50 intangibles  57, 106–17, 120, 125–6, 144, 305–6 Joint Transfer Pricing Forum (JTPF)  173, 231–5 profit split method  104, 109, 112–13, 120, 129 Public Accounts Committee (PAC)  12 residence/source dichotomy  20 risks and capital and other high risk ­transactions  117–29, 306–7 state aid  236, 267–80 value creation  21, 311 transfer pricing documentation advocacy groups  141 aggregate country-wide reporting  141, 143 appropriate use  145–6 arbitration  234–5 benefits/advantages  142, 147 BEPS project  51, 130, 138–47, 231–3 Code of Conduct on transfer ­pricing ­documentation for associated ­enterprises  231–3 compliance costs  140 confidentiality  140–1, 144–6 country-by-country reporting by tax ­authorities  138–47, 231–3, 307, 312 data, sources of  142 developing countries  146 EU law  141, 146, 231–3 exchange of information  140, 144–6 global master files  139–41 groups of companies  140, 145–7 implementation arrangements  146 intangibles  106–17, 144 interest payments, reporting  145 Intra-Group Services Discussion Draft (OECD)  119–20 language  139–40, 144 local country files  139–43, 311–12 master files  139–44, 307, 311–12 materiality thresholds  139, 141, 143 OECD CbC Discussion Draft  138–41

Index CbC Follow-Up Report  145 CbC Revised Discussion Draft  143–5, 307 White Paper on Transfer Pricing ­Documentation  138-9, 232–3 penalties for non-compliance  140 risk assessment  139–40, 143–4, 307 royalty payments, reporting  145 scientific secrets  140 service fees between associated enterprises, reporting  145 small and medium-sized enterprises  142 standards  140–1, 143 templates  138–45 three-tier approach  142–3, 307 timing  145 trade secrets  140 treaty networks  141 two-tier approach  139–40, 142, 307 Transfer Pricing Guidelines (OECD) BEPS project  46, 314 Commodities Discussion Draft (OECD)  123–4 comparability adjustments to quoted price  123 deemed pricing, guidelines on  123 documentation  139 European Parliament  181 Intra-Group Services Discussion Draft (OECD)  118, 306 Profit Split Discussion Draft (OECD)  120 Risk and Re-characterisation Discussion Draft (OECD)  124–5 royalties  275 significant adjustments to price  122–3 state aid  269–78 transparency Action Plan (Commission)  181–3, 187–8, 312 banks  7, 290, 294 BEPS project  49, 232–3 CBI Principles  1 Code of Conduct Group for Business Taxation (EU)  196–8 corporate social responsibility  29, 31–2, 37, 40, 232–3 country-by-country reporting  232–3 disclosure of aggressive tax planning ­arrangements  134, 138 economic substance criteria  213 European Taxpayer’s Code, proposal for  27 exchange of information  187–91, 228 Extractive Industries Transparency ­Initiative  182 Financial Transaction Tax, proposal for  302 Foreign Account Tax Compliance Act, Model inter-governmental agreement on ­implementation  182, 312

341

Global Forum on Transparency and Exchange of Information for Tax Purposes  181 good governance  24, 26–7, 31 harmful tax practices, countering  11, 76–7, 81 modified nexus approach  213 multilateral exchange facility, cooperation on a pilot  182 Mutual Agreement Procedure  149 Mutual Assistance Directive, amendments to  182 OECD Common Reporting Standard  182, 312 Pre-Action Plan Communication (EU)  174–5 preferential tax regimes  6, 81 Revised Capital Requirements Directive  182 shell companies, crackdown on ­anonymous  182–3 state aid  242, 247 tax havens  11 Tax Transparency Package  81, 187–92, 195, 287, 308 treaties see double tax treaties; OECD Model Tax Treaty treaty shopping  51, 220–8 double non-taxation  220 forum shopping  222–3, 316 free movement of capital  221–3, 225 freedom of establishment  221–3, 225–6 prevention of abuse  86, 88–9, 91–2, 95, 305, 311 Turkey  145 UK Uncut movement  9 unilateral measures, concerns over  310, 314–16 United Kingdom see also Diverted Profits Tax (DPT) (‘Google Tax’) (UK) boardroom, tax in the  41 developing countries  9 disclosure of aggressive tax planning ­arrangements  138 enhanced cooperation procedure  295–300 Financial Transaction Tax, proposal for  291, 293, 295–300 HM Revenue and Customs  16–18, 43–4, 313 House of Lords EU Committee  295–9 IP boxes  199–200 Luxembourg, tax clearances arranged by PWC in  138 multilateral exchange facility, cooperation on a pilot  182 nexus approach  81–2 patent box regimes  81–2, 199–200, 213–14 Public Accounts Committee (PAC)  11–19, 38

342

Index

Stamp Duty Land Tax (SDLT)  296 state aid  258–61, 264, 267, 280 Stop Tax Dodging initiative  9 transparency  181–2 United Nations (UN) developing countries  159 Doha Declaration on Financing for ­Development  24 good governance  23–4, 27 transfer pricing  311 value creation  311 United States arbitration  151–2 BEPS project  21, 314 boardroom, tax in the  41 check-the-box regime  20, 70 controlled foreign companies  70 corporate social responsibility  39 double non-taxation  314 double tax treaties  86, 92, 96, 98 exchange of information  181 Financial Transaction Tax, proposal for  297 Foreign Account Tax Compliance Act  181–2, 312 GAAR disputes  152 harmful tax practices  7 Intra-Group Services Discussion Draft (OECD)  118 Limitation-on-Benefits  86, 92, 96, 98 Microsoft, use of outside experts to ­audit  160 Model Tax Treaty  314 OECD Model Tax Treaty, reservation to  102 residence/source dichotomy  19–21 Risk and Re-characterisation Discussion Draft (OECD)  128 savings clauses  88, 94 Senate hearings  19–21 Stop Tax Haven Abuse Act, proposal for  21 transfer pricing  20, 314 Treaty Abuse Second Revised Discussion Draft (OECD)  314 value added tax see VAT value creation principle arm’s length principle  159–61 BEPS project  50, 305, 312 cost contribution arrangements  116 developing countries  159–61 digital economy  194 intangibles  106–10, 116, 305–6 Profit Split Discussion Draft (OECD)  120

Risk and Re-characterisation Discussion Draft (OECD)  128 risks and capital and other high risk ­transactions  118 transfer pricing  106–10, 305–6, 311–12 VAT  163–6, 186, 308 administration  54, 57–8 arm’s length principle  164 Court of Justice, development of principle of abuse by  163–6, 186, 308 digital economy  54, 57–8, 192–5 directives  166, 218–19 economic/commercial reality, transactions reflecting  165–6, 217 re-characterisation  164 Sixth VAT Directive  163–5 sole purpose test  166 supply of services  163 view of the corporation aggregate or nexus of contracts view  32 artificial entity view  32 real entity view  32 Vodafone  11, 17 white lists of jurisdictions  8 wholly or partly artificial arrangements, rules targeting  208–11 Anti-Abuse Communication (­Commission)  168–9 BEPS Action Plan  208–11, 308 controlled foreign companies  67, 206, 208, 210–11 Court of Justice, case law of  206, 208–10, 308 economic/commercial reality, transactions reflecting  206–7, 208–10 EU law, compatibility of BEPS project with  208–11, 308 excessive loan interest payments  211 free movement of capital  225 freedom of establishment  206, 225 hybrid loans and mis-matches  208 principal purposes test  229 proportionality test  168, 206, 208–10, 308 purpose or intention test  206 thin capitalisation  209 treaty shopping  225 United Kingdom  209–10 withholding tax  55, 74, 87, 89, 93, 109, 204 World Bank, guidance from  158–9 zero taxation  177