Single Taxation? 9087224915, 9789087224912

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Single Taxation?

Single Taxation?

Editor: Joanna Wheeler

IBFD Visitors’ address: Rietlandpark 301 1019 DW Amsterdam The Netherlands Postal address: P.O. Box 20237 1000 HE Amsterdam The Netherlands Telephone: 31-20-554 0100 Fax: 31-20-622 8658 www.ibfd.org © 2018 IBFD 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, electronic, mechanical, photocopying, recording or otherwise, without the written prior permission of the publisher. Applications for permission to reproduce all or part of this publication should be directed to: [email protected]. Disclaimer This publication has been carefully compiled by IBFD and/or its author, but no representation is made or warranty given (either express or implied) as to the completeness or accuracy of the information it contains. IBFD and/or the author are not liable for the information in this publication or any decision or consequence based on the use of it. IBFD and/or the author will not be liable for any direct or consequential damages arising from the use of the information contained in this publication. However, IBFD will be liable for damages that are the result of an intentional act (opzet) or gross negligence (grove schuld) on IBFD’s part. In no event shall IBFD’s total liability exceed the price of the ordered product. The information contained in this publication is not intended to be an advice on any particular matter. No subscriber or other reader should act on the basis of any matter contained in this publication without considering appropriate professional advice. The IBFD and/or the author are not responsible for external content, broken links or risks within the external websites that are referenced as hyperlinks within this publication. Where photocopying of parts of this publication is permitted under article 16B of the 1912 Copyright Act jo. the Decree of 20 June 1974, Stb. 351, as amended by the Decree of 23 August 1985, Stb. 471, and article 17 of the 1912 Copyright Act, legally due fees must be paid to Stichting Reprorecht (P.O. Box 882, 1180 AW Amstelveen). Where the use of parts of this publication for the purpose of anthologies, readers and other compilations (article 16 of the 1912 Copyright Act) is concerned, one should address the publisher.

ISBN 978-90-8722-491-2 (print) ISBN 978-90-8722-489-9 (eBook, ePub); 978-90-8722-490-5 (eBook, PDF) NUR 826

Table of Contents Foreword

xi Part 1 Single Taxation as a Policy Goal

Chapter 1: In Search of Single Taxation Francesco De Lillo 1.1. Introduction 1.2. The single tax principle: Historical background 1.2.1. Preliminary remarks 1.2.2. The single tax principle 1.2.2.1. Notion 1.2.2.2. Origin and developments of the principle in the international tax framework 1.2.3. The legal justification: Is there an international tax regime? 1.2.4. The theoretical justification: Single taxation as a remedy against which “evils”? 1.2.4.1. The intermediate ideal 1.2.4.2. More than single taxation 1.2.4.3. Less than single taxation 1.3. Reverse hybrids: Why less than single taxation? 1.3.1. Methodological approach: Linking theory and practice 1.3.2. The Dutch CV-BV structure 1.3.2.1.  Commanditaire vennootschap: Legal framework 1.3.2.2. Features of the structure 1.3.2.3. Tax implications 1.3.3. Why less than single taxation? 1.3.3.1. Counting the levies 1.3.3.2. Base erosion: Who is the victim? 1.3.3.3. The origin of the “evil”: Tax arbitrage in the international debate 1.4. Achieving single taxation: The application of the BEPS Action 2 recommendations 1.4.1. The achievement of single taxation as envisioned by the OECD v

3 3 5 5 5 5 8 10 15 15 16 17 17 17 19 19 19 21 22 23 25 27 29 29

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1.4.2. Neutralizing hybrid mismatch arrangements: Recommendations for domestic law 30 1.4.2.1. The main solution 30 1.4.2.2. The linking rule applied to the CV-BV structure: Single taxation, finally? 31 1.4.2.3. The other specific recommendations 32 1.4.2.4. The treaty hybrid provision  34 1.5. Some critical remarks 35 1.5.1. Single taxation as an economic concept 36 1.5.2. Single taxation principle versus independent entity principle: Clash of the titans? 38 1.5.3. Taxing income or taxing persons? 39 1.5.4. Taxing somewhere, no matter where 40 1.6. Exploring other scenarios: The thin line between single and double taxation 42 1.6.1. Alternative measures 42 1.6.2. First hypothesis: Dual inclusion with relief 43 1.6.2.1. The OECD alternative for achieving single taxation 43 1.6.2.2. Brief remarks on the risks of over-taxation46 1.6.3. Second hypothesis: Withholding tax on payments to a hybrid 47 1.6.4. Third hypothesis: Agreement on the qualification of the hybrid 48 1.6.5. The thin line between single and double taxation 49 1.7. Conclusions 50 Chapter 2: Exploring Single Taxation: From Concept to Implementation?  Daniel M. Berman and Xu Yan

55

2.1. The concept of single taxation 2.2. Origins of the single taxation principle 2.3. Comments on single taxation 2.3.1. US tax law compared to single taxation 2.3.2. BEPS 2.3.3. Rate of single taxation 2.3.4. Economic double taxation 2.3.5. Customary international law 2.4. US territorial taxation 2.4.1. Change in policy

55 55 58 58 60 61 62 65 67 67

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Appendix:

Excerpts from official explanation of new legislation69

Chapter 3: Single Taxation as a Policy Goal: Controversial Meaning, Lack of Justification and Unfeasibility Prof. Dr. Luís Eduardo Schoueri and Guilherme Galdino

83

3.1. Introduction 83 3.2. What does “single taxation” mean? 84 3.2.1. Formal approach to single taxation: The number of levies does not mean anything 84 3.2.2. Substantive approach to single taxation: The tax rates determined by the benefits principle 86 3.2.3. Single taxation as an economic concept: Juridical double taxation versus economic double non-taxation89 3.3. Why should single taxation be a policy goal? 92 3.3.1. Efficiency argument: The limitation of CEN 93 3.3.2. Equity arguments: The limitation of one perspective96 3.4. Is the adoption of single taxation feasible? 99 3.4.1. Desirability: Single taxation against a nation’s will 99 3.4.2. Possibility: Single taxation beyond a nation’s capacity101 3.5. Conclusion 102 Part 2 Do Taxpayers Have a Right to Effective Double Tax Relief? Chapter 4: Do Taxpayers Have a Right to Effective International Tax Relief? A Sampling Analysis of the Universe of International Tax Systems Luís Flávio Neto 4.1. Introduction 4.2. International tax systems and methods to relieve international taxation 

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4.2.1. Sovereignty, sources of law and fragmentation of international tax law 109 4.2.2. International tax relief and tax policy issues: Method, intensity, extension  115 4.3. Sources of law and evidence about international rights for tax relief 122 4.3.1. Customary international tax law 122 4.3.2. Double tax treaty models: Have the OECD and UN adopted the international tax relief pattern? 125 4.3.3. Tax treaties effectively signed: DTAs and multilateral instruments 131 4.3.3.1. DTAs: The clearest evidence of international tax system(s) 132 4.3.3.2. Multilateral instruments: Is the MLI a game-changer?135 4.3.4. What tax relief are tax authorities and tribunals applying?141 4.4. Is there a process of harmonization in progress?  148 Chapter 5: Do Taxpayers Have a Right to DTR? Joanna Wheeler 5.1. Introduction 5.2. Effective DTR 5.3. Possible foundations of a right to DTR 5.3.1. Current international order 5.3.2. Fairness  5.3.3. Ability to pay 5.3.4. Right to peaceful possession of property 5.3.5. Constitutional commercial principles 5.3.6. Broader human rights principles 5.4. Other types of double taxation 5.5. Conclusion 

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149 149 149 153 154 156 160 163 164 170 175 179

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Part 3 Single Taxation in the EU Internal Market Chapter 6: Single Taxation in a Single Market? Frans Vanistendael

183

6.1. What is meant by single taxation in a single market? 183 6.2. Applying the single taxation principle in the European Union 184 6.3. Single taxation in the EMU 185 6.4. Double and single taxation and basic tax principles 186 6.4.1. The benefits principle permits double taxation 186 6.4.2. The ability-to-pay principle limits double taxation187 6.4.3. The role of fiscal sovereignty 188 6.4.4. Conclusion as to double or single taxation 188 6.5. Double and single taxation in the single market 190 6.5.1. Difference between the EU and international tax communities 190 6.5.2. Limits on the legislative powers of income taxation in the European Union 190 6.5.3. Single taxation is no justification of national anti-abuse measures 191 6.5.4. Single taxation in CFC rules: Overruling national fiscal sovereignty 192 6.5.5. Single taxation and hybrids in the ATAD 194 6.5.6. Single taxation and barriers to interest deduction in the ATAD 197 6.6. General conclusions 202 Chapter 7: Double (Tax) Jeopardy Peter J. Wattel 7.1. Single taxation or equitable taxation? 7.2. Ne bis in idem: Parallels between double taxation and double punishment 7.3. Single taxation as a human right? 7.4. Internal consistency or the territoriality principle as a remedy for double taxation in the European Union? 7.5. Conclusion

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Appendix Oxford-Style Debate Chapter 8: International Single Taxation: A Misguiding Notion Eric C.C.M. Kemmeren and Francesco De Lillo 8.1. Introduction 8.1.1. The motion of the House 8.1.2. Research question and methodology 8.2. The idea of single taxation 8.2.1. Theoretical framework 8.2.2. Traces of the notion of single taxation in the international tax framework 8.2.3. Single taxation: Can one really define it? 8.2.3.1. Taxing the same subject?  8.2.3.2. Taxing the same object? 8.2.3.3. Taxing at the fair rate? 8.3. Is single taxation the Holy Grail? 8.3.1. Over-taxation of cross-border income 8.3.2. Undertaxation of cross-border income 8.4. The idea of single taxation tested 8.4.1. The principle of (tax) sovereignty  8.4.2. The direct benefits principle 8.4.3. Internation equity 8.4.4. The principle of origin 8.4.5. Tax neutrality 8.4.6. The BEPS Project’s mission 8.5. Conclusions Chapter 9: International Single Taxation: The Holy Grail Dr Svetislav V. Kostić and Neha Mohan 9.1. Introduction: From Chalcedon to Byzantium, with Mahabharata at their side 9.2. The two chimeras 9.3. Picking the Apple at Runnymede 9.4. The Ummah mindset and the Dutch migrant to Belgium who became the King of the Franks 9.5. The Echnaton conclusion 

219 219 219 219 220 220 222 223 224 225 226 226 227 228 229 229 231 232 233 233 234 235 237

237 240 243 249 254

List of Contributors257

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Foreword IBFD is proud to present this book as the product of a symposium held in October 2017 to celebrate the third year of the advanced LL.M. programme, “International Tax Law: Principles, Policy and Practice”, offered jointly by the University of Amsterdam and IBFD. This symposium is an annual event held at the IBFD premises with many leading speakers, a limited number of participants and a programme designed to encourage debate. Much of the programme takes the form of “duets”, in which two speakers engage with each other about one segment of the symposium topic. In 2017, the programme for the first time concluded with an Oxford-style debate between two academics, each supported by a graduate of the 2016/17 LL.M. programme, which provided a lively close to the day. This book starts with an adapted version of the LL.M. thesis written by one of the graduates of the 2016/17 programme, which explores the notion of single taxation and raises many questions. It continues with two contributions for each of the segments addressed during the symposium. In providing two discussions of the same issue, with different approaches, the aim of the book is to explore the richness of international tax law in order to provide inspiration to future generations of students and encourage them to develop their own approach to the discipline. IBFD wishes to express its gratitude to all the speakers/authors for their contributions to the symposium and their written contributions to this book. We look forward to future editions of both and hope that we can continue to provide inspiration to students of international tax law, whether they are studying for their master’s degree or are further advanced in their career but still interested in the fundamental issues. Joanna Wheeler Programme Director, Advanced LL.M., “International Tax Law: Principles, Policy and Practice”

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Part 1

Single Taxation as a Policy Goal

Chapter 1 In Search of Single Taxation Francesco De Lillo1

1.1. Introduction Traditionally, the efforts of international cooperation in the field of taxation have primarily targeted double taxation issues. With regard to cross-border income, conflicting taxing claims overlap potentially leading to the imposition of an excessive tax burden that might hinder international trade and investments. Tax treaties represents the product of such an effort, as they are explicitly aimed at removing the “obstacles to the development of economic relations between countries”2 deriving from international juridical double taxation. In the past decades, the concerns of the international framework have increasingly shifted towards the opposite problem, which arises when cross-border income is unduly subject to a reduced level of taxation or somehow remains completely untaxed. It has been recognized that multinational enterprises diffusely engage in tax planning so as to achieve double non-taxation, and this phenomenon has become too significant to be further tolerated by the international community. The BEPS initiative promoted by the OECD and G20 ultimately constitutes the acknowledgement of such an emergency. In this context, single taxation appears to be the policy goal envisioned by scholars and embodied by the relevant international organizations to address the harmful implications of both double taxation and double non-taxation. As suggested by the terminology itself, the concept of single taxation implies that income is taxed once and only once. From a global policy 1. This chapter is an adapted version of F. De Lillo, In Search of Single Taxation: The Twilight of an Idol?, LL.M Thesis, University of Amsterdam (2017). The author is deeply grateful to Joanna Wheeler for her patient supervision and the essential scientific (and moral) guidance: the paper is indeed the product of many afternoons spent together discussing the topic. Special thanks go also to Professor Reuven Avi-Yonah for his cosupervision and to Professors Daniel Berman, Frans Vanistendael and Luís Schoueri for their precious feedback. 2. OECD, Model Tax Convention on Income and on Capital, Introduction, para. 1 (OECD 2017), Models IBFD.

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Chapter 1 - In Search of Single Taxation

perspective, the imposition of a single layer of taxation would thus constitute the ideal and rightful tax treatment of cross-border income. It would hence seem consequential to recognize an underlying jurisdictional issue and to question where the single levy should be imposed and on the basis of which policy considerations. Prima facie, the single tax principle could be regarded as an allocation rule conceived to divide the concurrent taxing claims of the residence and the source jurisdictions on cross-border income. Nevertheless, while pursuing the ideal of single taxation, the international debate tends to be reluctant to explicitly address such a jurisdictional issue. Yet, if the main concern does not involve the identification of the jurisdiction entitled to impose the single levy, what would be the rationale of the single tax principle? In the light of which considerations would one layer of fiscal imposition be more rightful than two or none? Taking into account the above observation, substantial doubts arise. It seems difficult to justify, from a theoretical perspective, the relevance of the number of levies per se imposed on cross-border income and to further argue that states should unilaterally comply with such a policy, designing their own systems on the basis of the features of the other jurisdictions. More likely, the problem that should be solved or fixed by single taxation is different: after reading the arguments in support of the existence of the single tax principle, the impression is that the real concern to be addressed can be regarded as an “amount issue” that involves the overall tax burden imposed on cross-border income. Thus, the chapter intends to analyse the theoretical configuration of the single tax principle and to assess how it has been envisioned by the OECD and promoted within the BEPS Project. The research will highlight several inconsistencies, which indicate that, at the current stage, it is still difficult to ascribe precise and coherent content to such a concept or to identify the underlying policy justifications. Section 1.2. examines the theoretical formulation of the principle by mainly focusing on Avi-Yonah’s theories. Section 1.3. analyses the so-called situation of “less than single taxation”, illustrating how double non-taxation occurs, why it is “evil” and for which reasons it should be addressed in compliance with the single tax principle. At the same time, the methodological approach that will be used in the overall research is introduced. A concrete hybrid mismatch arrangement, the Dutch CV-BV structure, will serve as a test to provide a better understanding of the theoretical background underlying the single taxation ideal. Section 1.4. assesses the achievement of single taxation as proposed by the OECD with regard to reverse hybrid mismatches, pointing out several 4

The single tax principle: Historical background

weaknesses of this solution. Lastly, section 1.5. takes into consideration some alternatives to neutralize the concrete mismatch, thus preparing the ground for drawing the overall conclusions.

1.2.  The single tax principle: Historical background 1.2.1. Preliminary remarks Reflecting on the taxation of cross-border income from an international policy perspective, two fundamental dilemmas must be addressed: – How should the income derived from international transactions be taxed, or, in other words, “what is the appropriate level of taxation that should be levied”3 upon it? – Where should such income be taxed and how should the revenues be divided between the involved jurisdictions? According to a controversial thesis formulated by some scholars (especially by Avi-Yonah), which has gained, over time, an increasingly wide consensus, the answer to these questions is provided by two interrelated concepts, i.e. the single taxprinciple and the benefits principle. In this context, these principles constitute the core of an allegedly inherent “international tax regime”. Yet, by reading the arguments of the single tax principle’s supporters, some questions arise intuitively: What does single taxation exactly mean? Are we dealing with a jurisdictional issue, hence related to the “number” of levies, or with an amount issue concerning the rates of taxation?

1.2.2. The single tax principle 1.2.2.1. Notion The single tax principle can be formulated as follows: “Income from crossborder transactions should be subject to tax once (that is, neither more nor less than once).”4 (Emphasis added) 3. R.S. Avi-Yonah, International Taxation of Electronic Commerce, 52 Tax Law Review 3, p. 517 (1997). The two basic issues are further expressed as “defining the tax base” and “dividing the tax base”. 4. Id. This formulation constitutes the starting point of a coherent structure further developed by Avi-Yonah, and it has been recalled in several papers. See, for example,

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By addressing the definition of the tax base in respect of income arising in one country and paid to a resident of another jurisdiction,5 the principle appears to entail per se the imposition of a single layer of taxation at the rates established by the benefits principle, which allocates the primary right to tax active income to the source jurisdiction while leaving to the residence state the primary tax claims over passive income. In the light of these indissociable rules, the concerns underlying the taxation of cross-border income can be regarded prima facie as a jurisdictional matter: the recognition of a sort of “natural” right to be subject to tax on every item of income only once unavoidably leads to the issue of where this single tax should be levied. The allocation rule incorporated in the benefits principle can be properly justified, both on a theoretical and a factual level.6 With regard to passive income, residence-based taxation seems to be the most reasonable and feasible solution, as investment income is mainly earned by individuals. In such case, residence can be easily established and the distributive function of taxation can be addressed more efficiently, as the resident individual can take advantage of all the social benefits provided by the jurisdiction in which he is established. On the other hand, business income is primarily derived by corporations, the residence of which is an extremely volatile concept, especially in the era of globalization and digital communications (both of the traditional criteria based on the place of incorporation (POI) or the place of effective management (POEM) can be easily manipulated by taxpayers). Since multinational enterprises are not part of a single society and their income cannot be attributed to any specific jurisdiction for distributive purposes, source-based taxation turns out to be more consistent from a benefits perspective; after all, businesses benefit from infrastructure, labour and other resources of the country in which they

R.S. Avi-Yonah, International Tax Law as International Law, 57 Tax Law Review 4 (2004); R.S. Avi-Yonah, Tax Competition, Tax Arbitrage and the International Tax Regime, 61 Bull. Intl. Taxn. 4, p. 131 (2007), Journals IBFD; R.S. Avi-Yonah, Who Invented the Single Tax Principle? An Essay on the History of U.S. Treaty Policy, 59 New York Law School Law Review, p. 306 (2014/15); and R.S. Avi-Yonah, Full circle? The Single Tax Principle, BEPS, and the New US Model, Global Taxation 1, pp. 12-13 (2016). 5. In this regard, see also J.M. de Melo Rigoni, The International Tax Regime in the Twenty-First Century: The Emergence of a Third Stage, 45 Intertax 3, p. 208 (2017). 6. For the sake of completeness, it is relevant to specify that Avi-Yonah recently proposed a re-evaluation of the benefits principle in light of the reality of globalization so as to tackle more effectively corporate tax avoidance and double non-taxation phenomena. In particular, passive income should be taxed primarily by the source state, while active income primarily by the residence state (see R.S. Avi-Yonah & H. Xu, Evaluating BEPS: A Reconsideration of the Benefits Principle and Proposal for UN Oversight, 6 Harvard Business Law Review 2, pp. 234-235 (2016-2017).

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The single tax principle: Historical background

operate. Lastly, from a practical point of view, the source jurisdiction has, by definition, the first chance to tax income generated within its territory.7 Up until this point, one might be tempted to operate a logical “inversion” and consider the single tax principle as a corollary of the benefits principle. In other words, one might assert that cross-border income should be subject to a single layer of taxation due to the fact that overlapping taxing claims can be correctly divided on the basis of the above theoretical and pragmatic grounds. Yet, several elements lead to a different conclusion that clashes with the idea of reducing the single tax theory to a mere jurisdictional issue. First, further arguments proposed by the major supporter of the thesis at stake, Avi-Yonah, assess the compatibility of the benefits principle with the single taxation principle by focusing on rates. After comparing the variability of the top marginal individual income tax rates and corporate tax rates among OECD member countries, Avi-Yonah concludes that “all income from cross-border transactions under current rate structures should be taxed at a rate between approximately 30% (the lower end of the source rates) and 60% (the higher end of the residence rates)”.8 As confirmed by the further considerations below, the impression is that the concerns underlying the single tax principle consist in the achievement of a “fair” rate of taxation more than a proper allocation of taxing rights. Second, with regard to corporate income of multinational enterprises, the above principles are unable to clearly address the issue of dividing the tax base among the different jurisdictions providing benefits.9 Last but not least, the single taxation principle allegedly includes a “residual” provision, by virtue of which the other jurisdiction should tax cross-border income if the state that has the primary taxing right under the benefits principle refrains from taxation10 so as to avoid undertaxation.11

7. For all of these arguments, see Avi-Yonah, supra n. 3, at pp. 520-521. 8. Id., at p. 522. The proposed range of rates was updated in a later study (the lower end of the source rates would be 25%, while the higher end of the residence rates would be 55%), but still, the distinction between active/corporate income and passive/individual income is compliant with the single taxation principle “since most of the rate divergence among taxing jurisdictions arises in the individual income tax, while corporate tax rates have tended to converge” (see Avi-Yonah 2007, supra n. 4, at p. 135). 9. Avi-Yonah, supra n. 3, at p. 517. 10. Id. 11. As further illustrated (see sec. 1.2.4.), double non-taxation is one of the “evils” that single taxation should prevent.

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If we consider especially the last statement, it becomes clear that the single tax principle is described as a concept that goes beyond allocation rules or the perspective of a single jurisdiction. It can be regarded as a sort of superior and intrinsic principle that has two faces: on one hand, the “right” – attached to every item of income arising from cross-border transactions – to be subject to taxation no more than once, and on the other hand, the “obligation” of being subject to taxation not less than once. In other words, income should be taxed once, regardless of where the single levy is imposed, at a rate that does not exceed the residence jurisdiction’s rate and is not lower than the source jurisdiction’s rate. But can one really speak about single taxation as ontology as if it was an inherent attribute of cross-border income? The answer obviously is no, and it appears logical to question from where this principle is derived, on what basis it could be justified and for what goal or consideration it should be implemented unilaterally in the international tax policy of each single jurisdiction.

1.2.2.2. Origin and developments of the principle in the international tax framework The first clear expression of the single tax principle within the international environment can be found in the work of the League of Nations. The commentary to the first model convention drafted by the Committee of Technical Experts in 1927 includes the following statement: It is highly desirable that States should come to an agreement with a view to ensuring that a taxpayer shall not be taxed on the same income by a number of different countries, and it seems equally desirable that such international cooperation should prevent certain incomes from escaping taxation altogether. The most elementary and undisputed principles of fiscal justice, therefore, required that the experts should devise a scheme whereby all incomes would be taxed once and only once.12 (Emphasis added)

It’s not a coincidence that such idea was already envisioned by Adams,13 the architect of the foreign tax credit adopted by the United States in 1918 (which implicitly embraced the single tax principle by denying the credit 12. Report presented by the Committee of Technical Experts on Double Taxation and Tax Evasion, Doc. G.216.M.85 II, p. 23 (League of Nations 1927). 13. See T.S. Adams, Interstate and International Double Taxation, in R.F. Magill et al., Lectures on Taxation, pp. 112-113 (Chicago Commerce Clearing House 1932): “The

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The single tax principle: Historical background

where no taxation was levied by the source state), which also took part in the work of the League of Nations. Yet, the tax policy developments – from both a unilateral and a bilateral perspective – of the ensuing years showed a greater focus on just one side of the single tax principle, i.e. double taxation relief. As Ault noted, “for tax competition reasons some countries were happy to see structures that reduced the tax burden on their multinational enterprises in their activities abroad, and facilitating double non-taxation was part of the effort”.14 In this regard, Ring explained that double taxation “exacts a high price” that could ultimately erase the profits of a transaction or even demand more than the income actually earned, and for this reason, both governments and taxpayers had a stronger interest in avoiding it. In contrast, double non-taxation is not able to hinder cross-border trade, but just distort its shape.15 The efforts of international cooperation have shifted to the prevention of double non-taxation following the publication in 1998 of the OECD Report on Harmful Tax Competition and the subsequent report on the Application of the OECD Model Tax Convention to Partnerships16 in 1999, and according to Avi-Yonah, starting from the early 21st century, the OECD Model Tax Convention on Income and on Capital (OECD Model Convention) has incorporated the single tax principle.17 Finally, the release of the final BEPS package on 5 October 2015 should represent the official commitment by the OECD and G20 to the single tax state which with a fine regard for the rights of the taxpayer takes pains to relieve double taxation, may fairly take measures to ensure that the person or property pays at least one tax.” (Emphasis added) 14. H.J. Ault, Some Reflections on the OECD and the Sources of International Tax Principles, 70 Tax Notes International 12, p. 1195 (2013). For an evaluation of the inconsistent approach towards double non-taxation (with a special focus on the US system), see Avi-Yonah 2014/15, supra n. 4. 15. D.M. Ring, One Nation Among Many: Policy Implications of Cross-border Tax Arbitrage, 44 Boston College Law Review 2, p. 106 (2002). 16. OECD, The Application of the OECD Model Tax Convention to Partnerships (OECD 1999), para. 52 [hereinafter the Partnership Report] explicitly states that the two basic purposes of the OECD Model Convention are the elimination of double taxation and the prevention of double non-taxation. 17. Avi-Yonah 2014/15, supra n. 4, at p. 314 makes reference to the limitation-onbenefits provision and the recommendations regarding partnerships and other entities not subject to taxation included OECD Model Tax Convention on Income and on Capital: Commentary on Article 1 (26 July 2014), Models IBFD [hereinafter Commentary on Art. 1 OECD Model]. Yet, the opposite conclusion is drawn by M. Lang, Double Non-Taxation – General Report, in IFA Cahiers de droit fiscal international, vol. 89a, pp. 77-119 (IFA 2004).

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principle, i.e. to the prevention of both double taxation and double nontaxation. A new Preamble was, in fact, inserted in the 2017 OECD Model Convention, which states that the contracting parties intend to conclude a Convention “for the elimination of double taxation with respect to taxes on income and on capital without creating opportunities for non-taxation or reduced taxation through tax evasion or avoidance”.18 In this regard, it is interesting to quote the words of OECD Secretary-General Angel Gurría, delivered during the presentation of BEPS Project output to be discussed at the G20 Finance Ministers meeting in Lima on 8 October 2015: BEPS is depriving countries of precious resources to jump-start growth, tackle the effects of the global economic crisis and create more and better opportunities for all. But beyond this, BEPS has been also eroding the trust of citizens in the fairness of tax systems worldwide. The measures we are presenting today represent the most fundamental changes to international tax rules in almost a century: they will put an end to double non-taxation, facilitate a better alignment of taxation with economic activity and value creation, and when fully implemented, these measures will render BEPS-inspired tax planning structures ineffective.19 (Emphasis added)

Whether or not one agrees with the conclusion that the Model Convention has formally incorporated the single tax principle, it is still reasonable to question the implications of the official commitment by the OECD. Leaving aside bilateral treaty dynamics, why should states adopt this perspective unilaterally, shaping their own domestic systems in accordance with the single tax principle? In other words, on the basis of which policy justifications should a jurisdiction care about what is happening elsewhere when, according to its own system, its tax base is not under threat of being eroded?

1.2.3. The legal justification: Is there an international tax regime? According to Avi-Yonah, the answers to the questions posed in section 1.2.2.2. are to be found in the existence of a greater “international tax regime” that is part of customary international law. 18. OECD/G20, Preventing the Granting of Treaty Benefits in Inappropriate Circumstances – Action 6: 2015 Final Report, p. 91, para. 72 (2015), International Organizations’ Documentation IBFD [hereinafter Action 6 Final Report]. 19. OECD Centre for Tax Policy and Administration, OECD presents outputs of OECD/G20 BEPS Project for discussion at G20 Finance Ministers meeting, Press release (5 Oct. 2015), available at http://www.oecd.org/tax/oecd-presents-outputs-of-oecd-g20beps-project-for-discussion-at-g20-finance-ministers-meeting.htm.

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Such belief is first grounded in the undisputable recognition of a “remarkable degree of convergence even in the purely domestic tax law of developed countries” that manifests itself in the emergence of a sort of international “common language” (e.g. the concept of residence, corporation or permanent establishment), as well as in similar strategies to address similar issues (e.g. the progressive incorporation of scheduler elements by jurisdictions with a global tax system).20 However, the main evidence of the existence of an international tax regime can be found in the bilateral tax treaty network: whether based on the OECD or UN Model Convention,21 tax treaties share analogous policy concerns, are drafted with similar wording and usually have a higher constitutional status than domestic legislation, hence being capable of limiting and overriding the latter.22 The result is that every jurisdiction implicitly accepts and complies with the superior international regime so that the freedom of most countries to adopt international tax rules is severely constrained:23 could a country ultimately extend its taxing claims over non-residents’ foreign-source income? The spontaneous answer is, of course, no. According to Avi-Yonah’s opinion, not only an international tax regime exists, but it would also rise to the level of international customary law, which is commonly regarded as the product of two elements: (i) diuturnitas, i.e. a uniform and consistent practice of states; and (ii) opinio juris sive necessitatis, meaning the awareness of a legal and binding obligation to follow that practice. The methods of double taxation relief could constitute an interesting example: although several economists have expressed a preference for a deduction of foreign taxes rather than a credit, states usually still grant a 20. R.S. Avi-Yonah, Commentary (Response to H.D. Rosenbloom), 53 Tax Law Review 2, p. 168 (2000) (see also Avi-Yonah 2007, supra n. 4, at p. 131). The same observation has been expressed by H.D. Rosenbloom, The David R. Tillinghast Lecture: International Tax Arbitrage and the “International Tax System”, 53 Tax Law Review 2, p. 139 (2000), although, as further explainedin this section, his opinion about the international tax system is significantly different. 21. UN Model Double Tax Convention Between Developed and Developing Countries (2011), Models IBFD. 22. In this regard, see also V. Thuronyi, International Tax Cooperation and Multilateral Treaties, 26 Brooklyn Journal of International Law 4 (2001). Quoting the American Law Institute, the scholar states that the OECD Model Convention “has almost acquired the status of multilateral instrument”. 23. Id., at p. 170.

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credit when the foreign-source income is not exempt. In addition, also the arm’s length principle and the non-discrimination principle would fall under the category of international customary law, as they are widely included in domestic tax policies.24 In this framework, the single tax principle would constitute “the core principle of international tax law”,25 and being part of international customary law would somehow shape states’ policy choices. These arguments might sound convincing – especially from a systemic perspective – and it is not surprising that Avi-Yonah’s voice has increasingly gained support among scholars and experts in the field. Vann wrote about the emerging of an (almost) worldwide consensus in respect of the features of the “international income tax regime”, stating that the achievement of single taxation represents the basic goal of the international income tax system.26 Ring admitted that the concept of an international tax regime is much more fluid than that of a domestic tax system because there is no supranational authority or even a multilateral agreement. However, despite the lack of a binding framework, she identified a common and shared structure underlying the bilateral treaty network, i.e. the work of the relevant international organizations and the domestic provisions regulating the taxation of cross-border transactions, which is inspired and shaped by the vision that income should be subject to a single (no more and no less) layer of taxation.27 Brauner observed that most rules comprising international taxation are very close to being de facto harmonized,28 and the single taxprinciple is at the core of tax treaty practice.29 Lastly, Pistone stated that the BEPS movement is laying the foundation for a “global supranational tax law”,30 and de Melo Rigoni recently proposed a chronology of the international tax regime, divided into three phases, wherein the primary relevance of the single tax principle is constant.31

24. Avi-Yonah 2004, supra n. 4, at pp. 496-500. 25. Avi-Yonah & H. Xu, supra n. 6, at p. 208. 26. R. Vann, International Aspects of Income Tax, in Tax Law Design and Drafting, vol. 2, p. 4 (V. Thuronyi ed., IMF1998). 27. Ring, supra n. 14, at pp. 104-105. 28. Y. Brauner, An International Tax Regime in Crystallization, 56 Tax Law Review 2, p. 263 (2003). 29. Id., at p. 291. 30. P. Pistone, International Tax Coordination through the BEPS Project and the Exercise of Tax Sovereignty in the European Union, in International Tax Law: New Challenges to and from Constitutional and Legal Pluralism, sec. 8.3.5. (J. Englisch ed., IBFD 2016). 31. de Melo Rigoni, supra n. 5.

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Yet, the assumption that the single tax principle is the underlying basis/goal of an international customary tax regime is far from being non-controversial. First of all, it has been observed that tax provisions have peculiar features that hinder the formation of international customary law, namely a significant level of technicality and specificity, along with the usual incorporation of qualifications derived from other branches of domestic law (international customary rules are, by definition, formulated in general terms and cannot reach the degree of accuracy of written law). In addition, the harmonization of domestic tax rules promoted by international organizations, the general acceptance of soft law recommendations and the repetition of similar wording among the multiplicity of existing bilateral treaties do not lead per se to the development of international customary rules.32 Leaving aside the arguments on the specific features of customary law, one of the most significant rejections of the single tax principle as well as the overall existence of an international tax regime was elaborated by Rosenbloom33 on the basis of the following observations: – there is an absence of a supranational authority or multilateral agreement embodying such a system;34 – double tax agreements, despite being a “triumph of international law in the field of taxation”, are elective, and therefore taxpayers might always refuse their application and invoke their rights under domestic law;35 and – domestic law by itself cannot embody the single tax principle if not through an unfeasible case-by-case approach, since tax arbitrage opportunities are different in nature and potentially open-ended.36 Given the above reasons, in Rosenbloom’s view, there would be no theoretical or legal justification for the single tax principle: “An attempt to ‘level the 32. G. Maisto, On the Difficulties Regarding the Formation of Customary Law in the Field of Taxation, in EU Law and the Building of Global Supranational Tax Law: EU, BEPS and State Aid, ch. 2, (D. Weber ed., IBFD 2017): “No evidence, in fact, exists in state practice that tax treaty rules are viewed as an expression of opinio juris, which would make states obliged to apply them even in the absence of a treaty.” With regard to the problems occurring in the assessment of the opinio juris requirement in respect of international tax rules, see also S.N. Menuchin, The Dilemma of International Tax Arbitrage: A Comparative Analysis Using the Cases of Hybrid Financial Instruments and Cross-border Leasing, pp. 16-22 (London School of Economics and Political Science 2005). 33. Rosenbloom, supra n. 19. 34. Id., at p. 164. In this regard, see also Maisto, supra n. 31, at para. 2.5.: “Treaties that have been found to crystallize norms of customary international law are generally multilateral treaties, which are extremely rare in the tax field.” 35. Id. 36. Id., at p. 165.

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playing field’ by mandating that foreign persons directly or indirectly entering the U.S. tax system must pay tax at some acceptable level on non-U.S. income is inconsistent with the practical nature of taxation.”37 (Emphasis added) According to Rosenzweig38 and Menuchin,39 no evidence of the single tax principle consensus can be found in the international tax framework, not even by narrowing the analysis to the mere tax treaty area. In Shaviro’s opinion, despite the intensification of international cooperation in the tax field, single taxation upon income deriving from cross-border transactions would be really hard to implement, as the multilateral coordination of all the bilateral interactions between a multiplicity of distinct jurisdictions across multiple dimensions would result in an impossible challenge.40 Even if its implementation would ultimately be feasible, it would be difficult to rationalize such policy goal, since there is no “direct normative reason to care about the number of taxes that are being levied on a given taxpayer transaction. After all, most of us would rather be taxed twenty times at 1 percent rate each time than once at 35 percent”.41 Lastly, in the General Report drafted by Lang for the 58th Congress of the International Fiscal Association held in Vienna in 2004, it was concluded that “[t]he existing [double tax conventions] based on the OECD [Model] cannot be easily seen as serving the prevention of double non-taxation. […] The individual provisions of the OECD [Model] cannot be generally interpreted so as to prevent double non-taxation”42 (Emphasis added). As noted by Black,43 despite the clarifications about the purposes of double tax conventions included in the Commentary first in 1977 and then in 2003,44 Lang’s statement has been confirmed by OECD in the Final Report on BEPS Action 6.45 37. Id., at p. 151. 38. A.H. Rosenzweig, Harnessing the Costs of International Tax Arbitrage, 26 Virginia Tax Review, p. 588 (2007). 39. Menuchin, supra n. 31, at p. 20. 40. D. Shaviro, The Crossroads Versus the Seesaw: Getting a “Fix” on Recent International Tax Policy Developments, New York University Law and Economics Working Papers, no. 408, p. 4 (2015). 41. D. Shaviro, The Two Faces of the Single Tax Principle, in New York University Law and Economics Working Papers, no. 419, p. 2 (2015). 42. M. Lang, supra n. 16, at p. 118. See also P. Harris, Neutralizing Effects of Hybrid Mismatch Arrangements, in Papers on Selected Topics in Protecting the Tax Base of Developing Countries, p. 4 (United Nations 2014). 43. C.M. Black, The Attribution of Profits to Permanent Establishments: Testing the Interaction of Domestic Taxation Laws and Tax Treaties in Practice, 2 British Tax Review 2, p. 172 (2017). 44. Commentary on Art. 1 OECD Model, sec. C(1)7. 45. Para. 68 Action 6 Final Report.

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1.2.4. The theoretical justification: Single taxation as a remedy against which “evils”? 1.2.4.1. The intermediate ideal As highlighted in section 1.2.3., the controversial existence of an international tax regime grounded on the single taxation principle represents the “normative framework” that should constrain and orient the policy choices of states, which are necessarily part of the system and have to comply with the framework’s rules. It is now important to understand the rationale behind the principle and the overall international tax regime, i.e. its theoretical justification. What is its exact aim and for what reason should a jurisdiction be concerned that income not included in its own tax base is taxed somewhere else at some minimum level? What policy, quoting Rosenbloom’s words, “justifies the elimination of otherwise available […] tax benefits for the sole reason that the person claiming such benefits (or an economically related person) also enjoys benefits, tax or otherwise, in another country”?46 As already mentioned in section 1.2.3., in the view of the supporters of the principle, single taxation constitutes a sort of intermediate ideal between two opposite and equally harmful situations, namely double non-taxation on one end and double taxation on the other. The concepts might be expressed graphically as a linear continuum, as if different levels of intensity of the same phenomenon are taken into account (see figure 1.1.). Figure 1.1.

Let us now examine the “evils” underlying the conditions of “more than single taxation” and “less than single taxation”.

46. See Rosenbloom, supra n. 19, at p. 147. For the sake of clarity, see also p. 149: “Why should the U.S. even consider altering the available U.S. interest deduction because Japan has lowered its corporate tax rate or Canada (for example) has adopted particularly beneficial rules for foreign investment?”

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1.2.4.2.  More than single taxation Elimination of double or multiple taxation can be considered without any doubt as one of the main goals of the international cooperation in the tax field since the very beginning.47 From an efficiency point of view, additional tax burdens on income arising from cross-border transactions give rise to “an inefficient incentive to invest domestically”.48 Furthermore, double taxation generally leads to cumulative tax rates that might be significantly high, with the consequence of hindering international investments and trade.49 The result is that the system cannot be neutral, neither from a capital-exporting50 nor from a capital-importing51 perspective. It is relevant to emphasize that double taxation is not wrong or noxious a priori: “[I]t is unjust only when one taxpayer is assessed twice while another in substantially the same class is assessed but once”.52 This is the reason why the object of the international framework’s concerns has always been juridical double taxation (i.e. the imposition of more than one levy of taxation over the same item of income in the hands of the same person). Economic double taxation (i.e. the imposition of more than one levy of tax over the same stream of income in the hands of the same or different persons), on the other hand, occurs in the context of business taxation as an intrinsic implication of the inclusion in the tax mix of both a personal and corporate income tax. It arises equally in domestic and cross-border scenarios and cannot be regarded as unfair.53 Therefore, the underlying assumption

47. See sec. 1.2.2.2. 48. Avi-Yonah, supra n. 3, at p. 518. 49. See para. 1 of the Introduction of the OECD Model Convention: “International juridical double taxation can be generally defined as the imposition of comparable taxes in two (or more) States on the same taxpayer in respect of the same subject matter and for identical periods. Its harmful effects on the exchange of goods and services and movements of capital, technology and persons are so well known that it is scarcely necessary to stress the importance of removing the obstacles that double taxation presents to the development of economic relations between countries.” 50. Capital export neutrality is defined as the situation “where investors are subject to the same level of taxes on capital income regardless of the country in which income is earned” (see IBFD Tax Glossary). 51. Capital import neutrality is defined as the situation “where investments within a country are subject to the same level of taxes regardless of whether they are made by a domestic or foreign investor” (see IBFD Tax Glossary). 52. E.R.A. Seligman, Essays in Taxation, 10th ed., p. 99 (Macmillan 1925). 53. OECD Model Tax Convention on Income and on Capital: Commentary on Article 23A (2017), Models IBFD and OECD Model Tax Convention on Income and on Capital: Commentary on Article 23B (21 Nov. 2017), Models IBFD explicitly exclude from the scope of the articles the cases of economic double taxation (see sec. C(23)1-2].

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Reverse hybrids: Why less than single taxation?

of the single tax principle is that most jurisdictions provide and would like to keep both personal income tax and corporate income tax.54

1.2.4.3. Less than single taxation In the light of symmetrical arguments, less than single taxation would be equally undesirable. If cross-border income is taxed less than domestic income or not taxed at all, foreign investments are inefficiently incentivized to the detriment of domestic investments. Hence, the system is once again not neutral. From an equity point of view, multinational enterprises would receive unfair tax advantages in comparison to small and medium businesses, and at the same time, labour income would be penalized more than business income (labour is far less mobile if compared to capital).55 These forms of discrimination are therefore related with the perception of abuse and tax morality: “[I]f the taxpaying public perceives cross-border tax arbitrage as an abuse available to (and used by) a limited pool of taxpayers […], then the public support for and confidence in the tax system may be undermined.”56 Lastly, in the case of under or non-taxation, an underlying concern of revenue losses arises. Yet, as the author intends to demonstrate in sections 1.3.3.1-1.3.3.2., even if one imagines a simple bilateral scenario, it’s not easy to identify the jurisdiction to which the loss can be ascribed. Given all of these considerations, this chapter will proceed by narrowing the focus down to a concrete example of double non-taxation in order to comprehend more effectively what “evil” occurs, for what reasons and to the detriment of which of the involved jurisdictions.

1.3.  Reverse hybrids: Why less than single taxation? 1.3.1. Methodological approach: Linking theory and practice Section 1.2. dealt with the theoretical structure of the single taxprinciple. The single taxprinciple states that cross-border income should be taxed 54. Avi-Yonah, supra n. 3, at p. 517. 55. Id., at pp. 518-519. 56. Ring, supra n. 14, at p. 122.

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neither more nor less than once, and it should be considered the core principle underlying the development of a customary international tax regime since the work of the League of Nations in the early 20th century. Historically, the efforts of international cooperation in the tax field primarily focused on the prevention of double or multiple taxation. Nevertheless, in the last decades, the focus has increasingly shifted to the other side of the single tax principle, and the BEPS initiative clearly aims at tackling the tax avoidance and double non-taxation phenomena. Yet, according to the author’s opinion, the arguments examined do not address in a fully persuasive way the questions previously raised:57 With special reference to corporate taxation (i.e. an intrinsic form of economic double taxation),58 what does single taxation exactly mean? Why, from a unilateral policy perspective, should the treatment of cross-border income be compliant with it? The most problematic issue lies in the approach towards double non-taxation cases. If one now fully agrees with the relevance of the single tax principle and, in particular, with the statement that the BEPS action plan has sealed the OECD’s “official commitment” to the single tax principle,59 trying to apply the theoretical framework with an example might be clarifying. Therefore, this section examines the functioning and the tax outcome of a concrete hybrid structure, as hybrid mismatch arrangements might be regarded as one of the main sources of double non-taxation. Before assessing and applying the OECD’s recommendations on how to address such mismatches,60, the analysis will focus now on what one might call, using Shaviro’s words, the “downside departures”61 from the single tax principle. The purpose is to understand what is “less than single taxation”, i.e. for what reasons it occurs and how it affects the jurisdictions involved.

57. See, in particular, sec. 1.1.1. 58. Business profits are first taxed in the hands of the corporation and then in the hands of the individual shareholder once distributed, unless a specific provision aimed at eliminating such economic double taxation applies. 59. Avi-Yonah 2016, supra n. 4, at p. 12. 60. See sec. 1.4. 61. Shaviro, supra n. 40, at p. 1.

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Reverse hybrids: Why less than single taxation?

1.3.2. The Dutch CV-BV structure 1.3.2.1.  Commanditaire vennootschap: Legal framework Under Dutch law, a commanditaire vennootschap (CV), or limited partnership, is a special type of general partnership that can be defined as the contractual agreement between one (or more) general partner and at least one limited partner. General partners are responsible for the day-to-day management of the partnership, represent the business in its dealings with third parties and are jointly and severally liable without limitations for the obligations or debts of the CV. Limited partners, on the other hand, are generally the funding provider parties and cannot be involved in direct and active management of the business. In this case, the liability is limited to amount of their capital contribution. Pursuant to the contractual freedom principle, no specific substantial requirement is to be included in the CV agreement, also with regard to the identity of the partners. Therefore, both individuals and entities can be partners in a CV, whether they are resident or non-resident. For tax purposes, the law distinguishes between “closed” limited partnerships and “open” limited partnerships. According to article 2 of the Dutch Corporation Tax Act (Wet op de Vennootschapsbelasting), only the latter category is subject to corporate income taxation, while closed CVs are tax transparent and their profits are taxed in the hands of the partners.62 Therefore, in this case, profit distributions to partners do not trigger dividend withholding tax, and the contribution of assets to a CV is not subject to capital tax. A CV is regarded as closed by the law if the admission of new partners or the transfer of shares is subject to authorization by the unanimity of all the partners. It follows that partners are essentially free to decide whether or not the partnerships should be subject to “flow-through” taxation by simply adapting the partnership agreement.

1.3.2.2.  Features of the structure The so-called “CV-BV” structure is frequently used by multinationals, mainly US residents,63 to avoid taxation on their foreign profits. The US 62. For the sake of clarity, it is proper to specify that profits are still computed at the level of the commanditaire vennootschap (CV, or Dutch limited partnership) and then shared among the partners for tax purposes. 63. As further explained (see sec. 1.3.2.3.), the US check-the-box rules play an essential role for the successful outcome of the scheme.

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multinational enterprise sets up a closed CV in the Netherlands, and the limited partner is generally the head office or another US-resident subsidiary and holds more than 95% of the partnership’s shares, while the general partner can be either another US resident or incorporated in a tax haven.64 The CV is the 100% shareholder of a Dutch operating company (a besloten vennootschap or BV, which is an entity ordinarily subject to corporate income taxation), which usually acts as a holding company for the multinational enterprise’s foreign operating companies (which are normally, but not necessarily, EU residents; see figure 1.2). Furthermore, the CV might grant loans or might license intellectual property to the BV. Figure 1.2.

64. See J. Vleggert, Dutch CV-BV Structures: Starbucks-Style Tax Planning and State Aid Rules, 70 Bull. Intl. Taxn. 3, p. 173 (2016), Journals IBFD.

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Reverse hybrids: Why less than single taxation?

1.3.2.3.  Tax implications The CV-BV structure (see figure 1.2) is essentially used to channel the profits of the operating subsidiaries to the CV by means of payments65 made by the BV. As explained in section 1.3.2.1., the CV is fiscally transparent according to Dutch law, and therefore not subject to corporate income taxation. The United States, on the other hand, grants to taxpayers the possibility of choosing whether or not to confer fiscal transparency upon controlled foreign entities (a so-called “check-the-box” system). For the purposes of the “correct” functioning of the structure that ultimately leads to double non-taxation or at least less than single taxation, the US-resident partners would opt for non-transparency of the CV, giving rise to the cross-border classification mismatch. Given such a framework, interest paid to the CV would be deductible at the level of the BV, and from the Netherlands’ perspective, the payment would flow through the limited partnership straight into the hands of the nonresident partners: no withholding tax would be levied according to either the domestic law or the Netherlands-United States treaty.66 From the United States’ point of view, the payment is received by an opaque entity, and the resident partners are not required to report any income as long as they do not receive any profit distributions from the CV. Due to US policy, partners are essentially able to defer residence taxation until profits are repatriated. The mismatch is not limited to interest paid from the BV to the CV. Under Dutch domestic law, US-resident partners should be subject to a 15% dividend withholding tax upon profit distributions from the BV to the CV, and the reduction to 5% granted by the treaty should not apply due to the

65. Although the analysis here is limited to interest, the structure can also be used to achieve advantageous tax treatment of dividends and royalty payments. 66. Dutch tax law does not provide for any withholding tax on outbound interest, and the treaty between the Netherlands and the United States (signed in 1992 and amended in 2004) states: “Interest arising in one of the States and beneficially owned by a resident of the other State shall be taxable only in that other State.” See Convention between the Kingdom of the Netherlands and the United States of America for the Avoidance of Double Taxation and the Prevention of Fiscal Evasion with Respect to Taxes on Income art. 12(1) (18 Dec. 1992), Treaties IBFD [hereinafter NL-US Treaty].

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hybrid entity provision of article 24(4)67 of the Netherlands-United States treaty. Under this provision, which incorporates the recommendations of the OECD Partnership Report,68 dividends distributed by the BV would be deemed to be derived by US partners to the extent that they are treated as income of US residents for US tax purposes. Conversely, provided that the option for non-transparency is exercised under the check-the-box rules, distributions made by the BV are considered income of the CV from the United States’ perspective, and the Netherlands should hence deny treaty benefits. Nonetheless, in a decree enacted on 6 July 2005,69 the Dutch State Secretary for Finance explained that the above hybrid provision does not apply to the Dutch CV-BV structure, subject to the condition that the BV carries out substantial activities in or via the Netherlands. The decree was published with the explicit purpose of not creating disadvantages for US parent companies holding shares in Dutch subsidiaries through hybrid entities.70

1.3.3. Why less than single taxation? The limited partnership within the context of the CV-BV structure can be classified as a “reverse hybrid”. Such a category, according to the Final Report of BEPS Action 2, is defined as “any person (including any unincorporated body of persons) that is treated as transparent under the laws of the jurisdiction where it is established but as a separate entity (i.e. opaque) under the laws of the jurisdiction of the investor”.71 Due to this condition of “asymmetrical taxation de lege lata”,72 reverse hybrids might, on one hand, be subject to unrelieved double taxation, and on the other hand, they might be exploited by taxpayers to create a hybrid 67. Art. 24(4) NL-US Treaty: “In the case of an item of income, profit or gain derived through a person that is fiscally transparent under the laws of either State, such item shall be considered to be derived by a resident of a State to the extent that the item is treated for the purposes of the taxation law of such State as the income, profit or gain of a resident.” 68. See the Partnership Report, supra n. 15. 69. NL: Staatssecretaris van Financiën, Decree n. IFZ 2005/546M (6 July 2005). 70. Vleggert, supra n. 63, at p. 177. 71. OECD/G20, Neutralising the Effects of Hybrid Mismatch Arrangements – Action 2: 2015 Final Report, p. 56, para. 140 (OECD 2015) [hereinafter Action 2 Final Report]. See also J. Barenfeld, Taxation of Cross-border Partnerships: Double Tax Relief in Hybrid and Reverse Hybrid Situations, p. 22, sec. 1.2. (IBFD 2005); and D.M. Benson et al., “Hybrid” Entities – Practical Application Under the Check-the-Box Regime, 26 Tax Management International Journal 8, p. 364 (1997). 72. Barenfeld, id., at p. 4, sec. 1.3.: “Asymmetrical Taxation is consequently something of a ‘tax paradox’. Depending on the facts of the individual case it will either give rise to unrelieved double taxation or double non-taxation.”

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Reverse hybrids: Why less than single taxation?

mismatch arrangement (like the CV-BV structure) and ultimately achieve unintended double non-taxation. For the sake of clarity, it is now interesting to analyse the tax outcome of the selected structure in the light of the single tax principle. In the context of the chosen scenario, what is the evil rejected by the single tax principle and what gives rise to it?

1.3.3.1. Counting the levies Taking a closer look at the tax consequences arising from the CV-BV structure, two different occurrences must be distinguished. With regard to the flow of interest payments, there is the following situation: – interest paid to the CV is first deductible from the taxable income of the BV (no taxation); – no withholding tax is then applied on the payment; and – the income is not included in the tax base of the US partners (or of anyone else). The above result represents a typical deduction/non-inclusion outcome (D/NI) that, quoting the Final Report on BEPS Action 2, arises “in respect of a payment to a reverse hybrid to the extent that the payment is deductible under the laws of one jurisdiction (the payer jurisdiction) and not included in ordinary income by a taxpayer under the laws of any other jurisdiction where the payment is treated as being received (the payee jurisdiction)”.73 (Emphasis added) Such an outcome, according to the same report, constitutes a paradigmatic case of double non-taxation that cannot be accepted anymore by the international framework and has to be addressed in order to restore the “natural order” embodied in the single tax principle. No question should arise in respect of the non-inclusion issue. It is evident, and intuitively “wrong”, that the interest payment – or better, its recipient – is left completely untaxed due to the fact that both of the jurisdictions involved refrain from imposing any levy on that entity. Yet, at least in the author’s view, the fact that the “evil” called double non-taxation involves also the deduction of the payment from the BV’s taxable income is somehow remarkable.74 After all, interest payments are commonly deductible for a specific policy consideration: interest can be regarded as a business expense, and therefore, it should not be included in the taxable income of 73. OECD/G20, supra n. 70, at p. 57, para. 147. 74. As further discussed (see sec. 1.4.), the main recommendation proposed by the OECD to address this undesirable outcome acts precisely on the deduction of the payment.

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the payer (in any case, it would constitute income for the receiver and be taxed in its hands). Imagining a similar scenario with the opposite result of double taxation (let us assume, for example, that both jurisdictions agree on the transparent treatment of the CV and that the payment is subject to withholding tax in the source state and, at the same time, to corporate income tax in the residence state), the deductibility at the level of the BV would, in this case, be out of the picture, and the problem to be fixed would concern exclusively the recipient of the interest (see figure 1.3). Figure 1.3.

It follows that the double non-taxation phenomenon is conceived as an economic concept in the international tax debate. It is not limited to the absence of one layer of taxation upon the recipient of a single item of income (i.e. juridical double non-taxation),75 but conversely, it embraces a stream of income that flows into more than one hand, starting from the deduction of the payment.

75. Whether one looks at the CV as transparent or opaque, the outcome remains unchanged: the recipient of the payment is not taxed on that income anywhere.

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Reverse hybrids: Why less than single taxation?

So far, it could be concluded that the single tax principle rejects both economic and juridical double non-taxation. It is important to stress at this point that, for the purpose of understanding the meaning of the single tax principle, the analysis focuses on the non-taxation of the interest payment. The issues regarding dividends are outside the scope of this chapter, and they will only be dealt with briefly. Dividends paid by the BV and flowing through the CV are actually subject to one layer of taxation (withholding tax levied by the Netherlands and reduced in its amount by the tax treaty in force between the Netherlands and the United States,76 as illustrated in section 1.3.2.2.). Nonetheless, this kind of scenario is also commonly labeled as a hybrid mismatch that leads to less than single taxation. By once again77 taking into consideration the new Preamble to the OECD Model Convention outlined by the Final Report of BEPS Action 6, which incorporates, in treaties, the intent of eliminating opportunities not only for non-taxation but also for reduced taxation, the impression that more than a jurisdictional issue lies behind the single taxation principle78 seems to be confirmed. Hence, assuming that single taxation rejects both double non-taxation and reduced taxation, the logical consequence would be the definition of the “acceptable” or “fair” rate of taxation.79 Yet, the single tax principle does not provide guidance to address such an issue.

1.3.3.2.  Base erosion: Who is the victim? The concept of double non-taxation implies that the tax base of at least one – if not both – of the involved jurisdictions is being eroded. From a public perspective, the major concern related to such a phenomenon is the loss of revenue. As stated in the OECD Report on Harmful Tax Competition, “[h] armful effects may also occur because of unintentional mismatches between existing tax systems, which do not involve a country deliberately exploiting the interaction of tax systems to erode the tax base of another country. Such

76. Naturally reduced rates provided by tax treaties should be granted by the source state in consideration of the further inclusion of the payment in the tax base of the residence jurisdiction, and for this purpose, the Netherlands-United States Treaty includes the aforementioned “hybrid entity” provision (see sec. 1.3.2.3.). Nonetheless, the Dutch authorities ignore the anti-abuse measure, provided that certain substantial conditions are met. It is hence reasonable to question whether one can really speak about unintended double non-taxation in such a scenario. 77. See sec. 1.2.2.2. 78. See secs. 1.2.1. and 1.2.2.1. 79. On the frequent connection/confusion between jurisdictional and amount concerns in the international tax debate, see P.B.W.L. Lamberts, Fair Taxation: Truth Is In the Eye of the Beholder, 45 Intertax 1, pp. 49-53 (2017).

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unintentional mismatches may be exploited by taxpayers to the detriment of either or both countries”.80 (Emphasis added) Keeping a constant focus on the chosen CV-BV structure, it is now interesting to examine the tax outcome in terms of base erosion in order to understand which jurisdiction is being affected by the scheme. Looking at the given scenario from the Netherlands’ point of view, the following observations can be made: – interest deductibility is generally granted, whether the payment is received by a resident or a foreign person; – the domestic law does not provide for any withholding tax on outbound interest payments; and – the closed CV is treated as fiscally transparent, even if it is established by non-resident partners. The Netherlands essentially refrains from exercising any taxing claim on the payment due to a generally applicable policy choice, and not because of unforeseen and undesirable elusive behaviour of the taxpayer. In other words, it cannot be argued that the Netherlands’ tax base is subject to a form of erosion; the specific design of the system itself does not include that payment unless its recipient is a resident and subject to corporate or personal income tax. On the other hand, the United States intentionally gives taxpayers the opportunity to select the tax qualification – in transparent or opaque terms – of their controlled foreign entities for US tax purposes. Once the option for non-transparency is exercised, the interest payment is attributed to a nonresident opaque entity from the US perspective, and no taxation can be legitimately levied on that income until profits are repatriated by means of dividend distribution by the CV to the partners. The conclusion that can be drawn does not differ from the previous one: refraining from exercising taxing rights is not an “accident”, but the product of a conscious policy choice. In the chosen scenario, it seems therefore hard to identify the “victim”. It is therefore questionable whether or not the double non-taxation outcome can be described as base erosion or if the undesirable tax implications arise from abusive conduct. After all, “hybrid mismatches are lawful and that is why the erosion of the tax bases is difficult to verify”.81 80. OECD, Harmful Tax Competition – An Emerging Global Issue, p. 15, para. 28 (OECD 1998). 81. F.D. Martínez Laguna, Abusive and Aggressive Tax Planning: Between OECD and EU Initiatives – The Dividing Line between Intended and Unintended Double Non-Taxation,

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Reverse hybrids: Why less than single taxation?

1.3.3.3. The origin of the “evil”: Tax arbitrage in the international debate Having concluded that the negative tax implications of the CV-BV structure cannot be ascribed to abusive or fraudulent conduct carried out by the taxpayer, it is now interesting to examine the cause of the problem at stake. Double non-taxation appears as the result of the different qualification for tax purposes of the limited partnership (i.e. the hybrid entity), and the mismatch actually arises as the consequence of the correct and proper application of two distinct tax systems to cross-border income.82 Such a scenario is called “tax arbitrage” in the international tax debate, and it can be defined as the situation in which “taxpayers who are subject to tax in multiple jurisdictions exploit differences in the rules of the tax regimes (whether it be different international tax regimes, different tax bases, different timing rules, different definitional elements, or otherwise) to technically comply with the law of both jurisdictions but incur a lower total net tax liability than if the transaction had been subject solely to the laws of either jurisdiction”.83 The origin of the “evil” (i.e. double non-taxation) can be therefore found in the so-called “tax diversity”, i.e. the existence of various and differently designed tax jurisdictions around the world as an expression of individual sovereignty. Due to its peculiar features, addressing tax arbitrage is an extremely complex issue from a policy perspective. Firstly, as noted in section 1.3.3.2., taxpayers’ conduct is perfectly compliant with the letter and spirit of the law from a unilateral point of view.84 Each of the jurisdictions involved in the CV-BV structure consciously chooses to give up its taxing rights; in a way, non-taxation is still a manifestation of tax sovereignty, and it is always intended.85 If one looks at international tax arbitrage from such 9 World Tax J. 2, sec. 4.2. (2017), Journals IBFD. See also OECD/G20, supra n. 70, at p. 15, para. 2: “The Hybrids Report concludes that the collective tax base of countries is put at risk through the operation of hybrid mismatch arrangements even though it is often difficult to determine unequivocally which individual country has lost tax revenue under the arrangement.” (Emphasis added) 82. Id., at para. 1: “The outcome of double non-taxation is not a legal problem as such but the due consequence of the proper application of the law in cross-border situations.” 83. Rosenzweig, supra n. 37, p. 560. 84. Rosenbloom, supra n. 19, at p. 143: “The beauty of international tax arbitrage when practiced most skillfully is that none of the objections to aggressive or abusive tax planning should apply anywhere because, from the vantage point of any single country, there is neither aggressiveness nor abuse”. 85. Martínez Laguna, supra n. 80, at sec. 2.3.

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a different angle, the line that separates it from other forms of tax incentives or subsidies (like exemptions or tax sparing credits) becomes faded. It follows that, in the context of tax arbitrage, speaking of base erosion is not really accurate; the revenue allegedly lost consists of a sort of “bilateral surplus”86 that could be equally claimed by every jurisdiction involved. Furthermore, modifying domestic tax provisions to respond to their exploitation in cross-border situations inevitably requires the sacrifice of the policy considerations (e.g. domestic efficiency) underlying their implementation and might consequently undermine tax sovereignty. For these reasons, some scholars – Rosenbloom in particular – have suggested a radical approach to tax arbitrage phenomena, which is basically indifference. Taking into account the fact that it arises from the interaction between different tax systems, tax arbitrage would not constitute a real issue, and there would be no policy ground to explain why a country should bother considering the benefits received by taxpayers in another jurisdiction in respect of income not included in its own tax base. In addition, in the absence of a world tax organization able to enforce a specific international tax policy and influence the interpretation and design of domestic systems, “the task of identifying elements in another country’s tax system that are a sufficient source of concern for otherwise available [domestic] tax benefits to be limited or denied is difficult, time consuming and endless”.87 Conversely, Avi-Yonah88 and other supporters of the single tax principle assert that tax arbitrage should be a primary policy concern also from a unilateral perspective, as well as one of the main targets of international tax cooperation. After all, the dissent repeatedly expressed by governments and international organizations suggests “an underlying rejection of the idea that cross-border income can face no taxation”.89 Essentially, international tax arbitrage violates the single taxation principle, which turns out to be expression of an ideal of worldwide efficiency, and as such, it must be tackled. According to this view, the single taxation principle itself is the policy concern that should encourage states to fight arbitrage also at a unilateral level. The goal, as was already discussed in section 1.2.4.2., is to avoid inefficient incentives towards cross-border investments limited to jurisdictions 86. Rosenzweig, supra n. 37, at p. 588. See also D. Shaviro, Money on the table: Responding to cross-border tax arbitrage, 3 Chicago Journal of International Law 2, p. 328 (2002). 87. Rosenbloom, supra n. 19, at p. 154. See also Martínez Laguna, supra n. 80, at sec. 2.3: “[T]here is no common legal basis in international public law yet to avoid (nor determine the proscription)” of double non-taxation. 88. See especially Avi-Yonah, supra n. 19. 89. Ring, supra n. 14, at p. 105.

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Achieving single taxation: The application of the BEPS Action 2 recommendations

where the tax intersection is most beneficial, as well as to prevent iniquities (both horizontal and vertical). In order to avoid such undesirable consequences and achieve single taxation, states should be willing to loosen their tax sovereignty and design their systems by taking into consideration what might happen outside their jurisdictions. Single taxation is ultimately a sort of spontaneous sovereignty compromise that is necessary to ensure global fairness and avoid distortions in the context of international trade and investments. However, once again, it is relevant to question why, in a world made of distinct sovereign jurisdictions, states should unilaterally adopt such a global perspective. Is it because tax arbitrage violates the correct allocation of the overlapping taxing claims? As demonstrated by the chosen example, the answer is clearly no: regardless of where the single levy should be imposed in accordance with the single tax principle, both of the jurisdictions affected by the CV-BV structure are actually consciously refraining from exercising their taxing rights. It seems more likely that, also from a unilateral perspective, the real problem to be addressed concerns the overall tax burden imposed on cross-border income (which, in the concrete example, is equal to zero), which could have negative consequences both in terms of equity and efficiency.

1.4. Achieving single taxation: The application of the BEPS Action 2 recommendations 1.4.1. The achievement of single taxation as envisioned by the OECD Following from the description of a (reverse) hybrid arrangement and the analysis of the consequent double non-taxation, the same concrete structure will now be used to illustrate how single taxation should be achieved and to further assess the content of the single taxation principle. For this purpose, it is assumed that the BEPS initiative represents the OECD’s official commitment to the single tax principle, as stated by Avi-Yonah,90 and the recommendations included in the 2015 Final Report of BEPS Action 2 (the Report)91 will hence be applied to the CV-BV structure.

90. 91.

Avi-Yonah (2016), supra n. 4, at p. 12. Action 2 Final Report.

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The Report identifies paradigmatic cases of hybrid mismatch arrangements, including the use of reverse hybrids, and proposes a set of measures to tackle their negative tax effects to be implemented in domestic law, as well as treaty provisions that should prevent the use of hybrid entities to unduly achieve treaty benefits. It follows that neutralizing the effects of such arrangements should restore the “rightful” condition of single taxation. The application of BEPS recommendations might therefore be particularly helpful to attain a better understanding of the single taxation principle as envisioned by the OECD.

1.4.2. Neutralizing hybrid mismatch arrangements: Recommendations for domestic law 1.4.2.1.  The main solution The first part of the Report suggests the implementation of domestic provisions to address mismatches arising from payments made under hybrid financial instruments or made by or to hybrid entities, along with hybrid mismatch arrangements imported into a third jurisdiction. The main recommendations (so-called “linking rules”) seek to align the tax treatment of a hybrid instrument/entity under a jurisdiction with the treatment of the same hybrid in the counterparty jurisdiction so as to ensure the imposition of one layer of taxation on the related cross-border payments.92 The primary linking rule is directed at the payer’s jurisdiction and essentially consists of denying the deduction of the payment, while the defensive linking rule, meant to be applied to the extent that the mismatch has not been successfully neutralized by the payer’s jurisdiction, provides for the inclusion of the payment in the tax base of the payee’s jurisdiction. The provision specifically tailored for the treatment of payments to a reverse hybrid are included in chapter 4 of the Report and must be read together with the other recommendations (Improvements to CFC and other offshore investment regimes, Limiting the tax transparency for non-resident investors and Information reporting for intermediaries) in chapter 5 of the Report.

92.

Id., at p. 11.

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1.4.2.2. The linking rule applied to the CV-BV structure: Single taxation, finally? With regard to payments made to a reverse hybrid,93 the Report exclusively recommends the adoption of the primary linking rule consisting of the denial of the deduction of the payment in the payer’s jurisdiction. Taking into account the further suggestions included in chapter 5 of the Report, no defensive provision in the payee’s residence state is regarded as necessary.94 The hybrid rule should apply automatically, regardless of what is happening in the counterparty jurisdiction, so as to be more clear, transparent and less burdensome for tax authorities.95 Yet, the automatic effect of the hybrid rule is triggered, provided that the following conditions are met: – the deductible payment to a reverse hybrid must result in a hybrid mismatch, meaning that the negative outcome would have not arisen had the payment been made directly to the investor without the interposition of the hybrid entity; – the payment must give rise to a deduction/non-inclusion outcome. It follows that if the payment is somehow included in the taxable base of one of the jurisdictions involved (for instance, under a controlled foreign company (CFC) regime), the linking rule shall not apply; and – the investor, the hybrid entity and the payer must be part of the same “control group”96 or the payment must be made under “a structured arrangement”97 of which the payer is a part. With regard to the CV-BV structure, all of the above conditions are satisfied, and according to the OECD’s recommendations, the Netherlands should hence deny the deduction of the interest payment made by the BV to the CV. No withholding tax would be then imposed on the interest, and the payment would not be included in the taxable income of the US resident partner (see figure 1.4).

93. For the OECD definition of reverse hybrids, see Action 2 Final Report. 94. See id., at p. 56, para. 144: “A defensive rule is unnecessary given the specific recommendations in Chapter 5 for changes [to controlled foreign company] rules and other offshore investment regimes that would require payments to a reverse hybrid to be included in income in the investor jurisdiction.” 95. Id., at p. 94, para. 277 and p. 95, para. 281: “Automatic rules are more effective than those that only apply subject to the exercise of administrative discretion and avoid the need for coordination of responses.” 96. For the definition, see ch. 11 Action 2 Final Report. 97. Id., at ch. 10.

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Figure 1.4.

Nevertheless, single taxation would be achieved and the negative tax implications of the hybrid mismatch arrangement neutralized. However, according to the author’s view, such solution turns out to be inconsistent with the fundamental features of income taxation and therefore deserves special consideration. However, before proceeding with several critical remarks, it is proper for the sake of completeness to provide an overview of the OECD proposals regarding the treatment of reverse hybrids.

1.4.2.3.  The other specific recommendations Along with the primary linking rule, the Report suggests additional counteractions to tackle the exploitation of reverse hybrids.98 Differently from the denial of the deduction, the following recommendations do not take the form of hybrid mismatch rules; rather than aligning the tax treatment of a payment in one jurisdiction to the treatment of the same item in the counterparty jurisdiction, they prescribe domestic improvements that should reduce the incidence of hybrid mismatches “by bringing the tax 98. See ch. 5 Action 2 Final Report (Specific Recommendations for the Tax Treatment of Reverse Hybrids).

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treatment of cross-border payments made to transparent entities into line with the tax policy outcomes that would generally be expected to apply to payments between domestic taxpayers”.99 The first recommended action involves the introduction or improvement of CFC, foreign investment fund or other anti-deferral rules in the investor’s jurisdiction so as to require resident taxpayers to report income allocated to them by a reverse hybrid. Similar provisions would neutralize the effects of the hybrid mismatch and allow the payer’s jurisdiction to suspend the application of the linking rule.100 The second recommendation consists of limiting the tax transparency for non-resident investors in the jurisdiction where the hybrid entity is established, provided that the entity derives income that is not otherwise taxed in the establishment state and that the domestic law of the establishment jurisdiction allocates the income to a nonresident investor that is part of the same control group. In such a scenario, the automatic application of the hybrid rule would be suspended, and the investor’s jurisdiction – which, in the meantime, would have included in its tax base the income allocated to the hybrid due to the implementation of the first recommendation (CFC or other anti-deferral provision) – should grant a credit to the investor for the tax paid in the establishment jurisdiction on the same income.101 The last counteraction (in section 5.3 of the Report on Information Reporting for Intermediaries) has an administrative nature and requires states to collect and maintain exhaustive information regarding transparent entities (e.g. the number and identity of the investors, shareholding percentages, amounts of income and expenditures allocated to investors).102 Leaving outs the latter recommendation, in the above alternative scenario, single taxation would be achieved by allocating and taxing the receipt of the payment in the hands of both the CV and the non-resident limited partner, and the taxes paid in the establishment jurisdiction would be credited in the investor’s jurisdiction (see figure 1.5).

99. 100. 101. 102.

Id., at p. 63, para. 170. Id., at p. 64, paras. 171-173. Id., at p. 64, paras. 174-175. Id., at p. 65, paras. 176-179.

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Figure 1.5.

1.4.2.4.  The treaty hybrid provision Part II of the Report concerns treaty issues and is aimed at preventing the exploitation of hybrid instruments or entities for the purposes of unduly obtaining treaty benefits. Chapter 14 (Treaty Provision on Transparent Entities) in particular incorporates the conclusions drawn in the OECD Partnership Report103 and extends them to transparent entities other than partnerships. The following addition is therefore included in article 1(2) (Persons Covered) of the 2017 OECD Model Convention:104 For the purposes of this Convention, income derived by or through an entity or arrangement that is treated as wholly or partly fiscally transparent under the tax law of either Contracting State shall be considered to be income of a resident of a Contracting State but only to the extent that the income is treated, for purposes of taxation by that State, as the income of a resident of that State.

103. See the Partnership Report, supra n. 15. 104. Para. 435 Action 2 Final Report.

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The provision should, on the one hand, ensure that treaty benefits are accorded when the taxpayer, due to the hybrid mismatch, is otherwise subject to double taxation. On the other hand, treaty benefits would be denied if neither contracting state recognizes the income of a transparent entity as income of one of its residents. Nonetheless, an extensive analysis of the above provision is not relevant for the purposes of this chapter, and it will therefore be limited it to a brief overview. Looking once again at the double non-taxation of the interest payment made by the BV to the CV, in fact, there is no issue of undue application of the double tax treaty between the Netherlands and the United States. Moreover, the treaty provision is clearly not able to prevent or address the double non-taxation deriving from a disparity between two different tax systems.105 Having considered and applied the overall OECD recommendations, the meaning of single taxation becomes more intelligible, and it is now possible to draw some further conclusions on the single taxprinciple.

1.5.  Some critical remarks The starting point of the present work is grounded on the obscure theoretical definition of the single tax principle, according to which income deriving from cross-border transactions should be taxed neither less nor more than once, possibly at the rates established by the benefits principle (source rates for active income and residence rates for passive income). The natural corollary of the single taxation rule, however, requires the counter-jurisdiction to tax cross-border income if the state that has the primary taxing right refrains from taxation. The BEPS initiative appears to be significantly inspired by such a theoretical framework, and the exercise of applying the Action 2 recommendations to a hybrid mismatch arrangement has served the purposes of attaining a concrete answer to the question of what single taxation exactly means. Still, the analysis of the concrete scenario previously described highlights several inconsistencies that deserve to be further explored.

105. See also D. Sanghavi, BEPS Hybrid Entities Proposal: A Slippery Slope, Especially for Developing Countries, 85 Tax Notes International 4, p. 358 (2017).

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1.5.1. Single taxation as an economic concept As illustrated in section 1.3.3.1., the undesirable outcome of the CV-BV structure arises initially from the deduction of the payment at the level of the BV, and the double non-taxation phenomenon is recognized from an economic perspective. If one once again takes into consideration the main solution proposed by the OECD with regard to reverse hybrid mismatches, i.e. the primary linking rule,106 one can conclude that the denial of the deduction of the interest from the BV taxable income is per se sufficient and able to neutralize the condition of double non-taxation. Denying the deduction equals taxing, and the imposition of the single layer of taxation on the crossborder payment in the hands of the payer represents the ideal condition of single taxation, at least in the OECD’s view. It follows that single taxation, just like double non-taxation, is perceived as an economic concept that looks at an overall stream of income flowing through different persons situated in different jurisdictions. One might therefore use the label of “economic single taxation” to indicate the ideal scenario between double non-taxation and double taxation. However, is the concept really so linear, and once again, what would be the meaning (or sense) of economic single taxation? By taking a closer look at the effects of the hybrid linking rule, two different components can be isolated in the context of the finally found single taxation: (1) the taxation of the payment at the level of the BV; and (2) the non-taxation of the recipient of the payment (previously labelled as “juridical double non-taxation”),107 regardless of whether the CV is regarded as transparent or opaque (for the sake of clarity, see figure 1.6).

106. See sec. 1.4.2.2. 107. See sec. 1.3.3.1.

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Figure 1.6.

The conclusion previously drawn should now be rephrased.108 Stating that the single tax principle rejects both juridical and economic double nontaxation appears inaccurate in the light of the above observation. Looking at the diagram in figure 1.6, it should be therefore inferred that the single tax principle refuses economic double non-taxation on one side and juridical double taxation on the other side, while juridical double non-taxation remains outside of its scope. Thus, the author’s first impressions were not correct,109 and single taxation reveals itself to be a non-linear concept that might rather be illustrated as a line with a vague and fuzzy middle (see figure 1.7). Figure 1.7.

108. Id. 109. See sec. 1.2.4.2.

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In the author’s opinion, it is extremely hard to give a rational justification to a similar configuration or to clearly delimit the boundaries of the notion of single taxation, although describing the single taxation principle as the rightful condition between two opposite extremes – as if one were dealing with different levels of intensity of the same phenomenon – might sound fascinating from a systemic perspective. Several issues arising from different causes actually fall under the umbrella of double non-taxation (tax arbitrage, exploitation of tax havens, reduced taxation and intended exemptions), and they likely need to be addressed separately. Reducing them to a unitary concept as opposed to double taxation seems simplistic, and it is not helpful for the purpose of understanding to define the exact meaning of the single tax principle. In particular, it is difficult to explain why the single tax principle would be satisfied by the neutralization of the economic double non-taxation when, at the same time, the recipient of the payment is taxed nowhere on that income. Such an outcome is probably due to the fact that the recommended linking rule applies only in respect of entities that are part of the same control group. Yet, this justification is not strong enough to hide the fragilities of the single tax principle as envisioned by the OECD for the reasons dealt with in sections 1.5.2.-1.5.4.

1.5.2. Single taxation principle versus independent entity principle: Clash of the titans? “The traditional international tax law is designed and interpreted based on the assumption that the various constituent entities or members of [multinational enterprise] groups are independent of each other and conduct transactions with each other at arm’s length.”110 While expressing an overall disagreement on this approach, Avi-Yonah recognizes that the independent entity principle and its corollary, i.e. the untouchable arm’s length standard, should be regarded as fundamental principles of international customary tax law, together with the single tax principle and the benefits principle.111 The validity of the principle is confirmed also by the BEPS initiative. Although the G20 mandate to tax multinational enterprises “where economic activities take place and value is created”112 implicitly suggests treating multinational groups as a single firm, the overall BEPS Project outcome

110. Avi-Yonah & Xu, supra n. 6, at p. 209. 111. Avi-Yonah 2004, supra n. 4, at p. 499. 112. Such a statement is reaffirmed in the Foreword of the Final Report on each Action of the OECD BEPS Project.

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is grounded on the legal fiction of the independent entity approach.113 Given the above framework (i.e. the overall single entity approach), the single tax principle, which relies on an economic configuration of double non-taxation and is hence fulfilled even if the recipient of income is taxed nowhere, appears to collide with another fundamental principle of international tax law, i.e. the independent entity principle. After all, the underlying policy of the linking rule is to tax the income before it “disappears” in the qualification mismatch of its recipient, thus taxing the payment in the hands of the payer just because it is part of the same control group of the payee. It is difficult to disregard or justify such inconsistency, especially in terms of fairness. Otherwise, how can one reconcile the fact that taxpayers are required to comply with the independent entity fiction for profit allocation purposes while, on the other hand, tax administrations can indifferently “strike” whichever entity of a group to address tax arbitrage?

1.5.3. Taxing income or taxing persons? The clash with the independent entity principle, as described in section 1.5.2., is not the only manifestation of the single tax principle’s fragility. In this chapter, it has been stressed more than once – and now it will become clear why – that concluding that the implementation of the single tax principle114 may tolerate the non-taxation of the recipient of the income is at least surprising. It is now time to further explain such a remark. Taking as a starting point the fundamental concepts of tax law, it should be borne in mind that income “in its widest and most generally accepted sense is the addition of (1) increase in net savings (capital assets) and (2) the purchase of consumption assets during a given period”.115 The notion of income per se is intrinsically attached to persons, but identified as such for tax purposes by national laws (individuals, corporations and other entities). Thus, from a design perspective, one of the essential features of income tax law is the identification of the taxable persons subject to tax imposition (due to their nature, income taxes are included in the category of “personal

113. BEPS Monitoring Group, Overall Evaluation of the G20/OECD Base Erosion and Profit Shifting (BEPS) Project (10 May 2015), available at https://bepsmonitoringgroup. wordpress.com/2015/10/05/overall-evaluation. 114. At least as conceived by the OECD. 115. P. Harris, Corporate/shareholder income taxation and allocating taxing rights between countries: A comparison of imputation systems, vol. I, p. 36 (IBFD 1996).

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taxes”).116 In other words, taxing income actually means taxing a person as the recipient of that income. The BEPS outcome seems oblivious to this consideration, and the effect of the main solution proposed to address reverse hybrid mismatches is to tax the income in the hands of the payer. Under this approach, the urgency of subjecting the cross-border financial flow to a single levy of taxation is so pressing that it overrides the importance of the fulfillment of the essential function of income taxation, which is taxing the recipient.117 In the light of such reasoning, what should be regarded as one of the fundamental principles of international (income) tax law (i.e. the single tax principle) paradoxically turns out to be a deviation from the basic features of the income tax itself. The consequential conclusion would be represented by the unacceptable idea that the single tax principle applies to income and not to taxpayers, as if single taxation was a sort of inherent attribute of income itself. Furthermore, another observation must be taken into account: income taxation is imposed on a net basis. In order to effectively recognize taxpayers’ ability to pay, the taxable income is computed after considering all the applicable deductions provided by law. Yet, the denial of the deduction has ultimately the same economic effect as withholding tax on the gross payment. It follows that single taxation as envisioned by the OECD doubly deviates from the essential features of income taxation and turns out to be a principle that applies to payments rather than income.

1.5.4. Taxing somewhere, no matter where The last inconsistency involves the identification of the jurisdiction that should be entitled to levy the single tax on the cross-border payment.

116. See Harris, supra n. 41, at p. 5. 117. As noted by Wheeler, a similar theoretical tension between taxation of persons and taxation of income is not new in the context of the international tax debate, and it is embodied in the ambiguous wording of tax treaties: “The scope of the treaty is defined by reference to persons, but the distributive provisions deal with various classes of income and so may appear to focus on the income rather than on the person […].” (see J.C. Wheeler, The Missing Keystone of Income Tax Treaties, p. 42 (IBFD 2012), who refers also to B.J. Arnold, J. Sasseville & E. Zolt, Summary of the Proceedings of an Invitational Seminar on Tax Treaties in the 21st Century, 56 Bull. Intl. Fiscal Docn. 6, pp. 233-245 (2002), Journals IBFD.

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In section 1.1., it was questioned whether the single tax principle addresses the issue of the amount of levies imposed on a cross-border payment (i.e. zero, once or more than one) or rather the issue of the overall amount of taxation, i.e. the rates. As a matter of fact, the theoretical formulation of the single tax principle appears to neglect the concerns regarding the rates of taxation, and its combination with the benefits principle (i.e. active income should be taxed at the source rate and passive income at the rate of the residence jurisdiction) makes the qualification of the underlying issue a jurisdictional one. Hence, it would be reasonable to expect that the implementation of the single tax principle is grounded on a clear and precise allocation criterion. Yet, as admitted by Avi-Yonah,118 the single tax principle is unable to solve the issue of dividing the tax base among the different jurisdictions providing benefits when it comes to the corporate income of multinational enterprises. Furthermore, uncertainties regarding the real nature of the single tax principle are raised also by the “residual” clause that demands that the counterjurisdiction tax the cross-border payment if the state that has the primary taxing right under the benefits principle refrains from taxation. It is relevant to underline that the overall indications included in BEPS Action 2 are strongly influenced by this theoretical framework.119 According to the Final Report on Action 2, no hybrid mismatch arises if the payment is taken into account as ordinary income “in at least one jurisdiction”120 (i.e. no matter where) and, more significantly, “[t]he Action Plan simply calls for the elimination of mismatches without requiring the jurisdiction applying the rule to establish that it has ‘lost’ tax revenue under the arrangement. [T]he hybrid mismatch rules apply automatically and without regard for whether the arrangement has eroded the tax base of the country applying the rule”.121 (Emphasis added) As noted by Kahlenberg and Kopec,122 such approach could hardly guarantee the improvement of the coherence of the international tax system and is hardly justifiable if it is not in the light of an allegedly inherent international tax regime, which, according to the author’s opinion, is still yet to come.

118. Avi-Yonah 2007, supra n. 4, at p. 135. 119. In this sense, see also D. Smit, International Income Allocation under EU Tax Law: Tinker, Tailor, Soldier, Sailor, 26 EC Tax Review 2, p. 69 (2017). 120. Para. 149 Action 2 Final Report. 121. Id., at para. 279. 122. C. Kahlenberg & A. Kopsec, Hybrid Mismatch Arrangements: A Myth or a Problem That Still Exists?, 8 World Tax J. 1, p. 75 (2016), Journals IBFD.

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If one simplifies the formulation of the single tax principle by stating that “income should be taxed somewhere, no matter where”, one ends up creating a sort of supranational (and supernatural) concept of “international income’”, which implies that it is a binding duty of every jurisdiction to ensure that someone at least levies tax on that income.123 Once again, what would be the source of such an obligation? Which policy concern would induce a jurisdiction to design its own tax system in compliance with the single tax principle?

1.6. Exploring other scenarios: The thin line between single and double taxation 1.6.1. Alternative measures In the concrete case that was examined, i.e. the CV-BV structure (see section 1.3.2.), the double non-taxation outcome arises due to the mismatched intersection of two different tax systems, which leads to a situation where each of the involved jurisdictions considers that the payment is received by a resident of the other state and thus refrains from taxing it. Given the qualification disparity regarding the identity of the payee, the hybrid linking rule essentially targets the payment in the hands of the payer so that taxation can be levied before the income somehow “disappears”. The approach intuitively represents the easiest way to address the mismatch, and by providing a single layer of taxation on the cross-border financial flow, it turns out to be perfectly compliant with the content and the aim of the single tax principle. Nonetheless, as demonstrated in section 1.5.4., the perusal of the implementation of single taxation with regard to reverse hybrids has shined a light on the flaws and inconsistencies of the underlying background. If income should be taxed neither less nor more than once, there should be a precise allocation rule that establishes where the single levy of taxation should be imposed. Conversely, it would be extremely complex to find a justification for the supranational duty of taxing income somewhere, no matter where, without imagining some international binding force or slipping into a sort of ontology of income wherein income has some inherent “rights” or “obligations”.

123. The same opinion is expressed by Rosenbloom, supra n. 19, at p. 144.

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Yet, the formulation of the single tax principle does not address the issue precisely in respect of income derived by multinational enterprises, and OECD recommendations included in the Final Report of BEPS Action 2 neglect the jurisdictional problem. Since, in the context of reverse hybrid mismatches, both the jurisdictions affected by the structure refrain from exercising any taxing claim on cross-border payments, the “residual clause”124 of the single tax principle applies, and as long as income is taxed somewhere, it doesn’t really matter where the single layer of taxation is levied. Thus, by applying the “taxing somewhere, no matter where” approach to the economic understanding of the double non-taxation phenomenon, the main solution envisioned by the OECD results in a fundamental theoretical problem, which is the unacceptable sacrifice of the essential feature and function of income tax itself. The single tax principle is, in fact, implemented by taxing the payment in the hand of the payer, while the recipient of the item of income remains untaxed anywhere. The paradoxical conclusion would be that single taxation applies to income and not to persons, as if it were an attribute attached to income,125 and that the underlying concern would be limited to the amount of levies imposed on cross-border payments. Given the self-evident fragility of a similar framework, this section intends to explore alternative scenarios and assess whether or not they might be single-taxation compliant in order to find further evidence on the real content and nature of the single taxation principle. The Dutch CV-BV structure will be used once again as a clarifying example.

1.6.2. First hypothesis: Dual inclusion with relief 1.6.2.1.  The OECD alternative for achieving single taxation With regard to arrangements that involve the exploitation of reverse hybrids, the Final Report on BEPS Action 2 suggests the implementation of specific domestic provisions together with the primary linking rule.126 If properly designed, such rules would be able to per se unilaterally neutralize the undesired effects of the hybrid mismatch, determining the suspension of the

124. As repeatedly explained, the corollary of the single tax principle establishes that the counter-jurisdiction is entitled to tax when the jurisdiction that has primary taxing rights refrains from taxation. 125. See sec. 1.5.4.3. 126. See sec. 1.4.2.3.

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hybrid rule.127 Assuming once again that the BEPS initiative fully adheres to the theoretical formulation of the single tax principle,128 it follows that also the outcome arising from the application of this additional set of provisions should be included in the notion of single taxation. Hence, such a scenario represents a convenient starting point for the purposes of the examination that the author will now carry out. According to chapter 5 of the Report, the jurisdiction in which the hybrid entity is established should design a rule that would limit the tax transparency of the hybrid in respect of non-resident investors. In other words, the establishment jurisdiction should treat the entity as a resident taxpayer and levy the ordinary corporate income tax upon it, provided that the following conditions are met:129 – the entity derives income that is not otherwise subject to taxation in the jurisdiction where it is established; – the income is wholly or partially attributed by the law of the establishment jurisdiction to a non-resident investor that is part of the same control group of the entity; and – the investor is not required, under the law of his residence jurisdiction, to report payments of ordinary income allocated to him by the hybrid entity. On the other hand, the investor jurisdiction should implement or improve CFC or other anti-deferral rules (e.g. changes to residency rules and taxing the investors on variations in the market value of the investment) that require the investors to report and take into account for tax purposes their share of payment of ordinary income allocated to them by a foreign reverse hybrid. A sort of underlying tax credit should then be granted for the corresponding share of taxes paid by the hybrid entity under the potential application of the above rule that limits its tax transparency. In respect of the concrete structure examined, all the necessary conditions for limiting the transparency of the CV would occur: the interest payment is not otherwise brought within the charge to taxation of the Netherlands and is attributed to the US parent company acting as a limited partner, which is not required to take into account the payment for tax purposes under US laws due to the exercise of the check-the-box option for non-transparency. The Netherlands could hence tax the payment in the hands of the CV together with the other items of income derived by the hybrid, granting at the same 127. Paras. 171-175 Action 2 Final Report. 128. The analysis carried out in sec. 1.4. actually demonstrated the above assumption. 129. Para. 175 Action 2 Final Report.

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time the deductions accorded to entities ordinarily subject to corporate income tax. On the other side, if the United States implemented one of the above anti-deferral rules, it would tax the same payment in the hands of the resident limited partner, providing a credit for the tax paid by the CV in the Netherlands so as to relieve the consequent double taxation of the payment. Is such an outcome an alternative manifestation of single taxation? Assuming that just one of the involved jurisdictions implemented the above recommendations, the result would be fully compliant with the content of the single tax principle. Only one single layer of taxation would be imposed on the income, whether in the establishment or investor jurisdiction. After all, according to BEPS reasoning, it doesn’t really matter where the imposition is levied, as long as the hybrid mismatch arrangement has been neutralized. In such terms, the situation essentially would not differ from the results of the application of the hybrid linking rule. Yet, in the author’s view, this latter solution would still be preferable for the following considerations. Whether imposed on the CV or on the US investor, the taxation of the income would be levied upon the recipient of the payment and not on the payer, in proper compliance with the theoretical structure of income taxes. Secondly, it must be recalled once again the fact that, from an economic perspective, denying the deduction of the payment indeed equals taxing the payment, but on a gross basis; the taxes imposed on the recipient would conversely be computed on a net basis (i.e. on profits), thus satisfying another essential feature of income taxation.130 Furthermore, as stated in the BEPS Action 2 Final Report,131 the specific recommendations included in chapter 5 do not take the form of hybrid mismatch rules. This means that such provisions do not seek to adjust the domestic treatment of a payment only due to the fact that the cross-border mismatch arises by looking at what happens in the counter-jurisdiction, but they are conceived as generally applicable rules that align the taxation of cross-border payments to reverse hybrids with the outcome that would be expected in respect of payments between domestic taxpayers.132 It follows that similar solutions should be less restrictive in terms of tax sovereignty and preserve the overall consistency of the domestic tax policy. 130. Among many others, see M. Norr, The Taxation of Corporations and Shareholders, p. 97 (Springer 1982); and Harris, supra n. 41, at p. 5: “[F]or most countries income is a net concept.” 131. Para. 170 Action 2 Final Report. 132. Such distinction is just partially clear, according to the author’s opinion. The limitation of the hybrid’s tax transparency, in fact, should apply only if the income derived by the entity is not allocated to the investors under the laws of the investor jurisdiction; see para. 175 Action 2 Final Report: “Recommendation 5.2 of the report applies where

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Nonetheless, each jurisdiction should unilaterally seek to address the hybrid mismatch by implementing the respective recommendation. The report suggests, in fact, “that every jurisdiction introduces a complete set of rules that are sufficient to neutralise the effect of the hybrid mismatch on a standalone basis”.133 Therefore, the outcome that should commonly occur is the inclusion of the payment in the tax base of both the establishment and the investor jurisdiction, the latter of which would provide for a credit for the taxes paid on the same income by the hybrid entity. Technically, in such a case, both the involved jurisdictions – which would otherwise refrain from taxation – are actually imposing a levy of taxation. As a matter of fact, the outcome is a situation of (economic) double taxation, which is then “fixed” by the investor’s jurisdiction. Yet, overall, chapter 5 of the Report clearly states that the above solution also leads to the elimination of double non-taxation and can hence be regarded as a way to achieve single taxation.

1.6.2.2. Brief remarks on the risks of over-taxation It must be noted, albeit briefly, not only that the alternative single taxation outcome envisioned by the OECD actually implies a situation of relieved double taxation, but also that the need of tackling and preventing the double non-taxation phenomenon appears to be so urgent that an evident risk of over-taxation is neglected (or even accepted). The rules described in section 1.6.2.1., in fact, should all be implemented domestically together with the primary linking rule. In order to be more effective and less burdensome for tax administrations, the linking rule should apply automatically,134 but at the same time, the implementation of one of the other recommended provisions would trigger its “switching off” (e.g. if the United States would provide for the inclusion of the income allocated to the US partner by the hybrid, the Netherlands should suspend the denial of the deduction of the payment made by the BV; the same would happen if the Netherlands would implement the limitation of tax transparency). Essentially, the correct functioning of the complex set of interrelated rules explained in section 1.6.2.1. implies an extremely efficient and swift a tax transparent person is controlled or otherwise owned by a non-resident investor and that investor is not required to take into account payments of ordinary income allocated to them by that person.” (Emphasis added) 133. Id., at para. 279. 134. Paras. 277 and 281 Action 2 Final Report.

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system of information exchange, as well as perfect coordination (if not synchrony) and cooperation between the jurisdictions affected by the hybrid structure. It is also implicitly assumed that every jurisdiction would implement and interpret the OECD suggestions in a consistent fashion. Yet, in reality, there are distinct and sovereign states that pursue different policy goals and are completely free to design the features of their own tax systems, and most likely, “there will be a proliferation of individual, uncoordinated measures that will lead to issue of double taxation”.135 In respect of reverse hybrid mismatches, the worst scenario would be represented by dual inclusion together with denial of the deduction. One last observation: who will pay the price of a similar intricacy? According to the Report, it will be the taxpayer that has the burden of demonstrating that the payment has not given rise to a deduction/non-inclusion outcome.136

1.6.3. Second hypothesis: Withholding tax on payments to a hybrid Taking into consideration the observations formulated with regard to the alternative scenario suggested by the OECD in chapter 5 of the Report, it might be interesting to explore less complex and burdensome options. One could imagine, for instance, the imposition of a withholding tax designed by the establishment jurisdiction in respect of payments made to transparent entities. A similar provision could apply irrespective of the residential status of the partner. It follows that, in respect of resident partners subject to income taxation in that jurisdiction, the domestic law should provide for double tax relief. In the context of the examined structure, the Netherlands would thus levy a withholding tax on the interest paid by the BV to the CV. Assuming that the United States has not implemented any counter-measure to address the mismatch, the double non-taxation outcome would still be neutralized, and a single layer of taxation would hence be imposed on the cross-border payment and on the recipient of the income. Conversely, if the payment is somehow allocated to the US partner under US laws, a typical hypothesis of juridical double taxation would arise that could be easily addressed by the tax treaty. Yet, as discussed in section 1.6.2.1., the dual inclusion is not really incompatible with the notion of single taxation. 135. Ault, supra n. 13, at p. 1199. The same opinion is expressed by Kahlenberg & Kopsec, supra n. 121, at p. 74. 136. Para. 154 Action 2 Final Report.

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A similar solution has the advantage of addressing the mismatch without requiring adjustments related to the tax treatment of the payment in other jurisdictions or sacrificing generally applicable tax policies (such as tax transparency from the Netherlands’ perspective and the check-the-box option from the US point of view). The drawback, though, is the fact that withholding taxes are applied on gross income. Nonetheless, as already stated in section 1.6.2.1., the economic effect of denying the deduction of the payment from the taxable income of the payer has essentially the same result.

1.6.4. Third hypothesis: Agreement on the qualification of the hybrid The last scenario that will be taken into consideration represents prima facie the ideal solution to address hybrid mismatch arrangements and prevent their exploitation for double-non taxation purposes. Given that the mismatch arises due to the different qualification of the hybrid entity in terms of transparent or opaque treatment, the most intuitive remedy is represented by an agreement on the nature of the entity for tax purposes. Since the entity is shaped under the law of the jurisdiction where it is established, it seems logical that the investor jurisdiction would follow the qualification given by the establishment jurisdiction. Such an agreement could be included in a specific treaty provision. Yet, if one considers that treaties are elective137 and unable to properly prevent double non-taxation, as admitted by OECD in the Final Report on BEPS Action 6,138 the implementation of a domestic rule that qualifies foreign entities on the basis of their tax treatment in the establishment jurisdiction might be more effective. Applying the above assumptions to the CV-BV structure, the interest payment by the BV would thus flow untaxed through the CV and would be included in the ordinary income of the limited partner under US laws. Single taxation would be ensured and the recipient of the income would be subject to net taxation also in accordance with the benefits principle. From a theoretical point of view, this solution would constitute the perfect embodiment of the single taxation principle. 137. See Rosenbloom, supra n. 19. 138. Para. 68 Action 6 Final Report.

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Still, some issues of double taxation may arise: provided that the CV carries out some substantial activity, the Netherlands could regard it as a permanent establishment of the US parent company and possibly include the payment within the permanent establishment’s profits.139 In such a case, article 7 of the Netherlands-United States double tax treaty would apply, granting taxing rights to the Netherlands and requiring the United States to give double tax relief. In the light of the considerations expressed in the section 1.6.2.1., this possibility would not affect the inclusion of the solution in the notion of single taxation. One should therefore conclude that the agreement on the nature of the hybrid entity represents the best of all possible worlds. Nonetheless, a similar outcome can be reached only bilaterally, or, provided that the investor jurisdiction has unilaterally adopted a linking rule for qualification purposes, the agreement hypothesis cannot be considered a general policy and does not suggest a rule that, from the establishment jurisdiction’s perspective, is able to neutralize on a stand-alone basis the effects of reverse hybrid mismatches.

1.6.5.  The thin line between single and double taxation Each of the hypotheses that have been examined has both advantages and disadvantages, and in the context of this chapter, it is not relevant to establish which one is the best option. Conversely, it is relevant to note that, in each scenario, single taxation is achieved only as a product of bilateral agreement, or when just one of the involved jurisdictions adopts some measure to address the reverse hybrid mismatch while the counter-jurisdiction remains inactive. Otherwise, single taxation is reached when double taxation occurs, provided that a relief mechanism is granted. After all, the statement is not surprising: the traditional response to the harmful effects of unrelieved international double taxation is represented by the obligation of providing double tax relief included in tax treaties. Treaties do not generally seek to design the perfect international taxation system where a single levy is imposed on cross-border income unless a specific underlying policy choice has been made. Treaties rather seek to contain the total tax burden imposed on cross-border activities: often allowing the concurrent exercise of taxing rights, they provide for a reduction of the source taxation, on one hand, and the obligation of 139. As a matter of fact, the permanent establishment issue could still arise even in the original hybrid mismatch situation. Yet, neither the Partnership Report nor the Action 2 Final Report take this possibility into account.

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granting double tax relief to the residence state, on the other hand. In respect of double taxation issues (i.e. one of the “evils” rejected by the single tax principle), the jurisdictional aspect is secondary: the main concern of the international framework is actually with regard to the overall amount of taxation. Nonetheless, tax treaties are based on models, but states remain free to bilaterally agree on more precise allocation rules. The same conclusions can be drawn with regard to the double non-taxation phenomenon: the OECD approach adopted in the context of BEPS Action 2 appears to neglect jurisdictional considerations. The main goal is to ensure the imposition of at least one layer of taxation on income that would otherwise not be subject to any taxation, no matter where. The single taxation principle promoted by the OECD hence involves amounts more than jurisdictional concerns. Why, then, should income be taxed just once? It is now time to draw the conclusions of the overall research.

1.7. Conclusions This chapter extensively analysed the theoretical background of the single taxation principle, as well as its implementation as proposed by the OECD in the BEPS Project. The research highlighted that what appears to be, at least prima facie, a linear and intuitive concept turns out to be a complex and unclear policy goal, the boundaries of which are far from being certain. According to its supporters, the single taxation principle essentially establishes that cross-border income should be taxed just once, neither less nor more, at the rates provided by the benefits principle, which divides taxing claims between the source and residence jurisdictions on the basis of the benefits received by the recipient of the cross-border income in accordance with the redistributive function of taxation. By overturning the order of its components, it could be asserted that cross-border income should be taxed just once due to the consideration that precise allocation rules are able to perfectly divide the concurrent taxing rights between the source and residence states. Nonetheless, the principle incorporates a “residual” provision, according to which the counter-jurisdiction should tax the income if the state that has the primary taxing rights refrains from taxation. In such a case, the allocation issue seems to lose its relevance to a greater concern.

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This theoretical framework was further assessed through the examination of a concrete hybrid mismatch arrangement (the Dutch CV-BV structure). In this example, the double non-taxation outcome actually originated from the correct and proper application of two distinct tax systems that disagree on the qualification of the hybrid entity in terms of tax transparency (tax arbitrage). No abusive behaviour could be recognized, and it was difficult to determine which of the involved jurisdictions was affected by base erosion. As a matter of fact, neither the establishment jurisdiction nor the investor jurisdiction included the payment to the reverse hybrid in its own tax base; the alleged revenue loss was represented by a sort of “bilateral surplus”.140 Yet, double non-taxation is one of the two opposite “evils” rejected by the single tax principle and should be thus fixed through the imposition of at least one layer of taxation, no matter where. The “residual” clause hence applies not only when the jurisdiction that has primary taxing rights according to the benefits principle refrains from taxation, but even when both the jurisdictions affected by the hybrid mismatch consciously choose to exclude a cross-border payment from their tax bases. That being said, which policy consideration should lead states to address double non-taxation unilaterally? In other words, why should a jurisdiction whose policy provides for the non-recognition of a specific payment (in the case of the CV-BV example, the payment to a reverse hybrid entity)141 be concerned about the tax treatment of that payment in the investor jurisdiction? The single taxation principle thus seems to embody an ideal of worldwide or supranational efficiency as the core principle of a binding international tax regime. Being an international customary law, states would hence be required to comply with it due to the awareness of a legal obligation to implement the principle. Regardless of whether one agrees with the existence of a binding international tax regime, it must be noted that the BEPS initiative is significantly influenced by such theoretical framework. Narrowing the focus down to hybrid mismatch arrangements, it can be observed that the linking rules recommended in the Final Report on BEPS Action 2 and their “switch-off” functioning are indeed aimed at ensuring the imposition of a single layer of taxation on cross-border payments. Nonetheless, the analysis of the application of the BEPS recommendations to the CV-BV structure has shown that the effort of designing domestic provisions that are able, even unilaterally, to fulfil the single taxation principle in its literal meaning leads to extremely intricate solutions and fragile and 140. Rosenzweig, supra n. 37, at p. 588. 141. It must also be observed that the concept of a reverse hybrid itself is actually the product of a global (or at least bilateral) perspective that ascertains the mismatched intersection of different tax systems.

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inconsistent results. By adopting a perspective that looks at multinational groups as a single entity,142 double non-taxation, and hence, single taxation, are conceived as economic concepts that involve a stream of income flowing into the hands of different persons. However, if one then reflects on the proposed denial of the deduction from the taxable income of the payer, the outcome is that single taxation is met even if the recipient of the income is left untaxed anywhere. In other words, single taxation erases economic double non-taxation, but still tolerates the residual occurrence of juridical double non-taxation. Taking into account the above result and further observing that, once again, the jurisdictional issue loses relevance to the extent that a single layer of taxation is imposed on cross-border income,143 one can reach the peculiar conclusion that single taxation is a sort of inherent attribute of the income itself, as if income and not persons should be taxed just once, neither less nor more. In this light, single taxation ends up deviating from the essential features of income taxation. Furthermore, even if one pretends to ignore such unacceptable conclusion, another question is still unsolved. If the single tax principle does not incorporate an underlying jurisdictional concern, could the main issue be really represented by the number of levies imposed on cross-border income? The answer is intuitively no. As stated by Shaviro, “most of us would rather be taxed twenty times at 1 percent rate each time than once at 35 percent”.144 Given the overall analysis, it becomes clear that the problem that the single tax principle is meant to address is an amount issue that concerns the overall tax burden imposed on cross-border income, i.e. the rates of taxation. After all, the negative effects of the double non-taxation or double taxation phenomena are not determined by the actual number of levies. The inefficient incentives are, in fact, given by the amount of tax imposed on the income, which might, at one extreme, be excessive, and on the other extreme, inexistent. The fact that levying more than one layer of taxation leads to an overall tax burden that hinders international trade and investment is no more than a contingency; yet, the problem would not subsist if the rates were low enough to not affect the taxpayers’ business decisions. – It is finally interesting to reflect on how and where the idea that crossborder income should be taxed just one time originates from. According 142. Such an approach clashes with the untouchable independent entity principle that has been reaffirmed by the OECD BEPS Project (see sec. 1.4.4.2.). 143. See sec. 1.4.4.3. 144. Shaviro, supra n. 40.

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to the author’s opinion, the conceptual misunderstanding of the single tax principle arises in the context of the traditional international effort aimed at avoiding (or better, providing relief for) double taxation. As already stated, double taxation has negative implications because it is assumed that the imposition of more than one layer of taxation leads to an excessive overall tax burden. The idea of a single levy seems like an intuitive remedy, although the problem is not represented per se by the number of levies. From a systemic and super-partes perspective, it is extremely appealing and logical to trace a line that links the two opposite and harmful extremes represented by double non-taxation and double taxation, as well as to establish that the ideal condition is single taxation, which is located exactly at the middle of that line. When the focus of the international cooperation started to shift towards the issues of double non-taxation, the same principle seemed to be, once again, the remedy, or better, the rightful condition that should be restored. However, the main logical flaw of such construction is represented by the fact that the two negative extremes of the line are actually intrinsically different: on one side, there is an economic concept (i.e. economic double non-taxation), while on the other side, there is a juridical concept (juridical double taxation). Furthermore, such a system implies the construction of a world where there is a perfect agreement on the division of taxing rights and a supranational force that can ensure the worldwide implementation of the single taxation principle. In other words, this would create a world where there is no tax diversity – a sort of global, unitary macrojurisdiction. After all, why should double taxation be negative per se? As Seligman stated, the imposition of two levies “is unjust only when one taxpayer is assessed twice while another in substantially the same class is assessed but once”.145 If we consider the current dynamics of international tax relations, where both the residence and the source jurisdiction have valid arguments to support their claims on cross-border income,146 it turns out that controlled double taxation is maybe the proper way of taxing cross-border business profits; perhaps “all business income should be taxed not once but twice […] politicians and academicians should embrace double taxation, and instead of seeking to dismantle it, they should seek to improve it”.147

145. See Seligman, supra n. 51. 146. The residence state provides non-business benefits for its resident taxpayers carrying out business activities abroad, while the source state provides business benefits to foreign enterprises operating within its jurisdiction. 147. H.J. Schlunk, Double Taxation: The Unappreciated Ideal, 33 Tax Notes International 8, p. 715 (2004).

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Chapter 2 Exploring Single Taxation: From Concept to Implementation? Daniel M. Berman and Xu Yan

2.1.  The concept of single taxation Cross-border investment flows and business operations lead most countries to exercise both residence-based tax jurisdiction and source-based tax jurisdiction, but each country does so generally in an independent exercise of national sovereignty. The overlap of one country’s source-based tax jurisdiction and another country’s residence-based tax jurisdiction can lead to international double taxation. This impedes international exchange and cooperation of economy, technology and capital, thus derogating economic globalization, and transnational investors may bear a heavier burden of taxation than domestic investors. Gaps between one country’s source-based tax jurisdiction and another country’s residence-based tax jurisdiction can lead to international non-taxation, inviting international tax avoidance and even evasion. The combination of seeking to prevent double taxation and seeking to avoid double non-taxation leads naturally to the “single taxation principle” as a possible compromise. This chapter will explore the extent to which single taxation has become a principle of international taxation.

2.2.  Origins of the single taxation principle Professor Avi-Yonah suggested in 1997 that there is a consensus on an “international tax regime [that] is based on two principles, the benefits principle and the single tax principle.1 The benefits principle states that active (business) income should be taxed primarily by the country of source, and passive (investment) income should be taxed primarily by the country of residence.2”3

1. R.S. Avi-Yonah, International Taxation of Electronic Commerce, 52 Tax L. Rev. 3, p. 507 (2007), as cited in Avi-Yonah (2014), infra n. 3 (2014), at p. 306. 2. Id. 3. R.S. Avi-Yonah, Who Invented the Single Tax Principle? An Essay on the History of US Treaty Policy, 59 N.Y. L. Sch. L. Rev., p. 306 (2014).

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The single tax principle states that cross-border income should be taxed once at the rate determined by the benefits principle.4 In other words, cross-border income should be taxed only once at the source-country rate for active income and at the residence-country rate for passive income. But if the preferred country (i.e., source for active, and residence for passive) does not tax, it is incumbent upon the other country to do so because otherwise … double non-taxation would result, which is just as damaging as double taxation.5,6

Avi-Yonah describes the benefits principal as non-controversial, but acknowledges that the single taxation principle has been subject to significant debate among professors of tax law. The very definition of the single taxation principle has not reached consensus. A somewhat different formulation was set forth by De Lillo in a comprehensive paper, stating that “[t] he single taxation principle states that cross-border income should be taxed once and only once regardless where the single levy is imposed, at a rate that does not exceed the residence jurisdiction’s rate and is not lower than the source [jurisdiction]’s rate”.7 (Emphasis omitted) This chapter will comment further on De Lillo’s formulation in section 2.3. Avi-Yonah notes that the United States, in an early (1932) tax treaty with France, reduced US withholding taxes and even eliminated the withholding tax on royalties, notwithstanding that France, at the time, employed a purely territorial tax system, exempting income from sources in the Unites States and other foreign countries from all residence-based taxation.8 Avi-Yonah also notes that the United States, in its 1962 tax treaty with Luxembourg, excluded from treaty benefits resident companies that were exempt from residence-based taxation under the latter country’s 1929 law on holding companies.9 He linked that point to the fact that the head of the US Treasury’s new Office of Tax Policy at that time was Professor Stanley Surrey, whose testimony to the US Senate in 1959 led to the rejection of “tax sparing” credits in the proposed tax treaty with Pakistan and established that position as US tax treaty policy that still stands at the present day. Avi-Yonah asserts that “[t]ax sparing was rejected because it involved double non-taxation”.10 Another source, however, reports that Surrey argued 4. Avi-Yonah, supra n. 1. 5. Id. 6. Avi-Yonah, supra n. 3. 7. F. De Lillo, In Search of Single Taxation: The Twilight of an Idol?, p. 22, thesis submitted in partial fulfillment of the LL.M. degree requirements for the University of Amsterdam-IBFD Advanced Master’s in International Tax Law (2017), see ch. 1 of this book. 8. Avi-Yonah, supra n. 3, at p. 306. 9. Id., at pp. 310-11. 10. Avi-Yonah, International Tax as International Law, 57 Tax L. Rev. 4 (2004).

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in his testimony “that the tax sparing credit violated fairness concepts, as it lowered the overall income tax liability of some U.S. companies below the level that would apply to business activities within the United States – in this instance, only those companies that chose to invest in Pakistan – while fully taxing all other U.S. companies”.11 Professor Surrey also argued that, given the structure of the tax legislative process under the US Constitution, “it would not be appropriate to make such a fundamental modification to the U.S. tax liability of U.S. companies through the treaty process”.12 These concerns did not suggest that double non-taxation should have been considered unacceptable had it been available more broadly than only to investors in Pakistan that were eligible for treaty benefits. Article 16(3) of the 1981 draft US model tax treaty, which was withdrawn on 17 July 199213 (having become obsolete in the late 1980s but not actually replaced by an official US model tax treaty until 1996), stated as the last paragraph of the limitation-on-benefits provision: “Any relief from tax provided by a Contracting State to a resident of the other Contracting State under the Convention shall be inapplicable to the extent that, under the law in force in that other State, the income to which the relief relates bears significantly lower tax than similar income arising within that other State derived by residents of that other State.”14 That draft model provision was generally reflected in only two US tax treaties, namely with Cyprus (1984) and Jamaica (Protocol, 1981).15 On the basis of that draft model treaty paragraph, as well as an explanation in an article published 2 years later,16 AviYonah accords the fatherhood of the single taxation principle to Professor Rosenbloom, who served as the US Treasury’s International Tax Counsel for 4 years, leaving office 5 months before the 1981 draft model tax treaty 11. D.M. Berman & V.J. Haneman, Making Tax Law, p. 248 (Carolina Academic Press 2014). 12. Id. 13. Technical Explanation of United States Model Income Tax Convention of September 20, 1996, introductory paragraph. 14. United States Model Income Tax Convention of 16 June 1981 (draft), art. 16(3). 15. D.M. Berman & N. Vélez Delgado, Limitation on Benefits Clauses in US Income Tax Treaties, 7 Intl. Taxation 5, p. 507 (2012). See, in particular, Convention between the Government of the Republic of Cyprus and the Government of the United States of America for the Avoidance of Double Taxation and the Prevention of Fiscal Evasion with Respect to Taxes on Income art. 4(6) (19 Mar. 1984), Treaties IBFD; and Technical Explanation of the Convention between the United States of America and Jamaica for the Avoidance of Double Taxation and the Prevention of Fiscal Evasion with Respect to Taxes on Income Signed at Jamaica on May 21, 1980, as Amended by the Protocol Signed at Jamaica on July 17, 1981 art. 17, Treaties IBFD. 16. H.D. Rosenbloom, Tax Treaty Abuse: Policies and Issues, 15 Law & Policy in Intl. Bus. 3, pp. 774-775 (1983), as cited in Avi-Yonah, supra n. 3.

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was published.17 However, the treaty policy inherent to that paragraph was reversed during the 1980s, authorizing discretion no longer to deny treaty benefits in specific cases, but to grant treaty benefits in appropriate circumstances. Article 28(2) of the Germany-United States tax treaty, which became the de facto US model treaty when it was signed in 1989,18 provided as follows: “A person that is not entitled to the benefits of this Convention pursuant to the provisions of paragraph 1 may, nevertheless, be granted the benefits of the Convention if the competent authority of the State in which the income in question arises so determines.”19 This authority can be applied to relieve double taxation, which always has been the principal stated objective of a tax treaty, but cannot be applied to prevent double non-taxation or even fiscal evasion.

2.3.  Comments on single taxation 2.3.1. US tax law compared to single taxation The foundational principle of US international tax policy, i.e. capital export neutrality, seeks to ensure that US-based capital faces the same level of taxation whether it is deployed within the United States or outside the United States.20 The equivalence is imperfect, however, because of the limitations on utilizing the US foreign tax credit, which generally allows a credit for foreign income taxes paid against the US residence or residual taxation imposed on the same income. The basic limitation is that the credit cannot exceed the amount of US taxation on the foreign income.21 However, that statutory limitation and the regulations thereunder are much more complex than that and have been modified frequently over several decades. The foreign tax credit often does not fully relieve double taxation; it operates essentially to allow taxation at the higher of the source country’s rate or the residence country’s rate, but in many cases, results in the imposition of 17. Avi-Yonah, supra n. 3, at p. 308. 18. D.M. Berman & J.L. Hynes, Limitation on Benefits Clauses in U.S. Income Tax Treaties, 29 Tax Management International Journal 12, p. 698, footnote 42 and antecedent text (2000). 19. Convention between the Federal Republic of Germany and the United States of America for the Avoidance of Double Taxation and the Prevention of Fiscal Evasion with Respect to Taxes on Income and Capital and to Other Certain Taxes art. 28(2) (29 Aug. 1989), Treaties IBFD 20. However, see sec. 2.4. of this chapter for a discussion of the newly enacted move by US tax law away from capital export neutrality. 21. US: Internal Revenue Code of 1986, as amended (Title 26 United States Code), sec. 904.

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residual US income tax even in circumstances where most observers may see the foreign tax as being imposed at a higher rate than the corresponding US tax. However, by not permitting tax sparing credits, the US system is structured not to result in double non-taxation. Typical of the United States, US tax laws do not necessarily follow the same principles when capital is moving in the other direction. US domestic tax law has applied an organized system of taxing inbound foreign investment and activity since 1966, more than 50 years ago. Gross-basis tax generally is imposed on and withheld from US-source income at the high rate of 30%, irrespective of the extent to which the foreign taxpayer may be subject to residence-based taxation on the same income. Treaty-based reductions in such source taxation generally are negotiated on the basis of reciprocal rate reductions, not by reference to the level of taxation imposed by both countries combined.22 The United States generally does not enter into tax treaties with countries that choose not to impose significant income taxation,23 and recently added a provision in its model tax treaty that denies benefits with respect to income protected by “special tax regimes”.24 However, the United States generally considers whether income is “liable to tax” in the other country rather than “subject to tax” by the other country – the extent to which the other country chooses to exercise its jurisdiction to impose tax on a particular class of income or taxpayer is a sovereign right of that country to define its own tax system, and generally has not been a concern of the United States. For example, about 25 years ago at the time of writing this chapter, the tax lawyers in the US Treasury Department’s Office of Tax Policy and on the staff of the Joint Committee on Taxation of the US Congress became aware that certain taxpayers from Japan were able to obtain double depreciation deductions in connection with equipment leases of US property by exploiting the different definitions of the “owner” of the leased property under the domestic tax laws of Japan and the United States. Some might have viewed that situation as tax abuse and may have sought to change US law in order to stop it. However, we in the US government at the time were comfortable that the US lease ownership rule was correct for the US economy: we felt that Japan was welcome to change its rule to be consistent with ours, but if Japan wanted to give away depreciation deductions with respect to property that the taxpayer did not own under US definitions, that was up to Japan. As another example, US domestic law waives source-based taxation of interest payments made by US persons to 22. D.M. Berman, Covering the World: The Expanding U.S. Tax Treaty Network, 74 Taxes 12, p. 1066 (1996). 23. Id., at p. 1067. 24. United States Model Income Tax Convention art. 3(1)(l) (17 Feb. 2016).

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unrelated non-US persons on portfolio debt obligations, irrespective of the level of taxation (if any) imposed on such interest income as received in the residence country.25 Congress sought to provide US businesses with direct access to the Eurobond capital market without needing to resort to backto-back financing schemes through the Cayman Islands or the Netherlands Antilles.26 The US focus has been on the rule that would be right for the United States, not on overall single, double or non-taxation. There is no indication in the development of these outbound and inbound rules that the Unites States was pursuing a policy of international single taxation. Based on 3 decades of observations of and participation in the development of the US tax laws applicable to cross-border investment and activity, as well as analysis of the highlights of the same history over the 3 prior decades, the author perceives those laws as having been developed from a national perspective of how the United States wants its tax laws to relate to the tax laws of other countries.

2.3.2. BEPS The BEPS Project of the G20 and OECD certainly can be seen as a widespread move toward aspects of single taxation. The BEPS proposals with respect to hybrid entities and instruments (Action 2)27 and treaty abuse (Action 6),28 in particular the latter’s new language for treaty preambles that opposes double non-taxation,29 appear to intend that the application of tax laws to specific situations be adjusted so as to prevent double non-taxation that would result from the normal operation of national and treaty-based

25. US: Internal Revenue Code, as amended, secs. 871(h) and 881(c). 26. Staff of the Joint Committee on Taxation, General Explanation of the Revenue Provisions of the Deficit Reduction Act of 1984, pp. 391-394 (1984). 27. OECD, Neutralising the Effects of Hybrid Mismatch Arrangements – Action 2: 2015 Final Report (OECD 2015), International Organizations’ Documentation IBFD. 28. OECD, Preventing the Granting of Treaty Benefits in Inappropriate Circumstances – Action 6: 2015 Final Report (OECD 2015). 29. “A Covered Tax Agreement shall be modified to include the following preamble text: ‘Intending to eliminate double taxation with respect to the taxes covered by this agreement without creating opportunities for non-taxation or reduced taxation through tax evasion or avoidance (including through treaty-shopping arrangements aimed at obtaining reliefs provided in this agreement for the indirect benefit of residents of third jurisdictions)’.” See Multilateral Convention to Implement Tax Treaty Related Measures to Prevent Base Erosion and Profit Shifting art. 6(1) (24 Nov. 2016), available at http://www.oecd.org/ tax/treaties/application-toolkit-multilateral-instrument-for-beps-tax-treaty-measures.htm (accessed 27 Dec. 2017).

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tax law. Certainly, the CV-BV (double-holding-company) structure30 in the Netherlands and the double-Irish holding-company structure31 don’t represent good international tax policy – from a broad perspective, arbitrage of the different definitions employed by two tax systems always should be disfavoured. However, to design a tax system as an exercise of national sovereignty that imposes tax on a particular item of income or a specific taxpayer if and only if another country does not impose tax on that item of income or specific taxpayer also seems like a poor approach to tax policy. It would be difficult to infer the national strategy or priorities inherent to such a tax regime.

2.3.3. Rate of single taxation Figure 2.1.  Permitted rate of single taxation?

As mentioned in section 2.2.2., De Lillo described the single taxation principle by stating that “cross-border income should be taxed once and only once regardless where the single levy is imposed, at a rate that does not exceed the residence jurisdiction’s rate and is not lower than the source [jurisdiction]’s rate”.32 In figure 2.1, one can see the impossibility of that mathematical inequality. There is no possible rate of tax that could be imposed on an item of income payable from sources in the United States to a resident of the United Kingdom or the Cayman Islands that is both not 30. CV = commanditaire vennootschap (closed limited partnership); BV = besloten vennootschap (operating company). In this structure, the CV holding company is treated as a corporation for US tax purposes, but a pass-through partnership for Dutch tax purposes, while the BV holding company is treated as a pass-through partnership for US tax purposes, but a corporation for Dutch tax purposes. 31. Both holding companies are incorporated in Ireland and one is resident there, but the other is resident in a tax haven country. 32. De Lillo, supra n. 7.

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lower than the US rate and also not higher than the UK or Cayman rate. The great variety of tax rates imposed by different countries makes it impossible both to establish a rule for a rate of single taxation and to analyse the concept of single taxation independent of rates.

2.3.4. Economic double taxation Although single taxation is essentially a jurisdictional concept, economic double taxation frequently is included in the discussion.33 Just as tax rates do not seem to solve the definitional issue of single taxation, economic double taxation in the form of multiple layers of taxation through multiple entities does not seem susceptible to prevention or even meaningful reference in a discussion of single taxation. As illustrated in figures 2.2 and 2.3, one would think that adequate single taxation would be seen in the Netherlands’ corporate income taxation at the rate of 25% plus dividend withholding tax at the applicable treaty rate (5% or 15%). As received by the US shareholder, the taxation of that dividend varies dramatically, depending on the shareholder’s classification as a US corporation (left column), as individual shareholders of the Netherlands corporation (middle column) or as individual shareholders of a Dutch entity treated as a partnership under the US “check the box” entity classification regulations34 (right column).

33. 34.

Id., at p. 43 et seq. US: Code of Federal Regulations, Title 26, secs. 301.7701-1 through -3.

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Figure 2.2.  Economic double taxation?

W/H tax = withholding tax

Figure 2.2 illustrates the top rates applicable under current US law as of the final week of 2017. Figure 2.3 illustrates the top rates (and a form of participation exemption) applicable under US tax law that was enacted on 22 December 201735 and generally took effect only 10 days later, on 1 January 2018.36

35. US: An Act to provide for reconciliation pursuant to titles II and V of the concurrent resolution on the budget for fiscal year 2018, H.R. 1, Pub. L. No. 115-97 (2017) (unofficially known as the Tax Cut and Jobs Act). 36. See sec. 2.4. for a discussion and explanation of the new US tax laws affecting cross-border investments and operations.

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Figure 2.3.  Economic double taxation?

Under both pre-2018 US tax law and post-2017 US tax law, the least favourable structure alternative is in the middle column, under which US individual shareholders own shares of a Dutch BV that is treated as a corporation for US tax purposes. The tax detriment is even more significant under new law than under current law. Under each set of laws, the magnitude of applicable US income tax depends on the domestic ownership structure chosen by the investor. The availability of alternative domestic ownership structures is certainly common worldwide, and such alternatives generally have business purposes and consequences apart from tax. Differential tax impacts also are common worldwide. Admittedly, the US entity classification regulations allow a separation of business purposes from tax consequences and could be open to criticism as a matter of tax policy. However, it should be clear that single taxation, as a suggested worldwide international tax policy, should have no implications for the economic single or double taxation presented in figures 2.2 and 2.3. Moreover, if there might be a suggestion that the enactment of a form of participation exemption for corporations as illustrated in figure 2.3 could have implications with respect to single taxation policy, it should be understood that any such suggestion would have found no audience in the US Congress.

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2.3.5. Customary international law Avi-Yonah has suggested that the international tax regime, including the benefits principle and the single taxation principle, constitutes customary international law and therefore is binding on all countries.37 The fundamental refutation that such a high-level consensus exists can be found in the widespread divergence of views, including broad disagreement with Avi-Yonah’s suggestion.38 While single taxation can fairly be viewed as a widely shared policy goal, it does not carry enough accepted authority, uniform interpretation or common implementation to constitute customary international law. Avi-Yonah offers examples of the US government seeming to abide by the binding nature of the international tax regime as customary international law. However, the behaviour of the US government in explaining its apparent derogations from the international tax regime demonstrates that the United States sees only common international norms, not binding international law. In the author’s extensive experience participating in the development of US tax law with cross-border effects,39 US legislators and government officials consider the tax sovereignty of the United States constrained by all treaties and agreements to which the United States is a party, but are free to choose whether or not to abide by international norms. Non-discrimination, for example, was accepted as a requirement under applicable tax and investment treaties and trade agreements, but otherwise was no constraint on possible tax legislation.40 The possibility that a body of customary international tax law could be binding on the United States was never even discussed. The BEPS recommendations can be viewed as an attempt to establish single taxation as a universal policy goal, and the Multilateral Instrument (MLI) (Action 15)41 as an attempt to bring those recommendations into international law, at least at the treaty level. Accession to the MLI involves listing bilateral treaties to be covered and offers certain alternative provisions and 37. Avi-Yonah, supra n. 10. 38. De Lillo, supra n. 7, at pp. 15-19. 39. S.G. Hirani, Treasury’s Berman Discusses International Tax Policy in Exit Interview, 172 Daily Tax Report J-1 (1997); L.A. Sheppard & J.A. Martin, Treasury’s Daniel Berman Reflects on Past and Future Int’l Tax Law, 76 Tax Notes 1387 (1997); and L.A. Sheppard & J.A. Martin, Berman, Part II: Outgoing Treasury Staffer Discusses Treaty Policy, 76 Tax Notes 1536 (1997). 40. Compare Avi-Yonah, supra n. 10, at p. 498. Congress, in 1989, retained a different rule applicable to non-US persons without treaty protection, i.e. a 30% withholding tax. 41. OECD, Developing a Multilateral Instrumentto Modify Bilateral Tax Treaties – Action 15: 2015 Final Report (OECD 2015), International Organizations’ Documentation IBFD.

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permitted reservations. The OECD maintains a database of each signatory country’s identified treaties and selected provisions and reservations. As of 20 December 2017, the MLI Database - Matrix of options and reservations included 72 rows and 76 columns.42 These represent 72 signatory countries and 76 choices that each country may make regarding alternative provisions and permitted reservations. The coverage of bilateral treaties could be shown in a matrix of approximately the same size. There is no simple way to express the incorporation of the BEPS recommendations into international tax treaty law. Consider another example. Notwithstanding its refusal to sign the UN Law of the Sea Treaty,43 the United States recognized that certain provisions of that treaty “generally confirm existing maritime law and practice” with respect to traditional use of the oceans, and thus would be accepted as customary international law.44 This is frequently cited as an example of a widely joined multilateral treaty that is binding on non-parties as customary international law.45 However, as specified by President Reagan in the official US statement, the United States does not recognize all provisions of the Law of the Sea Treaty as customary international law, particularly the treaty’s provisions that would regulate mining on the deep seabed.46 According to the International Court of Justice, a multilateral treaty can be considered as evidence of customary international law only to the extent that it “(1) codifies existing customary international law; (2) causes customary international law to crystallize; [or] (3) initiates the progressive development of new customary international law”.47 Some scholars suggest that “those parts of multilateral treaties which are generalizable beyond the particulars of the treaty can serve as a source of customary international law provided three basic conditions are met: (1) The treaty is accepted by a sufficient number of states in the international system. (2) Among the parties to the treaty there are a significant number of those states whose interests are most affected by the treaty. (3) The treaty provisions are not subject to reservations by the accepting parties”.48 With each of its signatories offered 76 selections as to 42. MLI Database - Matrix of options and reservations, available at http://www.oecd. org/tax/treaties/mli-database-matrix-options-and-reservations.htm (27 Dec. 2017). 43. United Nations, Convention on the Law of the Sea, 1833 U.N.T.S. 397 (10 Dec. 1982). 44. Ronald Reagan, Statement on United States Oceans Policy (10 Mar. 1983), available at https://www.state.gov/documents/organization/143224.pdf (27 Dec. 2017). 45. See M.L. Lee, The Interrelation between the Law of the Sea Convention and Customary International Law, 7 San Diego Intl. L. J. (2006). 46. Reagan, supra n. 44. 47. Lee, supra n. 45, at p. 408, citing the International Court of Justice. 48. G.L. Scott & C.L. Carr, Multilateral Treaties and the Formation of Customary International Law, 25 Denv. J. Intl. L. & Policy 71/72, p. 408 (1996).

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alternative provisions and permitted reservations, it is clear that the MLI does not satisfy these requirements. The MLI does not codify the single taxation principle as customary international law; rather, it confirms that the single taxation principle is not customary international law.

2.4.  US territorial taxation 2.4.1. Change in policy The United States, on 22 December 2017, enacted major tax legislation that, inter alia, moved away from capital export neutrality to an exemption system for the active business income of a US corporation.49 Most of the provisions of the legislation are effective only 10 days later. Under the new participation allowance, a US corporation generally is permitted to deduct the non-US-source portion of all dividends received from foreign corporations in which it owns at least 10% of the stock, measured by vote or value.50 Many limiting, conforming, clarifying, anti-abuse and related rules also are included in the legislation. As a transition matter for the change from deferral to exemption, the legislation imposes a current tax (that may be spread over 8 taxable years) on the shareholder’s pro rata share of all accumulated deferred income of the foreign corporation. The tax is imposed at the rate of 15.5% on the foreign corporation’s cash position (defined broadly), and 8% on remaining assets.51 The appendix to this chapter presents excerpts from the official congressional explanation of the conference that reconciled the House and Senate bills. Other international-related provisions of the new legislation address the US foreign tax credit system, controlled foreign corporation rules, hybrid transactions and entities, base erosion and other matters.52 Although this new US legislation does represent a significant step toward single taxation, it is does not appear that such was one of the goals of the legislation. In the official legislative history of US tax statutes, the recitations of the motivation for the legislation are set forth in the “Reasons for Change” sections of the committee reports of the tax-writing committees, House Ways & Means and Senate Finance, which typically would “describe the purpose and scope of the legislation and the reasons that it is 49. US: An Act to provide for reconciliation pursuant to titles II and V of the concurrent resolution on the budget for fiscal year 2018, supra n. 35, at secs. 14101-14502. 50. Id., at sec. 14101. 51. Id., at sec. 14103. 52. Id., at secs. 14201-14502.

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recommended for approval”.53 The House Ways & Means committee report on the new legislation explained the primary reason for enactment as follows: “The Committee believes that a territorial system with appropriate anti-base erosion safeguards, combined with a lower corporate tax rate, will make American workers and companies competitive again, and also will remove tax-driven incentives to keep funds offshore.”54 Similarly, the Senate committee report explained the reason for enactment as follows: “The provision would allow U.S. companies to compete on a more level playing field against foreign multinationals when selling products and services abroad by eliminating an additional level of tax.”55 The single taxation principle is not mentioned in either of these committee reports or any of the other official policy papers56 or explanations57 issued with respect to the legislation. Like prior US tax legislation, as discussed in section 2.3.1., all indications show that this legislation was developed in pursuance of a national strategy to lower tax burdens on US corporations and make them more competitive against foreign competition, not to pursue international tax policy goals such as single taxation. Because of the suddenness of this major change in US international tax law, it likely will take months before the full implications of this new legislation will be understood in the United States.

53. Berman & Haneman, supra n. 11, at p. 33. 54. US: Tax Cut and Jobs Act – Report of the Committee on Ways and Means, House of Representatives, on H.R.1, H. Rept. 115-409, 115th Cong. 1st Sess., p. 370 (2017). 55. US: Explanation of the Senate Finance Committee FY 2018 Reconciliation Legislation, incorporated into US: Senate Committee on the Budget, Reconciliation Recommendations Pursuant to H.Con.Res. 71, S.Prt. 115-20, 115th Cong. 1st Sess., p. 358 (2017). 56. US: A Better Way, tax policy paper of the Republican Party (24 June 2016); US: 2017 Tax Reform for Economic Growth and American Jobs, White House fact sheet on proposed tax reform (26 Apr. 2017); US: House of Representatives Committee on Ways & Means, The Tax Cuts and Jobs Act Policy Highlights (2 Nov. 2017); and US: House and Senate Conference Committee, The Tax Cuts and Jobs Act Policy Highlights (16 Dec. 2017). 57. US: Conference Report to the bill (H.R. 1), to provide for reconciliation pursuant to titles II and V of the concurrent resolution on the budget for fiscal year 2018 (including Statement of Managers) (15 Dec. 2017); and US: Joint Explanatory Statement to the bill (H.R. 1), the Tax Cuts and Jobs Act (16 Dec. 2017).

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Appendix: Excerpts from official explanation of new legislation58 INTERNATIONAL TAX PROVISIONS A. Establishment of Participation Exemption System for Taxation of Foreign Income 1. Deduction for foreign-source portion of dividends received by domestic corporations from specified 10-percent owned foreign corporations (sec. 4001 of the House bill, sec. 14101 of the Senate amendment, and new sec. 245A of the Code) House Bill In general The provision generally establishes a participation exemption system for foreign income. This exemption is provided for by means of a 100-percent deduction for the foreign-source portion of dividends received from specified 10-percent owned foreign corporations by domestic corporations that are United States shareholders of those foreign corporations within the meaning of section 951(b) (referred to here as “participation DRD”). A specified 10-percent owned foreign corporation is any foreign corporation with respect to which any domestic corporation is a United States shareholder. The phrase does not include a passive foreign investment company within the meaning of subpart D of part VI of subchapter P. The term “dividend received” is intended to be interpreted broadly, consistently with the meaning of the phrases “amount received as dividends” and “dividends received” under sections 243 and 245, respectively. Under proposed section 245A(e), the Secretary of the Treasury may prescribe such regulations or other guidance as may be necessary or appropriate to carry out the rules of section 245A, including clarifying the intended broad scope of the term “dividend received.” For example, if a domestic corporation indirectly owns stock of a foreign corporation through a foreign partnership and the domestic corporation would qualify for the participation DRD with respect to dividends from 58.

Joint Explanatory Statement, id., at pp. 466-477 (citations omitted).

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the foreign corporation if the domestic corporation owned such stock directly, the domestic corporation would be allowed a participation DRD with respect to its distributive share of the partnership’s dividend from the foreign corporation. Foreign-source portion of a dividend The participation DRD is available only for the foreign-source portion of dividends received from specified 10-percent owned foreign corporations. The foreign-source portion of any dividend is the amount that bears the same ratio to the dividend as the specified foreign corporation’s post-1986 undistributed foreign earnings bears to the corporation’s total post-1986 undistributed earnings. Post-1986 undistributed earnings are the amount of the earnings and profits of a specified 10-percent owned foreign corporation accumulated in taxable years beginning after December 31, 1986, as of the close of the taxable year of the foreign corporation in which the dividend is distributed and not reduced by dividends distributed during that year. Post-1986 undistributed foreign earnings are, in general, the portion of post-1986 undistributed earnings that is not attributable to post-1986 undistributed U.S. earnings. Post-1986 undistributed U.S. earnings are, in general, undistributed earnings attributable to: (a) the corporation’s income that is effectively connected with the conduct of a trade or business within the United States, or (b) any dividend received (directly or through a wholly owned foreign corporation) from an 80-percent-owned (by vote or value) domestic corporation. Rules similar to the rules described above apply when a dividend is paid out of earnings and profits of a specified 10-percent owned foreign corporation accumulated in taxable years beginning before January 1, 1987. As a consequence, the participation exemption system is available for both post-1986 and pre-1987 foreign earnings. An ordering rule provides that dividends are treated as first being paid out of post-1986 undistributed earnings to the extent of those earnings. An additional rule provides for the treatment of distributions of a specified 10-percent owned foreign corporation in excess of undistributed earnings. Under section 316(a)(2), a distribution of earnings and profits of a corporation in the taxable year of the distribution is treated as a dividend even if the distribution exceeds accumulated earnings and profits. The determination of the foreign-source portion of such a distribution is calculated in a similar manner as for other types of dividends.

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Foreign tax credit disallowance; foreign tax credit limitation No foreign tax credit or deduction is allowed for any taxes (including withholding taxes) paid or accrued with respect to a dividend that qualifies for the participation DRD. For purposes of computing the section 904(a) foreign tax credit limitation, a domestic corporation that is a United States shareholder of a specified 10-percent owned foreign corporation must compute its foreign-source taxable income (and entire taxable income) by disregarding the foreign-source portion of any dividend received from that foreign corporation for which the participation DRD is taken, as well as and any deductions properly allocable or apportioned to that foreign-source portion or the stock with respect to which it is paid. Six-month holding period requirement A domestic corporation is not permitted a participation DRD in respect of any dividend on any share of stock that is held by the domestic corporation for 180 days or less during the 361-day period beginning on the date that is 180 days before the date on which the share becomes ex-dividend with respect to the dividend. For this purpose, a domestic corporation is treated as holding a share of stock for any period only if the corporation is a specified 10-percent owned foreign corporation and the taxpayer is a United States shareholder with respect to such corporation during that period. Effective date.−The provision applies to distributions made (and for purposes of determining a taxpayer’s foreign tax credit limitation under section 904, deductions in taxable years beginning) after December 31, 2017. Senate Amendment In general The provision allows an exemption for certain foreign income. This exemption is provided for by means of a 100-percent deduction for the foreign-source portion of dividends received from specified 10-percent owned foreign corporations by domestic corporations that are United States shareholders of those foreign corporations within the meaning of section 951(b) (referred to here as “DRD”).

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A specified 10-percent owned foreign corporation is any foreign corporation (other than a PFIC that is not also a CFC) with respect to which any domestic corporation is a U.S. shareholder. Foreign-source portion of a dividend The DRD is available only for the foreign-source portion of dividends received by a domestic corporation from specified 10-percent owned foreign corporations. The foreign-source portion of any dividend is the amount that bears the same ratio to the dividend as the undistributed foreign earnings bears to the total undistributed earnings of the foreign corporation. Undistributed earnings are the amount of the earnings and profits of a specified 10-percent owned foreign corporation as of the close of the taxable year of the specified 10-percent owned foreign corporation in which the dividend is distributed and not reduced by dividends distributed during that taxable year. Undistributed foreign earnings are the portion of the undistributed earnings attributable to neither income described in section 245(a)(5)(A) nor section 245(a)(5)(B), without regard to section 245(a)(12). Hybrid Dividends The DRD is not available for any dividend received by a U.S. shareholder from a controlled foreign corporation if the dividend is a hybrid dividend. A hybrid dividend is an amount received from a controlled foreign corporation for which a deduction would be allowed under this provision and for which the specified 10-percent owned foreign corporation received a deduction (or other tax benefit) from taxes imposed by a foreign country. If a controlled foreign corporation with respect to which a domestic corporation is a U.S. shareholder receives a hybrid dividend from any other controlled foreign corporation with respect to which the domestic corporation is also a U.S. shareholder, then the hybrid dividend is treated for purposes of section 951(a)(1)(A) as subpart F income of the recipient controlled foreign corporation for the taxable year of the controlled foreign corporation in which the dividends was received and the U.S. shareholder includes in gross income an amount equal to the shareholder’s pro rata share of the subpart F income, determined in the same manner as section 951(a)(2). Foreign tax credit disallowance No foreign tax credit or deduction is allowed for any taxes paid or accrued with respect to a dividend that qualifies for the DRD.

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For purposes of computing the section 904(a) foreign tax credit limitation, a domestic corporation that is a U.S. shareholder of a specified 10-percent owned foreign corporation must compute its foreign-source taxable income by disregarding the foreign-source portion of any dividend received from that foreign corporation for which the DRD is taken, and any deductions properly allocable or apportioned to that foreign-source portion or the stock with respect to which it is paid. Holding period requirement A domestic corporation is not permitted a DRD in respect of any dividend on any share of stock that is held by the domestic corporation for 365 days or less during the 731-day period beginning on the date that is 365 days before the date on which the share becomes ex-dividend with respect to the dividend. For this purpose, the holding period requirement is treated as met only if the specified 10-percent owned foreign corporation is a specified 10-percent owned foreign corporation at all times during the period and the taxpayer is a U.S. shareholder with respect to such specified 10-percent owned foreign corporation at all times during the period. Effective date.−The provision is effective for taxable years of foreign corporations beginning after December 31, 2017, and for taxable years of U.S. shareholders in which or with which such taxable years of foreign corporations end. Conference Agreement In general The provision in the conference agreement generally follows the provision in the Senate amendment, with some changes, as described below, and allows an exemption for certain foreign income by means of a 100-percent deduction for the foreign-source portion of dividends received from specified 10-percent owned foreign corporations by domestic corporations that are United States shareholders of those foreign corporations within the meaning of section 951(b) (referred to here, as above, as “DRD”). A specified 10-percent owned foreign corporation is any foreign corporation (other than a PFIC that is not also a CFC) with respect to which any domestic corporation is a U.S. shareholder. The term “dividend received” is intended to be interpreted broadly, consistently with the meaning of the phrases “amount received as dividends” and 73

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“dividends received” under sections 243 and 245, respectively. For example, if a domestic corporation indirectly owns stock of a foreign corporation through a partnership and the domestic corporation would qualify for the participation DRD with respect to dividends from the foreign corporation if the domestic corporation owned such stock directly, the domestic corporation would be allowed a participation DRD with respect to its distributive share of the partnership’s dividend from the foreign corporation. The DRD is available only to C corporations that are not RICs or REITs. Foreign-source portion of a dividend The DRD is available only for the foreign-source portion of dividends received by a domestic corporation from specified 10-percent owned foreign corporations. The foreign-source portion of any dividend is the amount that bears the same ratio to the dividend as the undistributed foreign earnings bears to the total undistributed earnings of the foreign corporation. Undistributed earnings are the amount of the earnings and profits of a specified 10-percent owned foreign corporation as of the close of the taxable year of the specified 10-percent owned foreign corporation in which the dividend is distributed and not reduced by dividends distributed during that taxable year. Undistributed foreign earnings are the portion of the undistributed earnings attributable to neither income described in section 245(a)(5)(A) nor section 245(a)(5)(B), without regard to section 245(a)(12). Hybrid dividends The DRD is not available for any dividend received by a U.S. shareholder from a controlled foreign corporation if the dividend is a hybrid dividend. A hybrid dividend is an amount received from a controlled foreign corporation for which a deduction would be allowed under this provision and for which the specified 10-percent owned foreign corporation received a deduction (or other tax benefit) with respect to any income, war profits, and excess profits taxes imposed by any foreign country. If a controlled foreign corporation with respect to which a domestic corporation is a U.S. shareholder receives a hybrid dividend from any other controlled foreign corporation with respect to which the domestic corporation is also a U.S. shareholder, then the hybrid dividend is treated for purposes of section 951(a)(1)(A) as subpart F income of the recipient controlled foreign corporation (notwithstanding section 954(c)(6)) for the taxable year of the controlled foreign corporation in which the dividends was received and the U.S. shareholder includes in gross income an amount equal to the 74

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shareholder’s pro rata share of the subpart F income, determined in the same manner as section 951(a)(2). Foreign tax credit disallowance No foreign tax credit or deduction is allowed for any taxes paid or accrued with respect to any portion of a distribution treated as a dividend that qualifies for the DRD. For purposes of computing the section 904(a) foreign tax credit limitation, a domestic corporation that is a U.S. shareholder of a specified 10-percent owned foreign corporation must compute its foreign-source taxable income (and entire taxable income) by disregarding the foreign-source portion of any dividend received from that foreign corporation for which the DRD is taken, and any deductions properly allocable or apportioned to that foreignsource portion or the stock with respect to which it is paid. Holding period requirement A domestic corporation is not permitted a DRD in respect of any dividend on any share of stock that is held by the domestic corporation for 365 days or less during the 731-day period beginning on the date that is 365 days before the date on which the share becomes ex-dividend with respect to the dividend. For this purpose, the holding period requirement is treated as met only if the specified 10-percent owned foreign corporation is a specified 10-percent owned foreign corporation at all times during the period and the taxpayer is a U.S. shareholder with respect to such specified 10-percent owned foreign corporation at all times during the period. Effective date.−The provision applies to distributions made (and for purposes of determining a taxpayer’s foreign tax credit limitation under section 904, deductions in taxable years beginning) after December 31, 2017. […] 3. Special rules relating to sales or transfers involving specified 10-percent owned foreign corporations (sec. 4003 of the House bill, sec. 14102 of the Senate Amendment and secs. 367(a)(3)(C), 961, 1248 and new sec. 91 of the Code)

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House Bill Reduction in basis of certain foreign stock Solely for the purpose of determining a loss, a domestic corporate shareholder’s adjusted basis in the stock of a specified 10-percent owned foreign corporation (as defined in new section 245A) is reduced by an amount equal to the portion of any dividend received with respect to such stock from such foreign corporation that was not taxed by reason of a dividends received deduction allowable under section 245A in any taxable year of such domestic corporation. This rule applies in coordination with section 1059, such that any reduction in basis required pursuant to this provision will be disregarded, to the extent the basis in the 10-percent owned foreign corporation’s stock has already been reduced pursuant to section 1059. Inclusion of transferred loss amount in certain assets transfers Under the provision, if a domestic corporation transfers substantially all of the assets of a foreign branch (within the meaning of section 367(a)(3)(C)) to a foreign corporation which, after such transfer, is a specified 10-percent owned foreign corporation with respect to which the domestic corporation is a United States shareholder, the domestic corporation includes in gross income an amount equal to the transferred loss amount, subject to certain limitations. The transferred loss amount is the excess of: (1) losses incurred by the foreign branch after December 31, 2017 for which a deduction was allowed to the domestic corporation, over (2) the sum of taxable income earned by the foreign branch and gain recognized by reason of an overall foreign loss recapture arising out of disposition of assets on account of the underlying transfer. For the purposes of (2), only taxable income of the foreign branch in taxable years after the loss is incurred through the close of the taxable year of the transfer is included. For transfers not covered by section 367(a)(3)(C), the transferred loss amount is reduced by the amount of gain recognized by the domestic corporation on the transfer (other than gains recognized by reason of overall foreign loss recapture). For transfers covered by section 367(a)(3)(C), the transferred loss amount is reduced by the amount of gain recognized by reason of such subparagraph.

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Amounts included in gross income by reason of the provision or by reason of section 367(a)(3)(C) are treated as derived from sources within the United States. The provision provides authority for the Secretary of the Treasury to prescribe regulations or other guidance for proper adjustments to the adjusted basis of the specified 10- percent owned foreign corporation to which the transfer is made, and to the adjusted basis of the property transferred, to reflect amounts included in gross income under the provision. Effective date.−The provision relating to reduction of basis in certain foreign stock for the purposes of determining a loss is effective for distributions made after December 31, 2017. The provision relating to transfer of loss amounts from foreign branches to certain foreign corporations is effective for transfers after December 31, 2017. Senate Amendment Sales by United States persons of stock In the case of the sale or exchange by a domestic corporation of stock in a foreign corporation held for one year or more, any amount received by the domestic corporation which is treated as a dividend for purposes of section 1248, is treated as a dividend for purposes of applying the provision Reduction in basis of certain foreign stock Solely for the purpose of determining a loss, a domestic corporate shareholder’s adjusted basis in the stock of a specified 10-percent owned foreign corporation (as defined in this provision) is reduced by an amount equal to the portion of any dividend received with respect to such stock from such foreign corporation that was not taxed by reason of a dividends received deduction allowable under section 245A in any taxable year of such domestic corporation. This rule applies in coordination with section 1059, such that any reduction in basis required pursuant to this provision will be disregarded, to the extent the basis in the specified 10-percent owned foreign corporation’s stock has already been reduced pursuant to section 1059.

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Sale by a CFC of a lower-tier CFC If for any taxable year of a CFC beginning after December 31, 2017, an amount is treated as a dividend under section 964(e)(1) because of a sale or exchange by the CFC of stock in another foreign corporation held for a year or more, then: (i) the foreign-source portion of the dividend is treated as subpart F income of the selling CFC for purposes of section 951(a)(1) (A), (ii) a United States shareholder with respect to the selling CFC includes in gross income for the taxable year of the shareholder with or within the taxable year of the CFC ends, an amount equal to the shareholder’s pro rata share (determined in the same manner as under section 951(a)(2)) of the amount treated as subpart F income under (i), and (iii) the deduction under section 245A(a) is allowable to the United States shareholder with respect to the subpart F income included in gross income under (ii) in the same manner as if the subpart F income were a dividend received by the shareholder from the selling CFC. In the case of a sale or exchange by a CFC of stock in another corporation in a taxable year of the selling CFC beginning after December 31, 2017, to which this provision applies if gain were recognized, rules similar to those in section 961(d) apply. Inclusion of transferred loss amount in certain assets transfers Under the provision, if a domestic corporation transfers substantially all of the assets of a foreign branch (within the meaning of section 367(a)(3)(C) as in effect before the date of enactment of TCJA) to a specified 10-percent owned foreign corporation with respect to which it is a U.S. shareholder after the transfer, the domestic corporation includes in gross income an amount equal to the transferred loss amount, subject to certain limitations. The transferred loss amount is the excess (if any) of: (1) losses incurred by the foreign branch after December 31, 2017, and before the transfer, for which a deduction was allowed to the domestic corporation, over (2) the sum of certain taxable income earned by the foreign branch and gain recognized by reason of an overall foreign loss recapture arising out of disposition of assets on account of the underlying transfer. For the purposes of (2), only taxable income of the foreign branch in taxable years after the loss is incurred through the close of the taxable year of the transfer, is included. The transferred loss amount is reduced by the amount of gain recognized by the taxpayer (other than gain recognized by reason of an overall foreign loss recapture) on account of the transfer.

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The amount of loss included in the gross income of the taxpayer under the proposed rule above for any taxable year cannot exceed the amount allowed as a deduction under new section 245A for the taxable year (taking into account dividends received from all specified 10-percent owned foreign corporations with respect to which the taxpayer is a U.S. shareholder). Any amount not included in gross income for a taxable year because of this proposed rule is included in gross income in the succeeding taxable year. Amounts included in gross income by reason of the provision are treated as derived from sources within the United States. Consistent with regulations or guidance that the Secretary of the Treasury may prescribe, proper adjustments are made in the adjusted basis of the taxpayer’s stock in the specified 10-percent owned foreign corporation to which the transfer is made, and in the transferee’s adjusted basis in the property transferred, to reflect amounts included in gross income under this provision. Repeal of active trade or business exception Section 367 is amended to provide that in connection with any exchange described in section 332, 351, 354, 356, or 361, if a U.S. person transfers property used in the active conduct of a trade or business to a foreign corporation, such foreign corporation shall not, for purposes of determining the extent to which gain shall be recognized on such transfer, be considered to be a corporation. Effective date.−The provision relating to reduction of basis in certain foreign stock for the purposes of determining a loss is effective for dividends received in taxable years beginning after December 31, 2017. The provisions relating to transfer of loss amounts from foreign branches to certain foreign corporations and to the repeal of the active trade or business exception are effective for transfers after December 31, 2017. Conference Agreement The provision in the conference agreement retains elements of both the House Bill and the Senate amendment, as follows. Sales by United States persons of stock In the case of the sale or exchange by a domestic corporation of stock in a foreign corporation held for one year or more, any amount received by the

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domestic corporation which is treated as a dividend for purposes of section 1248, is treated as a dividend for purposes of applying the provision. Reduction in basis of certain foreign stock Solely for the purpose of determining a loss, a domestic corporate shareholder’s adjusted basis in the stock of a specified 10-percent owned foreign corporation (as defined in this provision) is reduced by an amount equal to the portion of any dividend received with respect to such stock from such foreign corporation that was not taxed by reason of a dividends received deduction allowable under section 245A in any taxable year of such domestic corporation. This rule applies in coordination with section 1059, such that any reduction in basis required pursuant to this provision will be disregarded, to the extent the basis in the specified 10-percent owned foreign corporation’s stock has already been reduced pursuant to section 1059. Sale by a CFC of a lower-tier CFC If for any taxable year of a CFC beginning after December 31, 2017, an amount is treated as a dividend under section 964(e)(1) because of a sale or exchange by the CFC of stock in another foreign corporation held for a year or more, then: (i) the foreign-source portion of the dividend is treated as subpart F income of the selling CFC for purposes of section 951(a)(1) (A), (ii) a United States shareholder with respect to the selling CFC includes in gross income for the taxable year of the shareholder with or within the taxable year of the CFC ends, an amount equal to the shareholder’s pro rata share (determined in the same manner as under section 951(a)(2)) of the amount treated as subpart F income under (i), and (iii) the deduction under section 245A(a) is allowable to the United States shareholder with respect to the subpart F income included in gross income under (ii) in the same manner as if the subpart F income were a dividend received by the shareholder from the selling CFC. In the case of a sale or exchange by a CFC of stock in another corporation in a taxable year of the selling CFC beginning after December 31, 2017, to which this provision applies if gain were recognized, rules similar to section 961(d) apply. Inclusion of transferred loss amount in certain assets transfers Under the provision, if a domestic corporation transfers substantially all of the assets of a foreign branch (within the meaning of section 367(a)(3)(C)) as in effect before the date of enactment of TCJA) to a specified 10-percent

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owned foreign corporation with respect to which it is a U.S. shareholder after the transfer, the domestic corporation includes in gross income an amount equal to the transferred loss amount, subject to certain limitations. The transferred loss amount is the excess (if any) of: (1) losses incurred by the foreign branch after December 31, 2017, and before the transfer, for which a deduction was allowed to the domestic corporation, over (2) the sum of certain taxable income earned by the foreign branch and gain recognized by reason of an overall foreign loss recapture arising out of disposition of assets on account of the underlying transfer. For the purposes of (2), only taxable income of the foreign branch in taxable years after the loss is incurred through the close of the taxable year of the transfer, is included. The transferred loss amount is reduced by the amount of gain recognized by the taxpayer (other than gain recognized by reason of an overall foreign loss recapture) on account of the transfer. Amounts included in gross income by reason of the provision are treated as derived from sources within the United States. Consistent with regulations or guidance that the Secretary of the Treasury may prescribe, proper adjustments are made in the adjusted basis of the taxpayer’s stock in the specified 10-percent owned foreign corporation to which the transfer is made, and in the transferee’s adjusted basis in the property transferred, to reflect amounts included in gross income under this provision. The amount of gain taken into account under this provision is reduced by the amount of gain which would be recognized under section 367(a)(3)(C) as in effect before the date of enactment of TCJA with respect to losses incurred before January 1, 2018. Repeal of active trade or business exception Section 367 is amended to provide that in connection with any exchange described in section 332, 351, 354, 356, or 361, if a U.S. person transfers property used in the active conduct of a trade or business to a foreign corporation, such foreign corporation shall not, for purposes of determining the extent to which gain shall be recognized on such transfer, be considered to be a corporation. Effective date.−The provisions relating to sales or exchanges of stock apply to sales or exchanges after December 31, 2017.

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The provision relating to reduction of basis in certain foreign stock for the purposes of determining a loss is effective for distributions made after December 31, 2017. The provisions relating to transfer of loss amounts from foreign branches to certain foreign corporations and to the repeal of the active trade or business are effective for transfers after December 31, 2017.

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Chapter 3 Single Taxation as a Policy Goal: Controversial Meaning, Lack of Justification and Unfeasibility Prof. Dr. Luís Eduardo Schoueri and Guilherme Galdino

3.1. Introduction Notwithstanding the fact that the idea to pursue single taxation has an embryonic basis in the work of the League of Nations,1 it has become well known by its main supporter, Avi-Yonah. According to Avi-Yonah, there would be a “coherent international tax regime” “embodied in both tax treaty networks and in domestic laws”, which presents two principles that are common in such treaties and underline such regime. Along with the benefits principle, there would be the so-called “single tax principle”,2 which would define that income from cross-border transactions should be taxed no more and no less than once, and would therefore impose single taxation.3 Although much controversy lies over the actual existence of an international tax regime, this chapter focuses on addressing single taxation as a policy goal. In this analysis, no concern is expressed towards the question of whether states currently adopt such principle as a policy. The purpose of this chapter is to examine the meaning of single taxation in order to verify the reasons that support it as a policy goal and the feasibility of adopting it.

1. See League of Nations, Double Taxation and Tax Evasion, Doc. G.216.M.85 II, p. 23 (League of Nations 1927), report presented by the Committee of Technical Experts on Double Taxation and Tax Evasion, available at http://biblio-archive.unog.ch/Dateien/ CouncilMSD/C-216-M-85-1927-II_EN.pdf (accessed 10 Jan. 2018). 2. R.S. Avi-Yonah, International Tax as International Law – An Analysis of the International Tax Regime p. 1 (Cambridge Tax Law Series 2007). 3. For authors praising the single taxation principle, see R.S. Avi-Yonah, International Taxation of Electronic Commerce, 52 Tax L. Rev. 507, p. 517 (1997); Y. Brauner, What the BEPS?, 16 Florida Tax Review 55 (2014); and J.M.M. Rigoni, The International Tax Regime in the Twenty-First Century: The Emergence of a Third Stage, 45 Intertax 1, p. 205 (2017). For authors rejecting or questioning the single taxation principle, see H.D. Rosenbloom, The David R. Tillinghast Lecture International Tax Arbitrage and the “International Tax System”, 53 Tax L. Rev. 137 (2000); F. De Lillo, In Search of Single Taxation: The Twilight of an Idol? LL.M Thesis, University of Amsterdam (2017), see ch. 1 of this book; and D.N. Shaviro, The Two Faces of the Single Tax Principle, 41 Brook. J. Intl. L. 1293 (2016).

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3.2.  What does “single taxation” mean? In 1927, the Committee of Technical Experts on Double Taxation and Tax Evasion of the League of Nations asserted the need to coordinate tax evasion and double taxation. The idea was to achieve an agreement – which would be “highly desirable” – that a taxpayer should “not be taxed on the same income by a number of different countries” and that “international co-operation should prevent certain incomes from escaping taxation altogether”. Therefore, “experts should devise a scheme whereby all incomes would be taxed once, and once only”.4 This may be called the embryonic basis of single taxation as a policy goal. Although one may be reminded of some policies in some countries and the growing focus on the prevention of double non-taxation by the OECD,5 the major person responsible for the formulation of the single tax principle is Avi-Yonah. According to him, “income from cross-border transactions should be subject to tax once (that is, neither more nor less than once)”.6 As it stands, such formulation may be read focusing only on the number of levies on income from cross-border transactions, which could be called the formal approach to single taxation (see section 3.2.1.). However, AviYonah explains that the benefits principle would determine the rates for the single tax principle, giving a substantive approach to single taxation (see section 3.2.2.). In any case, it seems that, even understood in a substantive way, single taxation is being interpreted differently, i.e. as an economic concept (see section 3.2.3.).

3.2.1. Formal approach to single taxation: The number of levies does not mean anything Considering the formal approach, the simple assertion that income from cross-border transactions should be taxed only once – not more and not less – solely implies the number of levies on such income. It does not require 4. League of Nations, supra n. 1, at p. 23. 5. See De Lillo, supra n. 3, at pp. 13-15; R.S. Avi-Yonah, Who Invented the Single Tax Principle?: An Essay on the History of U.S. Treaty Policy, 59 N.Y.L. Sch. L. Rev. 305 (2014-2015); and Rigoni, supra n. 3. 6. Avi-Yonah, supra n. 5; Avi-Yonah, supra n. 3, at p. 517; R.S. Avi-Yonah, Tax Competition, Tax Arbitrage and the International Tax Regime, 61 Bull. Intl. Taxn. 130, p. 133 (2007), Journals IBFD; Avi-Yonah, supra n. 2, at p. 1; and R.S. Avi-Yonah, Commentary (Response to article by H. David Rosenbloom), 53 Tax L. Rev. 167, p. 169 (2000).

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an appropriate level of taxation. It relies on the presumption that one levy is better than no levy or two or more levies. Although a formal concern is not in itself objectionable, as single taxation could be justified on the grounds of simplification and legal certainty, such approach opens many questions. The idea that one levy is always better than two or more levies is misleading. From the taxpayer’s viewpoint, it is not a matter of how many times, but rather of how much. It is irrelevant whether one pays two or three different taxes. The real question is the cost of taxes that one will pay. As Shaviro states, “most of us would rather be taxed twenty times at a one percent rate each time than once at 35 percent”.7 If single taxation intends to address the dangers of double taxation, which are simply the consequences of excessive taxation, it is not correct to merely determine how many levies should be applied. At the end of the day, one levy must imply a total amount of tax burden lower than two or more levies. The idea that one levy is always better than no levy is also problematic. A state may want no taxation or at least provide regimes that create possibilities of tax planning (e.g. the US check-the-box rules).8 Several reasons may be connected to such behaviour. Not only does a state want to attract investments through low or no taxation, but it could also be its policy not to tax because of the consideration of the existence of other sources of income (other taxes, states’ properties, etc.). Also, there is no guidance concerning how double non-taxation should be addressed by single taxation. Under what circumstances should a state tax an “income” in order to achieve single taxation? Even if one accepts the idea that active income should be taxed exclusively by the source country and passive income taxed solely by the residence country, any exemption given by one state will need to be addressed by the other jurisdiction. Thus, the residual provision to prevent non-taxation would emerge. Nevertheless, such approach presents at least two objections. First, source countries may lose their capacity to attract investments, as they will not see any other way than to tax active income. The incentive derived from the non-taxation of such income would be nullified by the residual provision, as the other state would tax it. However – and this is the second 7. D.N. Shaviro, Fixing U.S. International Taxation p. 11 (Oxford U. Press 2014). 8. Shaviro, supra n. 3, at pp. 1299-1301; and Rosenbloom, supra n. 3, at p. 153.

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objection – source countries may only impose minimum rates (e.g. 0.01%),9 which would have almost the same impact as an exemption, but this could be enough to ensure the attraction of investment. Given the formal approach of single taxation, one could not argue that source countries would not be respecting it. From the perspective of residence states, this practice would be seen as dodging single taxation. In any case, if double non-taxation threatens national tax bases, again, revenue is not a matter of how many, but a matter of how much. The formal approach of the single taxation does not address the problem that it intends to solve; the number of levies does not mean anything. According to Avi-Yonah, the single tax principle would be the responsible for defining the tax base and should not implicate undertaxation. While the benefits principle would address the problem of dividing the taxing rights, the single tax principle would present the answer to the question regarding “the appropriate level of taxation that should be levied on income from cross-border transactions”. However, if the benefits principle determines “[t]he appropriate rate of tax for purposes of the single tax principle”,10 the single tax principle does not define anything. Presenting as it is, the single tax principle does not get to the heart of the issue because it does not answer such question (i.e. what is the appropriate level of taxation). The single tax principle only insinuates that cross-border transactions shall be taxed only once, not more or less. Considering that this means only one economic burden on income received by a taxpayer, which means that residence states would address minimum rates adopted by source states through foreign tax credits, single taxation still does not define the tax base, because it depends on the benefits principle to determine the (range of) tax rates. The question that remains is: What does single taxation mean in light of the benefits principle, considering a substantive approach?

3.2.2. Substantive approach to single taxation: The tax rates determined by the benefits principle The benefits principle addresses the problem of dividing the taxing rights, establishing that while the source jurisdiction has the primary right to tax active income, the residence state has the primary right to tax passive 9. Shaviro, supra n. 3, at p. 1294, footnote 5. 10. Avi-Yonah, supra n. 2, at pp. 8-9.

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income.11 Therefore, in the light of the benefits principle, single taxation imposes one tax only, being on active income by the source state and on passive income by the residence state – but at what rate(s)? Based on the tax rates (both corporate and personal) of the OECD member countries in 1995, Avi-Yonah proposed at first that income from cross-border transactions “should be taxed at a rate between approximately 30% (the lower end of the source rates) and approximately 60% (the higher end of the residence rates)”.12 Afterwards, also based on the practice of OECD member countries, in 2006, the mentioned author updated such range of rates, sustaining that income from cross-border transactions “should be taxed at a rate between approximately 25% (the lower end of the source rates) and approximately 55% (the higher end of the residence rates)”.13 According to Avi-Yonah, despite the wider range of divergence in individual income tax from 8.5% (in Latvia) to 60.1% (in Sweden) in 2016,14 such variability would be acceptable since, “under the benefits principle, most income derived by individuals in cross-border transactions is investment income that generally is subject only to residence-country tax”. In this sense, residence jurisdictions would usually determine “the single tax rate for investment income”. On the other hand, the corporate tax rates did not vary so widely, from 8.5% (in Switzerland) to 35% (in the United states) in 2016,15 as more than two thirds of OECD member countries applied a rate between 25% and 35%.16 Thus, “active income (mostly corporate)” should be taxed at a rate in the 25%-35% range.17 The formulation of single taxation based on the rates and the allocation rights determined by the benefits principle also faces some challenges in addressing the appropriate level of taxation. 11. Avi-Yonah, supra n. 2, at pp. 11-13. For a reconsideration of the benefits principle, establishing exactly the opposite, see R.S. Avi-Yonah & H. Xu, Evaluating Beps: A Reconsideration of the Benefits Principle and Proposal for UN Oversight, 6 Harvard Business Law Review 185 (2016). 12. Avi-Yonah, supra n. 3, at p. 522. 13. Avi-Yonah, supra n. 2, at pp. 12-13. 14. See OECD, Tax Policy Analysis: OECD Tax Database: B. Personal taxes (OECD 2016), available at http://stats.oecd.org/index.aspx?DataSetCode=TABLE_I7 (accessed 14 Jan. 2018). 15. See OECD, Tax Policy Analysis: OECD Tax Database: C. Corporate and capital income taxes (OECD 2016), available at http://stats.oecd.org/index.aspx?DataSetCode=TABLE_II1 (accessed 14 Jan. 2018). 16. Despite being true, such affirmation – considering the database of 2006 – 10 years later, most countries apply a corporate tax rate lower than 25%. 17. Avi-Yonah, supra n. 2, at pp. 12-13.

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First, the proposed range of rates is too wide to achieve consensus regarding the appropriate level of taxation. Although supporters (e.g. Avi-Yonah) of single taxation acknowledge that countries do not adopt similar rates, even if only OECD member countries are considered, their conclusion still remains: such range is satisfactory for single taxation. However, not only is this range too wide, since the highest tax rate is more than twice the lowest tax rate, but also, as it will be discussed in section 3.3.1., the proposed range presents the presumption of a state with high taxation. It would thus be necessary for most states – now including non-OECD member countries – to raise their tax rates and choose what would be an appropriate level between 25% and 55%. Therefore, one may not conclude that the substantive meaning of single taxation finds an appropriate tax rate in order to achieve the adequate level of taxation. Second, even if consensus regarding the fair tax rate could be achieved, giving an appropriate meaning to single taxation, the problem related to the allocation of taxing rights would remain. Although some states (e.g. developing countries) have a policy that source states shall tax active income as well as (part of the) passive income, single taxation is conceived to operate in a different way: source states have the primary right to tax active income, while residence states have the primary right to tax passive income. Brazilian tax treaty policy, for example, adopts the imposition of taxation on passive income at a certain level on source states. Taxation on royalties is granted to the source state at (in most tax treaties) 15%. Thus, the classification of “active” versus “passive” income relies on the assumption that there is consensus on the division of the allocation of taxing rights, which does not tend to be verified in practice. Therefore, one may conclude that the meaning of single taxation is related only to the view of developed countries, since it would operate based on common grounds of developed countries’ policies. Third, double non-taxation is a consequence of “different causes”, which may not all be addressed through the same approach. Not only may tax arbitrage and exploitation of tax havens result in double non-taxation, but also, some states may adopt reduced taxation as a policy, such as in intended exemptions. For example, in tax arbitrage, it is hardly difficult to find out which state lost revenue. As tax arbitrage can be defined as the taking advantage of mismatches between tax systems to achieve low or no taxation, it is impossible

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to affirm where taxation shall take place.18 From the perspective of both countries, the taxpayer respected the law: “there is neither aggressiveness nor abuse”.19 Moreover, tax arbitrage may arise not only from “full-blown rules of exemption”, but also might derive from different constituent elements and concepts, like many other discrepancies between domestic systems, so that a better tax outcome exemption may arise from irreconcilable definitions of income adopted in domestic tax systems.20 Thus, when single taxation puts tax arbitrage and, for instance, intended exemption in the same basket, which may be related to certain tax policies and not to particularities of a system, it may be seen as “simplistic”21 because many causes boil down to the same concept. If single taxation is analysed in light of the benefits principle in order to have a substantive meaning, its content may be jeopardized, since it relies on questionable assumptions. At the end of the day, single taxation does not define what should be an appropriate level of taxation because its meaning depends on a wide range of rates. Also, its formulation may be seen as biased in favour of policies of developed countries. In addition, one may point out that single taxation is insufficiently precise in relation to double non-taxation since it intends to comprise different causes through the same approach. In addition to the problems that arise in both the formal and substantive approaches to single taxation, one may argue that the meaning of single taxation itself presents some problems, because it may imply an economic concept on one side and a juridical idea on the other side.

3.2.3. Single taxation as an economic concept: Juridical double taxation versus economic double non-taxation Given that the formulation of single taxation requires that income from cross-border transactions shall be taxed only once, one may examine it 18. For more considerations regarding tax arbitrage, see B. Kuzniacki et al., Preventing Tax Arbitrage via Hybrid Mismatches: BEPS Action 2 and Developing Countries pp. 2-3, WU International Taxation Research Paper Series, No. 2017-03 (2017), available at https:// ssrn.com/abstract=2941617 (accessed 20 Jan. 2018); Avi-Yonah 2007, supra n. 6; and Rosenbloom, supra n. 3. 19. Rosenbloom, supra n. 3, at p. 143. 20. H.D. Rosenbloom, Cross-Border Arbitrage: The Good, the Bad and the Ugly, 85 Taxes 115, p. 117 (2007). 21. De Lillo, supra n. 3, at p. 45.

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according to its “faces”:22 (i) not more than once; and (ii) and not less than once. Although both the work of the League of Nations and Avi-Yonah seem to recognize a juridical concept in both faces, BEPS Project launched by the OECD23 goes in another direction. No question arises regarding the face of single taxation regarding taxation no more than once. Based on the perspective of the taxpayer, single taxation imposes the elimination of double taxation, which can be “defined as the imposition of comparable taxes in two (or more) states on the same taxpayer in respect of the same subject matter and for identical periods”.24 Therefore, single taxation grants a “right”25 for the taxpayer to have only one levy (economic burden) be imposed for the same subject matter in a certain period. Thus, it is clear that this face of single taxation is not an economic concept, as it intends to eliminate juridical double taxation. The circumstance that an item of income may be economically taxed twice is not a problem in respect of single taxation, provided that one state taxes the company distributing the profits and the other state taxes the beneficiary of the dividends. In other words, economic double taxation is not affected by single taxation. Differently, the face of single taxation regarding taxation no less than once may not go in the opposite direction, i.e. the prevention of juridical double non-taxation. This face may not be interpreted in order to obligate the taxpayer to be “subject to taxation not less than once”.26 One may adopt a focus on income, namely that the flow of income related to the same subject matter may not be undertaxed. Thus, it would be irrelevant if one taxpayer was not taxed, provided that the income had already been taxed, and in this sense, juridical double non-taxation would be tolerated. De Lillo27 sustained that the recommendations of Action 2 of the BEPS Project – which is grounded on single taxation and has the purpose of

22. Shaviro, supra n. 3; and De Lillo, supra n. 3, at p. 12. 23. See OECD, Action Plan on Base Erosion and Profit Shifting (OECD 2013), available at http://dx.doi.org/10.1787/9789264202719-en (accessed 20 Jan. 2018) [hereinafter BEPS Action Plan]. 24. OECD Model Tax Convention on Income and on Capital, Condensed Version p. 9 (18 Dec. 2017), available at http://dx.doi.org/10.1787/mtc_cond-2017-en (accessed 20 Jan. 2018). 25. De Lillo, supra n. 3, at p. 12. 26. Id. 27. Id., at pp. 43-46.

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addressing aggressive tax planning in hybrid mismatch arrangements28 in a coordinated way29 – conceive an economic concept of double non-taxation. The example used by De Lillo is the reverse hybrid. According to BEPS Action 2, a reverse hybrid is any person that is treated as opaque under the laws of the jurisdiction of the investor and as transparent under the laws of the establishment jurisdiction. Therefore, the problem presupposes a conflict of qualification regarding how this person should be treated for tax purposes. A situation of (economic) double non-taxation arises when the payment made to a reverse hybrid is deductible under the laws of the payer jurisdiction and not included as income under the laws of the payee jurisdiction. Thus, it is an example of deduction/no inclusion (D/NI). As stated by Action 2, in order to neutralize this mismatch, the payer jurisdiction (source state) should deny the deduction on payments made to a reverse hybrid.30 Consequently, the solution recommended by Action 2 implies that the recipient of the payment may not be taxed at all; juridical double nontaxation is seen as acceptable. The recipient (taxpayer) is not taxed in the payer jurisdiction (source state), as the taxation imposed there, by means of a non-deduction mechanism, simply increases the taxable income of the payer (the other taxpayer). Also, as the payment received is not included as income of the payee, he is not taxed under the laws of his jurisdiction. In short, the outcome proposed by Action 2 does not address juridical double non-taxation, but only economic double non-taxation. One may note, therefore, that the adoption of non-deductibility as a response addresses the other taxpayer, which does not have such income, thereby preventing solely economic double non-taxation, since that other taxpayer (the payer) is taxed. As envisaged in BEPS Action 2, the two faces of single taxation present different approaches, since each one has a different perspective. On the one hand, single taxation addresses juridical double taxation, establishing that income from cross-border transactions received by a taxpayer shall not be taxed more than once. It is clear that this face is directed from the 28. See OECD, Neutralising the Effects of Hybrid Mismatch Arrangements – Action 2: 2015 Final Report (OECD 2015), International Organizations’ Documentation IBFD, available at http://dx.doi.org/10.1787/9789264241138-en (accessed 21 Jan. 2018) [hereinafter BEPS Action 2]. 29. For an empirical analysis of such coordination on the corresponding provisions in the Multilateral Convention to Implement Tax Treaty Related Measures to Prevent Base Erosion and Profit Shifting (24 Nov. 2016), Treaties IBFD, see L.E. Schoueri & G. Galdino, Action 2 and the Multilateral Instrument: Is the Reservation Power Putting the Coordination at Stake?, 45 (Intertax 2, p. 104 (2018). 30. BEPS Action 2, supra n. 28, at pp. 55-61.

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viewpoint of the taxpayer. On the other hand, at least following the results of the BEPS Project in Action 2, single taxation may tolerate juridical double non-taxation if the economic double non-taxation is eliminated. In this case, the face follows the income and not the taxpayer. Although this approach adopted in BEPS Action 2 may present other consequences, such as the notion that an item of income is taxed and not a person,31 it indicates that the meaning of single taxation also has problems, since it may be understood as an economic concept on one of its faces. In any case, considering that single taxation has a substantive approach, why should it be a policy goal?

3.3.  Why should single taxation be a policy goal? Since the formal approach to single taxation is not enough to address the issue, given the irrelevance of the number of levies, this chapter will only consider its substantive approach for the purpose of investigating a justification of single taxation as a policy goal; the concern does not involve how many levies, but the total amount of the tax burden. However, to answer the question of why single taxation should be a policy goal, there is no need to justify the elimination of double taxation or to find reasons to address double non-taxation per se. Although single taxation intends to address double taxation and double non-taxation, its substantive approach imposes a range of rates and an operational way to be implemented.32 While source states have the primary right to tax active income, residence states have the primary right to tax passive income, but the nonexercise of such right leads to residual taxation by the other jurisdiction, whether residence or source. Given such considerations, the purpose of this section (3.3.) is to describe the arguments used by supporters of single taxation and to examine whether single taxation presents reasons for its adoption. As the justification of single taxation generally can be found on the grounds of efficiency (see section 3.3.1.) and equity (see section 3.3.2.), one must analyse each of these grounds separately. 31. De Lillo, supra n. 3, at pp. 45-49. 32. As this chapter does not present the purpose of questioning whether the single taxation principle is being applied in states or if it is an international custom, it is being treated as a policy that may be implemented.

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3.3.1. Efficiency argument: The limitation of CEN Single taxation could be grounded on an efficiency claim. Such affirmation is based on the different tax treatment of income from cross-border transactions and domestic income. On the one hand, an (inefficient) incentive would be created to invest domestically if domestic income were taxed less heavily than income from cross-border transactions. On the other hand, an (inefficient) incentive would be created to invest internationally if domestic income were taxed more heavily than income from cross-border transactions. From both sides, single taxation would prevent the “deadweight loss” resulting from undertaxation or overtaxation.33 While the “no more than once” face of single taxation would prevent the restraint of international investment, the “no less than once” face of single taxation would prevent the erosion of the national tax bases. Thus, the adoption of the credit method would impose on investors the same level of taxation on their inbound and outbound investments. There would be no distortion in their decisions, and the most efficient allocation of resources would be achieved. In short, the justification to implement single taxation is based on capital export neutrality (CEN),34 which would be “widely accepted”.35 However, as CEN does not bring efficiency, there is no international consensus on such proposition. Not only are there other factors that impact the tax policy of a country, such as tax inversions and reciprocal influences among states, but CEN also presupposes the non-existence of other relevant economic distortions, such as other taxes and the role of the infrastructure. CEN only takes into account income taxes as a factor that impacts the behaviour of states and investors, leaving behind many other elements that may have the same importance.36 Considering the relevance of the perspective of the investors for CEN and the assumption of high-tax states of the single tax principle, one may examine the importance of the level of benefits provided by states.

33. Avi-Yonah, supra n. 2, at p. 10. 34. Id., at p. 518, footnote 44; Avi-Yonah 2000, supra n. 6, at p. 171. 35. Avi-Yonah, supra n. 2, at p. 9. 36. For considerations regarding the adoption of capital export neutrality, see L.E. Schoueri & R.A. Galendi, Jr., Justification and Implementation of the International Allocation of Taxing Rights: Can we take on take one thing at a time?, in Tax Sovereignty in the BEPS Era p. 47, (S.A. Rocha & A. Christians eds., Wolters Kluwer 2017), Series on International Taxation vol. 60; and R.A. Galendi, Jr., Fundamentos da Tributação de Lucros no Exterior, 33 Direito Trib. Atual 389 (2015).

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Investors take a lot more into consideration than simply the tax rate, such as the corresponding level of services provided by the state in which they intend to invest. Neutrality, in a larger sense, means the non-interference of taxes, but also non-interference by governmental activities.37 Therefore, one can make the assumption that, in a given state, the level of taxes charged is proportional to the level of services provided. Jurisdictions that charge low rates cannot generally offer a high level of services, which implies that taxpayers should be expected to be prepared to supplement it. On the contrary, jurisdictions that demand high taxes usually can offer a stronger state in the sense of governmental activities. Although “income taxes are not measured by the use of public goods”,38 it is undeniable that investors take into account more than income taxes, since they consider other factors that they can or cannot expect, such as the level of public health, education and economic stability. Thus, investment choices present a double consideration of (i) where taxes are lower; and (ii) where benefits are higher. However, offering more services requires more taxes: one depends on the other.39 Nevertheless, the assumption that states that impose high taxes provide more services is generally true for developed countries. Although developing countries may charge high taxes, given some deficiencies, they may not achieve the corresponding level of services. The raising of taxes is not enough to provide more services. There is a whole range of factors involved, such as political and administrative systems, human capital and infrastructure.40 Unless there are other reasons, such as non-renewable, immobile factors, the equalization of tax rates may change the focus of the investors, as they may only invest in developed countries, since it would not be worthwhile to invest in a state with high taxes and low benefits (i.e. developing countries adopting such high rates). Suppose that Country A levies high taxes and provides a corresponding supply and quality of public goods, Country B imposes high taxes and provides less than a proportional amount of services regarding the level of taxes

37. See K. Vogel, World-wide vs. Source Taxation of Income – A Review and Reevaluation of Arguments, in Influence of Tax Differentials on International Competitiveness p. 141 (C.E. Mclure et al. eds., Kluwer 1989). 38. Id. 39. L.E. Schoueri, Tax Sparing: A Reconsideration of the Reconsideration, in Tax, Law and Development pp. 119-120 (Y. Brauner et al. eds., Edward Elgar 2013). 40. Vogel, supra n. 37, at p. 142.

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paid and Country C imposes lower taxes and provides a few benefits. What would be the country chosen by a certain investor? Definitely, Country B would not be the first option, or even the second. Also, it is incorrect to assume that either Country A (high-tax state) or Country C (low-tax state) is preferable. Investors have reasons to believe that both are efficient, each in their particular way.41 Neutrality can be regarded not only as total absence of interference, but as a particular situation in which negative (inefficient) incentives are cancelled out by positive (efficient) incentives. It thus becomes a political option to choose Country A or C, and one could hardly claim that the way in which states organize and offer services should be the same. The efficiency argument used to support single taxation relies on an assumption that neutrality depends only on the level of taxation. If the same level occurred, the allocation of resources would be efficient. However, this is not true, since investors take into account also the corresponding level of services. The imposition of a range of tax rates between 25% and 55% will force some developing countries to increase taxation, but this would require offering services at a proportional level, which, as will be further discussed in section 3.4., may not be verified. Moreover, (total) neutrality in CEN could only be achieved if residence states would be prepared to reimburse taxpayers for the negative difference. As the tax of the source state may be higher than the tax of the residence state, it would not result in a positive difference, as usually occurs, the outcome of which is the complementary taxation by the residence state (considering the foreign tax as credit). On the contrary, it would result in a negative difference, which, in order to achieve neutrality, should imply the reimbursement by the residence state to the taxpayer. However, this is not being proposed, and it also seems unrealistic that residence states would be prepared to reimburse the excess burden paid to the source state. Thus, CEN is not applied in equal terms, considering different situations.42 Given such considerations, from an efficiency perspective, single taxation based on CEN should not be adopted, since it cannot ensure neutrality. Looking at only one factor (income tax) does not guarantee efficiency because resources may be allocated where the benefits provided by the country are higher. 41. L.E. Schoueri, Direito Tributário p. 43 (Saraiva 2018). 42. Schoueri, supra n. 39, at p. 120.

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However, single taxation may be justifiable by the equity argument.

3.3.2. Equity arguments: The limitation of one perspective Single taxation could also be supported by equity considerations on income earned by individuals. As stated by Avi-Yonah, neither the single taxation principle nor the benefits principle solves the problem of “how to divide the corporate income tax base among the various jurisdictions providing benefits”.43 Although such limitation is a problem per se since one of the biggest concerns currently is the taxation on multinational enterprises’ income,44 one must examine in detail the equity argument on income earned by individuals. According to Avi-Yonah, undertaxation of cross-border transactions would violate both horizontal and vertical equity in comparison to the taxes imposed on domestic transactions, especially taking into account domestic labour income.45 Thus, he sustains that single taxation would be supported by an equity argument from the viewpoint of the relationship among taxpayers (equality).46 Single taxation would satisfy that individuals with the same wealth would face the same taxation (horizontal equity), as well as that wealthier individuals would pay more taxes (vertical equity). However, single taxation does not ensure such equity. Equity should not be seen only from the perspective of the residence state. There are two different perspectives: a taxpayer receiving income from a foreign source must be compared to (i) his fellow residents; and (ii) his competitors in the source country. If one considers residents A and B of Country R, with A investing only domestically and B investing in Country S, one could argue that, because they are residents of the same country, residents A and B should face the same tax rate, as it would not be fair to tax local-source income differently from foreign-source income. The application of the foreign tax credit by Country R would ensure that both residents would be taxed at the same way.

43. Avi-Yonah, supra n. 2, at p. 13. 44. See BEPS Action Plan, supra n. 23, at p. 8. 45. Avi-Yonah, supra n. 2, at p. 10. 46. Equality is one of the approaches necessary to discuss equity; see Vogel, supra n. 37, at pp. 153-161.

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Nevertheless, foreign investments take place in very different conditions in comparison to domestic investments. On the one hand, different treatment may arise from the offering of less benefits by the source country. More taxation on the income received by resident B in order to ensure the equity with resident A would only shift the investments of resident B in Country S to Country R. It would not be worthwhile for resident B to maintain such investments in Country S, considering the “additional tax”, since he would be in a worse position in comparison to his competitors in Country S. On the other hand, if such different treatment in Country S arises solely by the fact that Country S, as a source country, generally taxes less, more taxation by Country R will only satisfy the equity argument from the perspective of Country R. Again, more taxation would put resident B at a disadvantage in Country S.47 One must note that the last situation (different treatment only regarding taxation) is solely for the purposes of argumentation. It is impossible to deem that domestic investment and cross-border investment are realized under the same conditions. The risks involved are always different because, despite the existence of great convergences, the cross-border investment depends on the other legal regime, political system and economic background (e.g. currency risks). In other words, even in the case that residents A and B benefit from the same amount of income, this does not necessarily mean that they are in comparable situations, since resident B (taxpayer investing abroad) will bear transaction costs that are not comparable to those faced by resident A (taxpayer investing in his own country). Also, a different situation may arise when the cross-border income is reinvested in the enterprise in Country S (source state) by investor B. The conditions of such income and domestic income are not the same, since investor B will continue to be subject to the risks involved, especially taking into account that sometimes such reinvestment is difficult to withdraw. For foreign income, the transfer may not be immediate. Therefore, as the criterion related to the disposition of income is not controversial, equity is not violated if the Country R (residence state) only considers the repatriated income important.48 The equity argument of single taxation is based only on the perspective of residence states, considering also that domestic income and cross-border income are earned under the same conditions. The source state’s viewpoint 47. K. Vogel, Tributação da Renda Mundial, 2 Revista dos Tribunais 7, p. 141 (1994). 48. Vogel, supra n. 37, at pp. 156-157.

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and the situations involving foreign income are not considered. Therefore, not only may efficiency be compromised by a higher taxation of Country R (residence state), as it may shift the allocation of resources, but also, the equity is not achieved from the perspective of Country S (source state). Moreover, considering single taxation as envisaged by BEPS Action 2, one may use the example of the reverse hybrids again to illustrate that the single tax principle greatly departs from the ability-to-pay principle. As explained in section 3.2.3., in the case of D/NI related to a conflict of qualification involving a person, the payer jurisdiction (source state) should deny the deduction for payments made to such person (reverse hybrid) in order to prevent double non-taxation. However, from the perspective of the source state, there is no justification to treat this situation differently (non-deductible) in comparison to other same situation (deductible). Actually, one may argue that such approach violates equality, since the criteria applied to different taxpayers are not the same. In addition, single taxation does not achieve equality in any of the jurisdictions, as the recipient of the payment is not taxed at source and at residence, but rather continues to be untaxed. Taking into account the residual provision, single taxation also raises questions on equity. If one jurisdiction (residence or source) does not exercise its primary taxing rights to tax an item of income (passive or active), the other jurisdiction shall tax it. As a result, the adoption of single taxation would greatly depart from the ability-to-pay principle and not the other way around. What would be the justification to tax following the residual provision? If it were the ability-to-pay principle, one would have to admit at least that the ability-to-pay principle of the other jurisdiction is applied. The residual provision does not require that the other jurisdiction charge the same amount as the jurisdiction with the primary right would. Only a (wider) range is imposed as a parameter. Therefore, the situation becomes subject to tax according to the ability-to-pay principle of the other jurisdiction. Even if single taxation would impose the same tax rate by all countries, it would not be grounded on an equity claim. As explained, the conditions under which income arises go beyond tax considerations. The level of services, as well as other features (e.g. disposition), must be taken into account. In short, given that single taxation does not achieve equity on the relationship between taxpayers, single taxation should not be adopted.

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Nevertheless, even if one believes that single taxation should be adopted, is its implementation feasible?

3.4.  Is the adoption of single taxation feasible? It is not enough to define and justify the implementation of a policy. The adoption of such policy should be feasible. Although the meaning of single taxation raises many questions and lacks reasons for its implementation, one must examine its feasibility. The purpose of this section is to demonstrate that, even overcoming such problems, single taxation (see section 3.4.1.) is not a policy that many countries are willing to adopt, and even if they were (see section 3.4.2.), many of them would not be able to implement it.

3.4.1.  Desirability: Single taxation against a nation’s will Many jurisdictions may not be willing to adopt single taxation because its implementation means (i) a certain model of state (i.e. a high-tax state); and (ii) a ceaseless demand for neutrality. As formulated, single taxation assumes the adoption of a range of taxation between a 25% to 55% rate, i.e. single taxation assumes a high-tax state from the perspective of the residence state. As a consequence, such implementation would only mean a radical change to countries that currently impose tax rates at less than 25%. In other words, low-tax jurisdictions would have to face the responsibility of increasing their level of benefits to reach the expectations of taxpayers. As explained in section 3.3.1., investors do not only take taxation into account when they are deciding on which country they will invest in. Thus, if a country increases taxation but does not offer a corresponding level of benefits, it may lose its capacity to attract investment. However, it may not be desirable for a country to increase its offering of services. For instance, a state may prefer to attract foreign investments through low tax rates. As a country characterized by low taxes and a low offering of services or with high taxes and a high level of services may be deemed efficient, it becomes a political choice as to what kind of state a jurisdiction

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wants to be. Each country aims at finding its own balance according to its needs and capacity. Therefore, it can be in the interest of a country to levy low taxes and have little or no revenue, but this could hardly mean that these countries would be jeopardizing their own revenues. Large tax revenue – and high taxes – cannot be taken as self-evidently desirable. Moreover, tax policies do not always serve the purpose of achieving as much neutrality as possible. From a worldwide perspective, neutrality requires that countries make decisions in order to increase efficiency wherever it occurs around the globe. This means that countries must accept that perhaps capital will be located elsewhere than within their own limits. However, policymakers happen to have a keen interest in where capital is located and where taxes are collected because these two places may or may not coincide. Sometimes it may be in the interest of a nation to implement CEN policies, while at other times, domestic or foreign investments are preferred. At the end of the day, the decision of what the best policy is remains largely an “empirical question”, as it depends on various circumstances that change not only from country to country, but also from time to time.49 Policy options undoubtedly will continue to be regarded as national matters, and as such, will continue to be subject to the particular political, economic, cultural and historical backgrounds pertaining to each country.50 Neutrality guarantees that capital will be rightfully allocated around the globe, but that extent of neutrality is not an obvious choice for countries, as some tax policies may prefer more interference, given the specific circumstances. To achieve neutrality on single taxation as envisaged by Avi-Yonah, (a range of) tax rates should be applied by widely different countries with diverse political options, economic conditions and historical backgrounds. To some extent, this is based on a supposed apathy of (some) nations regarding their

49. M.J. Graetz, The David R. Tillinghast Lecture – Taxing International Income: Inadequate Principles, Outdated Concepts and Unsatisfactory Policies, 54 Tax L. Rev. 261, pp. 281-282 (2001). 50. Id., at p. 279. In the same sense, see R.T. Santos, Instrumentos Financeiros Híbridos e a Arbitragem Fiscal Internacional – As Considerações de Política Fiscal na Ação 2 do Projeto BEPS in A Tributação Internacional na Era Pós-BEPS p. 130 (L.E. Schoueri et al. eds., Lumen Juris 2016).

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own interests. However, whether single taxation should or could be a policy goal is also a matter of whose goal it is. Many countries may not be willing to adopt single taxation. Not only may increasing the level of taxation in a jurisdiction not be desirable, but also, the neutrality may not always be a goal pursued by countries. Nevertheless, even if all countries were willing to adopt single taxation, would it be possible to do it?

3.4.2.  Possibility: Single taxation beyond a nation’s capacity Although many countries may be willing to adopt single taxation, it would still be a matter of their actual capacity to implement it, as well as the difficulty to coordinate such policy during that time. The level of taxation is not a free choice and does not lie entirely on a matter of will. Tax policy choices are conditional upon a number of circumstances. As discussed in section 3.3.1., the adoption of single taxation would not mean a dramatic change for high-tax countries as compared to low-tax jurisdictions. A high level of taxation should be followed by a corresponding level of benefits. It is not to say that high taxes mean inefficient incentives, but they require a corresponding level of services. However, it is often the case that implementing some policy is not against the will of a nation, but beyond its capacity. Differently from increasing taxes, which usually depends only on the majority at a political assembly, the offering of services relies on the capacity of the state to do it. Given some deficiencies in, e.g. infrastructure, public health, education or economic stability, it may not be possible to provide more services at a level proportional to the taxation. In short, developing countries often do not choose to provide less service; they simply are not equipped to do so. As a result, even if all countries agreed on meeting the 25-55% tax rate range, developing countries would still be at an unfair disadvantage because, despite imposing high taxes, they would have nothing to give in return. Therefore, requiring the same tax burden would neutralize only one thing, i.e. developing countries’ capacity to attract investment. Thus, their competitiveness would be affected in relation to developed countries.

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As one may point out, the practical need for a balance between tax burden and revenue benefits is based, to a great extent, on national perspectives. Once this viewpoint is considered, the coordination required for the implementation of single taxation may be jeopardized. Besides the difficulty regarding the lack of consensus on the tax rates, there is no “supranational ‘force’ that can ensure the worldwide implementation of the single tax principle”.51 Not only would it be important to guarantee in any way the range of the tax rates to be adopted, but the coordination would also require a high consensus on concepts of taxation. As exemplified in the situation of tax arbitrage in section 3.2.2., if double non-taxation must be avoided, the problem of conceptual divergence between domestic laws should also be addressed. However, to demand that countries adopt similar domestic law concepts to conform to an international tax regime is asking for too much. The fact that it is impossible to create a tax system out of the blue52 does not mean that some diversity cannot exist. Otherwise, the problem of hybrids would not have arisen. The implementation of single taxation is grounded on a high harmonization of tax policies and tax systems. Not only does single taxation assume high-tax states, which may lead to an (impossible) corresponding level of services (tax policy), but it also intends to address tax arbitrage, requiring, at the end of the day, harmonization of tax regimes: a “utopic solution”.53

3.5. Conclusion The scope of this chapter was to answer the question of whether single taxation should be a policy goal. The conclusion reached is that single taxation should not be a policy goal. The meaning of single taxation may be considered controversial. A formal approach is irrelevant, since the number of levies does not mean anything. At the same time, single taxation does not answer the question intended to be solved, because it does not define the tax base or establish the appropriate level of taxation. It depends on the content of the benefits principle, which establishes a wide range of tax rates and is based on the assumption that 51. De Lillo, supra n. 3, at p. 61. 52. Arguing that such limitation would imply the existence of an international tax regime, see Avi-Yonah, supra n. 2, at p. 1. 53. Santos, supra n. 50, at p. 123.

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there is consensus regarding the allocation of taxing rights. Also, single taxation puts in the same basket divergent causes of double non-taxation that may not be addressed through the same approach. In addition, taking into account single taxation as envisaged in Action 2 of the BEPS Project, one may sustain that its meaning presents some problems, because it may imply an economic concept on one side and a juridical idea on the other. Single taxation should not be adopted, since it lacks justification for implementation. The efficiency argument that would support such principle – which is simply the application of CEN – only considers the taxation as a factor for allocating resources, leaving behind other elements such as the corresponding level of services provided by the state receiving the investment. Also, the equity argument sustained by single taxation supporters (e.g. Avi-Yonah) should not be taken into account, since the principle does not ensure such equity. As it considers only the perspective of residence states and assumes that domestic income and cross-border income are earned under the same conditions, this argument leaves aside the source state’s viewpoint and the situations involving foreign income. The consequence is that equity is not achieved from the perspective of the source country, and its achievement from the residence state’s point of view implies the shifting of the allocation of resources, which would jeopardize efficiency. In addition, one may argue that, aside from not respecting equality, single taxation departs from the ability-to-pay principle. Single taxation is unfeasible. Many jurisdictions may not be willing to adopt single taxation because its implementation presupposes a specific model of state (i.e. high-tax) and a ceaseless demand for neutrality. Increasing the level of taxation of a country may not be desirable, and it may not always be a goal pursued by countries. Moreover, such adoption may be beyond the capacity of a nation. Given some deficiencies, most developing countries may not achieve the corresponding level of services demanded by increasing taxation. Also, it would be too difficult to coordinate such policy during that time, since it requires the harmonization of tax policies and of tax systems.

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Part 2

Do Taxpayers Have a Right to Effective Double Tax Relief?

Chapter 4 Do Taxpayers Have a Right to Effective International Tax Relief? A Sampling Analysis of the Universe of International Tax Systems Luís Flávio Neto

4.1. Introduction The theme of the 2017 “Duets in International Taxation” seminar was the single-taxation theory. The prestigious event centred around juridical and economic trends involving this controversial topic, including its relationship to the benefit theory and the foundation of an international tax system. This chapter focuses on a topic discussed in one of its panels, namely whether taxpayers whose income is connected to more than one country have a right to receive effective international tax relief. The author assumes that the interaction between these two theories (singletaxation and benefit) suggests an international tax relief standard, in the sense that the behaviour of states would tend to consistently follow the same pattern (henceforth “the international tax relief pattern”). This international tax relief pattern would be composed of two faces, like two sides of the same coin: (i) international tax relief must be provided to avoid double taxation according to the benefit theory (i.e. the positive side); and (ii) one state must deny the tax relief in order to prevent under or non-taxation (i.e. the negative side).1 Assuming that the single-taxation and benefit theories are feasible tax policies in theory2 (which is itself controversial), it becomes necessary to deal with the question of whether the suggested international tax relief pattern would be binding enough to provide a universal right to international double tax relief.

1. R.S. Avi-Yonah, International Tax as International Law, University of Michigan Law School Law & Economics Working Papers (2004), available at https://repository. law.umich.edu/law_econ_archive/art7. 2. The question of whether both sides of the international tax relief pattern are effective requires mainly a legal approach, as opposed to the economic approaches adopted in other chapters of this book dealing directly with tax policy matters.

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The author proposes an investigation guided by the concepts of “sovereignty”, “consent” and “source of law” (see section 4.2.1.), opening room for possibilities other than the the international tax relief pattern herein examined (see section 4.2.2.). Since there is not simply one single international tax law, but a universe of international self-contained tax regimes, the theme is approached considering the phenomenon of the fragmentation of international law, with the author proposing that such an international tax relief pattern might be demonstrated or refuted by considering each particular international tax system. Nevertheless, this chapter is not intended to be an exhaustive investigation of all possible sources of international law. Rather, it presents just a sampling analysis of evidence provided by various sources of international law, mainly customary international law (see section 4.3.1.); double tax treaty models (see section 4.3.2.); tax treaties effectively signed (see section 4.3.3.), bilateral (see section 4.3.3.1.) and multilateral (see section 4.3.3.2.) instruments; and court decisions applying international selfcontained tax regimes (see section 4.3.4.).

4.2. International tax systems and methods to relieve international taxation The grand illusion of a single, worldwide tax system that would eliminate all international inefficiencies and assist all the nations of the world in maximizing their relative advantages is commonly accepted as utopian. Academic and professional literature in the field of international taxation has grown exponentially in the last decade, but no significant work has been done to prove or disprove the validity of this hypothesis. Yariv Brauner3

The single-taxation and benefit theories, as well as their corollary, the international tax relief pattern, are based on the existence of an international tax regime that turns their content into principles and rules. According to Avi-Yonah,4 “a coherent international tax regime exists, embodied both in the tax treaty network and domestic laws, and … it forms a significant part of international law (both treaty-based and customary)”. 3. Y. Brauner, An International Tax Regime in Crystallization, 56 Tax L. Rev. 259 (2003), available at https://scholarship.law.ufl.edu/cgi/viewcontent.cgi?article=1009&co ntext=facultypub. 4. Avi-Yonah, supra n. 1, at p. 21.

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His theory asserts that states would be constrained to follow two basic principles: (i) the single-taxation principle; and (ii) the benefits principle. While the single-taxation principle would determine that income should be taxed once, “not more and not less”, the benefits principle would impose the tax rate as well as allocate the right to tax between the states related to the same income (“active business income should be taxed primarily at source, and passive investment income primarily at residence”). To establish parameters for the cogency, or even the persuasive relevance, of any international tax relief pattern, this chapter explores the concepts of sovereignty, consent and sources of law. It will bring findings on the fragmentation of international law into the discussion, proposing the existence of many international self-contained tax regimes (see section 4.2.1.). Furthermore, it will examine several methods of relief and tax policy matters, suggesting that countries may prefer to adopt relief methods and tax policies that do not match with the pattern analysed (see section 4.2.2.).

4.2.1. Sovereignty, sources of law and fragmentation of international tax law But we should not pretend that there are no binding, widely accepted international tax norms that we should flout only when significant national interests are at stake. Reuven S. Avi-Yonah5

Does an international tax law system exist? This is a very controversial question in the literature. Scholars have taken several positions: some recognize it as a well-established system;6 others suggest it is an ongoing process;7 and others refuse to recognize its existence at all.8 A similar question has been proposed for more than 100 years on a much broader basis: does an international law system exist? It happens to be that international law encounters challenges that generally do not arise in national environments. Internal systems, in general, are centralized and unitary, with (vertical) hierarchies of sources and institutions able to enforce 5. Id. 6. Id.; see also J.M. de Melo Rigoni, The International Tax Regime in the Twenty-First Century: The Emergence of a Third Stage, 45 Intertax 3 (2017). 7. Brauner, supra n. 3. 8. H.D. Rosenbloom, The David R. Tillinghast Lecture: International Tax Arbitrage and the “International Tax System”, 53 Tax L. Rev. 137 (1999-2000).

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the law. On the contrary, international law obeys a plural and horizontal order. Where there is an absence of a central authority legitimated to impose the coercive fulfilment of their international law obligations on national governments, what would prevent a rise in international anarchy?9 Addressing the urgent legitimation of international law at the very beginning of the twentieth century, Oppenheim10 stated that violations of international law would certainly be frequent, but that offenders would always try to prove that their acts did not violate the law of nations; in doing so, they would not deny the existence of this set of rules but would recognize its existence through the endeavour to somehow interpret the law of nations in a way favourable to their acts. Theories of international regimes have been explained by several approaches, from comprehensive ones that link them with predictable behaviours, to more restricted definitions that “treat[] regimes as multilateral agreements among States which aim to regulate national actions within an issue-area”.11 Indeed, a theory of international regimes could provide explanations for why international rules would be obeyed, especially in terms of accepting the goals behind treaties, the coercion exercised by powerful countries and reciprocal interests. Cooperation among states might be explained by the benefits that each state could obtain through the existence of an organized system and the strengthening of its reputation vis-à-vis international actors (i.e., self-interest). Therefore, among other possible effects, violations of such rules by a state would stigmatize it before public opinion and the governments of other states.12 Currently, the existence of international law as a set of cogent legal norms finds extensive doctrinal13 and jurisprudential basis. Supported by the idea of sovereignty, consent would be one of the most important – if not the most important – factors in connecting two states. The role of the sources of 9. See D. Baderman, The Spirit of International Law p. 1 (University of Georgia Press 2002); L. Oppenheim, International Law: A Treatise, Volume I (of 2) – Peace § 2 (Longmans 1912); and R.K Gardiner, International Law p. 9 (Pearson 2003). For debates about so-called international anarchy, see A. Amaral Júnior, Curso de Direito Internacional Público pp. 1-2 (Atlas 2013). 10. Oppenheim, supra n. 9, at § 10. 11. S. Haggard & B.A. Simmons, Theories of international regimes, 41 International Organization 3, pp. 491-517 (1987). 12. See Oppenheim, supra n. 9, at § 10; and Amaral Júnior, supra n. 9, at pp. 15-16 and 25. 13. See H. Thirlway, The Sources of International Law pp. 1-2 (Oxford 2014); and Gardiner, supra n. 9, at p. 13.

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international law is to produce norms agreed to by states for the composition of this system, or even to legitimate evidence for its recognition: if an instrument cannot be considered related to a source of international law, it cannot become an international binding rule. While in a domestic legal system the constitution assumes the role of an elementary formal source, its analogue in international law may be the consent of the states. Based on positivist or voluntarist approaches, the legal theory of formal sources assumes the premise that states are only bound by norms to which they have consented (pacta sunt servanda). Nevertheless, such a principle may not be absolute, allowing exceptions imposed by cogent norms of international law (jus cogens), as well as by fundamental norms of each contracting state, since treaties signed by states deviating from these standards would not be legally recognized (articles 27 and 46 of the Vienna Convention on the Law of Treaties (VCLT)).14 The consensualist approach may articulate at least three maxims on international law: (i) its limits are agreed upon by the states themselves; (ii) its rules shall be construed as only involving the states which have so agreed; and (iii) there is only one degree of consent for all states party to a convention.15 A very important milestone for the current scenario occurred after the end of World War II, accompanied by the establishment of the United Nations: international law became based predominantly on international agreements, inititating the “era of treaties”.16 Among other relevant events, at least two may be highlighted: (i) the ratification of the VCLT, representing a legal framework by which states formally recognize the duty to respect the obligations arising from treaties and from international customs;17 and (ii) the foundation of the International Court of Justice (ICJ). Clearly influenced by consensualist theory, article 38(1) of the Statute of the International Court of Justice (SICJ) has been widely considered to be an inventory of the sources of international law, as follows: a. international conventions, whether general or particular, establishing rules expressly recognized by the contesting states; 14. See Thirlway, supra n. 13, at pp. 1-8. 15. See S. Besson, Theorizing the Sources of International Law, in The Philosophy of International Law pp. 164-166 (S. Besson & J. Tasioulas eds., Oxford 2010). 16. See H.T. Torres, O combate à evasão e à elisão tributária de caráter internacional, 1 Revista Internacional de Direito Tributário – ABRADT 2, p. 155 (2004). 17. See UN, Yearbook of the International Law Commission 1962: Documents of the fourteenth session including the report of the Commission to the General Assembly (UN 1962); and UN, Yearbook of the International Law Commission 1966: Records on the 866th meeting p. 173 et seq. (UN 1966).

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b. international custom, as evidence of a general practice accepted as law; c. the general principles of law recognized by civilized nations; d. subject to the provisions of Article 59, judicial decisions and the teachings of the most highly qualified publicists of the various nations, as subsidiary means for the determination of rules of law.

The highly controversial question posed above regarding the existence of an international tax law might be answered bearing in mind this background. The adjectives “tax” and “international” attribute qualities to the noun “law” predicting a remarkable phenomenon in international law: a number of specialized branches have been established to cover the most distinct issues (e.g. trade law, human rights law, environmental law, law of the sea, European law, investment law and international refugee law). The Fragmentation Report published by the International Law Commission of the United Nations (ILC-UN)18 notes that the VCLT does not prevent states from establishing special rules to satisfy possible demands of the various segments of international law. More than 100 years ago, Oppenheim19 distinguished two species of international law: universal and particular. The former, based on international customs and treaties, would bind all civilized nations without exception. Nevertheless, each particular international law would bind only two or more given states based on agreements that have been formalized among themselves. Although the idea of fragmented international systems is not new, it is more current than ever. The era of treaties has increased the fragmentation of international law and has made it increasingly less universal, because each agreement between two or more states can create distinct and self-contained regimes.20 More recently, referring to these particular international law systems, Thirlway21 observes that the acceptance of states in entering into a treaty and contracting duties that would not otherwise exist creates a special legal regime between such parties that does not extend to third parties. To illustrate this relationship, Merkouris22 suggests that “[i]nternational law 18. See UN, Reports of the Study Group of the International Law Commission – General Assembly. Fragmentation of International Law: Difficulties Arising from the Diversification and Expansion of International Law (UN 2006). 19. Oppenheim, supra n. 9, at § 1. 20. Amaral Júnior, supra n. 9, at p. 24. 21. Thirlway, supra n. 13, at p. 43. 22. P. Merkouris, Introduction: Interpretation is a Science, is an Art, is a Science, in Treaty Interpretation and the Vienna Convention on the Law of Treaties p. 7 (M. Fitzmaurice, O. Elias & P Merkouris eds., Martinus Nijhoff 2010).

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is a ‘universe of inter-connected islands’, a house with many rooms. Each room/island is a different area of international law”. Considering the findings of fragmentation theory, it seems that there is not only “one single international tax law” but a universe of international selfcontained tax systems. International tax law has not been a house ruled by countless regulations overlapping asymmetrically. It has been a universe of international tax systems gravitating around the public international law axis, legitimated by the “sources of law” and “sovereignty” principles. It also seems to be true that civilized countries (article 38(1)(c) of the SICJ) recognize the principle of pacta sunt servanda as a foundation of the rule of law, excluding deviations imposed by jus cogens and constitutional norms. The concept of an autonomous branch of law dedicated to the question of international taxation arose in the doctrine as early as the late nineteenth century.23 Currently, one may affirm that international tax law is one of Merkouris’s many islands, a “particular”, and not a “universal”, international law. Additionally, international tax law is itself fragmented, and its remarkable feature is the ability to become distinct in each double taxation agreement (DTA). Topics like sovereignty24 and source of law are highly important for the debate, because they provide the definition and dimensions of each international self-contained tax system. Founded on the principle of sovereignty, a certain tax policy becomes enforceable in a given state on the basis of its own decision, unless it breaches jus cogens or the domestic law of fundamental and manifest importance in that state. DTAs and other sources of law consented to by sovereign states in their capacity as autonomous states can include any clause that does not conflict with peremptory norms, namely jus cogens or domestic law of fundamental and manifest importance of each of the states involved (articles 27 and 46 of the VCLT).

23. See A. Garelli, Il Diritto Internazionale Tributario (Roux Frassati e co. 1899). 24. Sovereignty is a precondition of jurisdiction. By applying such concepts as sovereignty and jurisdiction to the field of tax law, states’ power to tax can only be exercised up to the limits of their jurisdiction. The relationship of a state to the taxable income is required to legitimate the exercise of the tax power. To be legitimated to tax a certain level of wealth, the state must somehow be connected with the wealth. The election of connecting elements must demonstrate that a particular arrangement is covered by the jurisdiction of one or more sovereign states, enabling them to exercise taxation. On this topic, see L.E. Schoueri, Preços de transferência no direito tributário brasileiro pp. 415419 (Dialética, 2013); and A. Xavier, Direito Tributário Internacional do Brasil (Forense 2010).

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This means that there is plenty of room for negotiation. Many tax policies could be considered, provided only that they do not conflict with constitutional rules or jus cogens, which leads to a complex matrix of possibilities, given the differences between the particular national systems involved. For example, in a specific context, the Austrian Supreme Administrative Court analysed whether the adoption of the exemption method of double taxation relief for a certain type of income (articles 7 and 23(2) of the AustriaLiechtenstein DTA) while another method of relief was adopted for another type of income (articles 14 and 23(1) of the Austria-Liechtenstein DTA) violated the Austrian constitutional rule of equality.25 Since the latter method (the foreign credit method) would not enable the state to provide the same intensity of relief from international double taxation as the former (the exemption method), it would represent an offense to the constitutional right of equality. In that case, the Austrian Constitutional Court subsequently decided that such discrimination should not be admonished, because income which qualified as business profit (article 7) would be distinct from income earned providing independent services (article 14). In addition, a different treatment could be justified based on the goal of preventing tax avoidance or evasion. There are a few disputes about the decisive role of the OECD and the UN in the “modelization”26 process of DTAs. Brauner27 points out that, “despite the complexity of the international tax system, both the structure itself and, to a lesser extent, the content of each of the sets of rules, are extremely similar throughout the world”, as well as that “rules that have significant implications for domestic tax policy would be more difficult to harmonize globally than the ‘pure’ international tax rules”. Brauner proposes a process of harmonization and presents arguments for improving it. Indeed, the idea of a harmonized international tax system, based on the single-taxation and benefits theories, has been well received by many scholars.28

25. AT:Vwgh [Supreme Administrative Court], 23 June 2014, case SV 2/2013-14, Tax Treaty Case Law IBFD. According to the IBFD summary, “[t]he Constitutional Court held that, although the precise scope of article 7 and article 14 are difficult to delineate, the different tax treatment was justified. While shifting profits to Liechtenstein under article 7 of the treaty was found to be done easily, thus making the credit method necessary to prevent abuse, income from independent services can be shifted only if the performed services are also functionally attributable to the fixed base in Liechtenstein. When attributing income from independent services to a fixed base, a strict standard must be applied. Having a fixed base in the source state and providing services in it is, in itself, not enough. These services must also be functionally connected to that fixed base”. 26. Brauner, supra n. 3. 27. Id. 28. Avi-Yonah. supra n. 1, at pp. 2-7; and de Melo Rigoni, supra n. 6.

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However, considering the inherent fragmentation of international tax law, this chapter proposes that such a question cannot be addressed in general terms. Since key elements remain open to negotiations by the states as regards the method used to relieve double taxation and the allocation of taxing rights, it is necessary to investigate whether a specific self-contained international tax system adopts such a pattern (i.e. the single-taxation and benefits theories).

4.2.2. International tax relief and tax policy issues: Method, intensity, extension Creditors are not usually so selfless as to say: “You can either pay me, or give the money to someone else who is entirely unrelated to me. So long as you pay someone, I don’t care who it is.” Yet this is what the foreign tax credit effectively does. Daniel Shaviro29

Complete fiscal neutrality might be achieved if tax considerations become entirely irrelevant when an investor chooses between a location, a form of investment or a form of business organization, since any choice would be subject to the same taxation.30 The European Commission31 accordingly considers that “double taxation in a cross-border context as a result of the inconsistent interaction of different domestic tax systems, is a major impediment and a real challenge for the internal market” and that its removal “should be a key element of every long-term strategy of the Commission”. It presents direct and indirect evidence that double taxation is one of the most important obstacles in cross-border situations,32 able to put the competitiveness of EU enterprises at risk, discouraging non-EU investments and becoming itself a source of 29. D. Shaviro, The Case Against Foreign Tax Credits, NYU School of Law, Public Law Research Paper No. 10-12; NYU Law and Economics Research Paper No. 10-09 (2010), available at SSRN: https://ssrn.com/abstract=1547312 or http://dx.doi.org/10.2139/ ssrn.1547312. 30. “Fiscal neutrality”, Glossary IBFD. 31. European Commission, Communication From the Commission to the European Parliament, the Council and the European Economic and Social Committee: Double Taxation in the Single Market, Brussels, 11.11.2011, COM(2011) 712 Final. 32. Id., at p. 6: “Indeed, the results of three recent Commission public consultations confirm that EU taxpayers remain significantly concerned by double taxation issues. In particular, in the specific public consultation on double taxation, it was said that the problem was significant: on average more than 20% of the reported cases were above 1 million € for corporate taxpayers and more than 35% were above 100.000 € for individuals.”

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legal uncertainty for taxpayers. It follows that “double taxation becomes not just a burden, but even a barrier, to economic activity”. The Commission’s Communication presents studies that indicate that the adoption of DTAs may be able to increase bilateral portfolio investment flows between contracting states by up to 50%, while seeming to decrease the cost of equity capital by approx. 0.24% per annum. Avoiding double taxation and providing an effective fiscally neutral environment for business is not only a question of the improvement and correction of mismatches in a given system, it is also – or even mainly – a matter of tax policy, which may reasonably vary for uncountable reasons, including the battle between national and global welfare.33 A given state may decide to provide relief in respect of international double taxation in several extensions and intensities, or it may decide not to provide such relief at all. Fiscal neutrality finds limits on tax competition. Although tax competition and tax coordination have been mentioned as interdependent by analysts of the BEPS Project, they are often considered to be incompatible concepts.34 In this process, two steps are clearly distinguishable: first, the state decides which tax policy must be adopted, and second, the state decides which method would fit better. As soon as the decision to avoid double taxation has been taken, a solution regarding the extension and intensity of that relief becomes necessary. In broader terms, either juridical or economic double taxation could be avoided. The former may be described as “the imposition of comparable taxes by two (or more) tax jurisdictions on the same taxpayer in respect of the same taxable income or capital”, whilst the latter may be described as “the imposition of comparable taxes by two (or more) tax jurisdictions on different taxpayers in respect of the same taxable income”.35 Measures to avoid double taxation can be provided by domestic rules (unilateral relief) or international instruments (bilateral or multilateral relief). While the latter is mainly devoted to the avoidance of juridical double

33. See D.N. Shaviro, Why Worldwide Welfare as a Normative Standard in U.S. Tax Policy?, New York University Law and Economics Working Papers, Paper 93 (2006). 34. See A. Christians, W. Schön & S.E. Shay, Foreword: International Tax Policy in a Disruptive Environment, 72 Bull. Intl. Taxn. 4/5 (2018), Journals IBFD. 35. “Double taxation”, Glossary IBFD.

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taxation, the former usually also leads to the avoidance of international economic double taxation.36 There is a list of methods for avoiding international double taxation, and these are able to provide for different levels of relief and to induce different tax policies. After World War I, income tax rates increased in most states, requiring an urgent solution to the problem of double taxation. Avery Jones37 relates that, during this period, “the UK, as a major capital exporter, needed to design a relief from scratch with a blank sheet” and that “the three solutions – Stamp’s evidence to the Royal Commission, Dominion Income Tax Relief, and the 1923 Report by the League of Nations’ economists – were all different”. Currently, the most important methods are deduction, exemption and credit, and all of them have economic advantages and disadvantages, as demonstrated by Shaviro.38 Following its economic goals, for instance, a given state may prefer a national neutrality policy, which focuses on the national economic welfare, creating a disincentive to invest abroad. A general deduction method could fit this policy, allowing the deduction of foreign taxes from the income tax base (instead of a foreign tax credit against the income tax to be paid).39 On the other hand, capital import neutrality (CIN) implies an emphasis on competitiveness, because a given investment may be subject to tax at the same rate regardless of the investor’s residence (i.e. it does not matter whether such investment is made by a domestic or by a foreign investor), which could be achieved by exemption methods.40 According to the exemption method, one state (usually the residence state) does not tax the income that may be taxed in the other state (usually the source state). If a “full exemption” method is adopted, the income that may 36. “Credit, indirect”, Glossary IBFD: “In relation to a dividend, an indirect credit may be granted for the tax levied on the profits of the company out of which the dividends have been paid (also referred to as ‘underlying tax’). Where dividends pass through a chain of companies, the credit may also be given for the tax levied on the profits of each company in the chain. In some cases this is limited to a number of levels, or ‘tiers’. Such relief may be given either under a tax treaty or in accordance with unilateral provisions.” 37. J.F. Avery Jones, Sir Josiah Stamp and Double Income Tax, 6 Studies in the History of Tax Law (2013). 38. See Shaviro, supra n. 29; and Shaviro, supra n. 33. 39. See “National neutrality”, Glossary IBFD. 40. See Shaviro, supra n. 33; and G.W. Kofler, Indirect Credit versus Exemption: Double Taxation Relief for Intercompany Distributions, 66 Bull. Intl. Taxn. 2 (2012), Journals IBFD; see also “Capital import neutrality”, Glossary IBFD.

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be taxed in the source state may not be taken into consideration by the residence state when determining the rate applicable on the rest of the income. If an “exemption with progression” method is adopted, the income exempted by the residence state may be taken into consideration when determining the tax to be imposed on the rest of the income.41 The Commentaries on the UN Model42 suggest that “[t]he amount of income to be exempted from tax by the State of residence is the amount which, but for the Convention, would be subjected to domestic income tax according to the domestic laws governing such tax. It may, therefore, differ from the amount of income subjected to tax by the State of the source according to its domestic laws”. Nonetheless, some DTAs have adopted the exemption method with a subject-to-tax provision, which means that the tax relief may only be applicable if the condition of a minimum tax burden is satisfied. Departing from the classical exemption method and adopting such a subject-to-tax provision is mainly a matter of tax policy. One may note that the international tax relief pattern herein investigated considers the exemption method to be a part of customary international law. However, when this pattern requires a subject-to-tax provision demanding that income be taxed at least once, such a theory actually departs from the classical exemption method. The third method is the foreign tax credit. Capital export neutrality (CEN) implies that a taxpayer would bear the same worldwide tax burden on foreign or on domestic investments, requiring a credit method allowing a full reimbursement of tax paid abroad. A pure CEN requires that even the foreign burden that exceeds the domestic tax on the foreign income should be recognized as a credit (the full credit method).43 Nevertheless, if an ordinary credit method is adopted, the relief given by the residence state for the tax paid in the source state may not exceed the burden that would be imposed on the income taxed in that other state.44 Referring to “the battle of neutralities”, Kofler45 has specified that CEN, “though theoretically achievable unilaterally, is unrealistic in the current tax 41. Paras. 13-14 OECD Model Tax Convention on Income and on Capital: Commentary on Article 23 (21 Nov. 2017), Models IBFD. 42. Para. 39 UN Model Tax Convention on Income and on Capital: Commentary on Article 23 (1 Jan. 2017), Models IBFD. 43. Shaviro, supra n. 33. 44. Para. 15 OECD Model: Commentary on Article 23. 45. Kofler,  supra n. 40.

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environment as it would require immediate taxation and unlimited indirect credits”, while CIN, as well as capital ownership neutrality (CON) “would, indeed, require the similarly unrealistic situation that all countries adopted a certain system”. While the exemption methods focus on the income, the credit methods focus on the tax.46 This leads to an ordinary scenario that tax benefits provided by the source state are naturally neutralized by the residence state, which would allow foreign credits only for the tax effectively levied by the source state.47 The credit method’s operation tends to match with the single-tax principle, avoiding double non-taxation or even taxation below ordinary rates. However, this common effect of the credit method may not correspond to the desire (consent) of the contracting states, which are able to adopt several provisions to impose their policy preferences and deviate from the single-tax principle. The Commentaries on the UN Model48 emphasize that “[o]ne of the principal defects of the foreign tax credit method, in the eyes of the developing countries, is that the benefit of low taxes in developing countries or of special tax concessions granted by them may in large part inure to the benefit of the treasury of the capital-exporting country rather than to the foreign investor for whom the benefits were designed. Thus, revenue is shifted from the developing country to the capital-exporting country”. As a matter of tax policy, a capital-importing country may prefer the exemption method (without any subject-to-tax condition) over the credit method. However, if the credit method is necessary, states may negotiate tax-sparing clauses as a feasible option.49 Indeed, adopting tax-sparing clauses, many DTAs have adopted the credit methods precisely to depart from the singletax theory, allowing low taxation or even double non-taxation provided by the source state. Although some scholars consider the exemption method with a subject-to-tax provision preferable to the credit method with tax-sparing clauses,50 neither of them entirely matches with the single-tax theory.

46. Para. 17 OECD Model: Commentary on Article 23. 47. Para. 72 OECD Model: Commentary on Article 23. 48. Para. 3 UN Model: Commentary on Article 23. 49. R. Julien, Elimination of Double Taxation, in The UN Model Convention and Its Relevance for the Global Tax Treaty Network (M. Lang et al. eds., IBFD 2017), Online Books IBFD. 50. See M. Gérard & E. (Edoardo) Traversa, Supplementing Consolidation and Apportionment with Anti-Abuse Provisions, in Tax Treaties: Building Bridges between Law and Economics (M. Lang et al. eds., IBFD 2010), Online Books IBFD.

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Tax-sparing clauses are present mainly in DTAs signed between developing countries (capital-importing countries) and developed countries (capitalexporting countries), as an alternative to article 23 of the OECD Model and UN Model.51 They are “designed to respect the source country’s taxing right and prevent the incentive effect of the measure in question being negated by residence taxation of the same income”.52 According to this method, generally applicable only to certain types of income,53 a credit is granted by the residence state, limited to the maximum source tax permitted under the treaty. Tax-sparing clauses are usually considered as the genus that matching-credit clauses belong to as species. However, these concepts are not defined unanimously. Among other definitions, a tax-sparing clause may be understood as “the granting of a credit in the residence state which [is] conditional on the existence of an incentive measure in the source state, and the amount of which is equivalent to the fiscal sacrifice offered by that state, i.e. tax sparing credit is equal to the tax renounced by the source state due to the incentive measures (for example, tax reductions, exemptions)”, while matching-credit clauses may be understood as being “independent from any type of incentive measures adopted by the source State, since the amount of the credit to be granted is predetermined in the tax treaty”.54 Although these clauses have as a possible consequence the improvement of investments in one (or both) of the contracting states, tax-sparing clauses do not differ from other means used to share tax competences through a DTA.55 If two sovereign states agree on a sharing of tax rights, the agreedupon method must be applied consistently. Like other methods available, there is a tax policy behind tax-sparing credit methods that motivated the DTA negotiation. Moreover, like all other methods to relieve double taxation, tax-sparing credit methods have their pros and cons.56 Indeed, such clauses have been high criticized in a number of studies conducted mainly by the OECD and 51. Para. 11 UN Model: Commentary on Article 23. 52. “Tax sparing credit”, Glossary IBFD. 53. Mainly dividends, interest and royalties. 54. V. Arruda Ferreira & A. Trindade Marinho, Tax Sparing and Matching Credit: From an Unclear Concept to an Uncertain Regime, 67 Bull. Intl. Taxn. 8 (2013), Journals IBFD. 55. See L.E. Schoueri, Tax Sparing: a reconsideration of the reconsideration, in Tax, Law and Development pp. 123-124 (Y. Brauner & M. Stewart eds., Edward Elgar 2013); and C.O.F. de Almeida, Tributação Internacional da Renda: A Competitividade Brasileira à Luz das Ordens Tributária e Econômica pp. 191-207 (Quartier Latin 2014). 56. See Shaviro, supra n. 29; and Shaviro, supra n. 33.

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countries like the United States.57 The Commentaries on the UN Model58 recognize positions that tax-sparing clauses would not be enough to convince capital providers from developed countries to invest in developing countries or even that adopting such clauses “may not be an appropriate policy”: Since the original publication of the United Nations Model Convention in 1980, there have been various studies undertaken of the economic justification for adopting fiscal incentives with the objective of stimulating investment. According to some members, these studies have demonstrated that tax factors may not themselves be decisive in the process of investment decisions made by the enterprises and therefore, in their view, tax sparing may not be an appropriate policy. Other factors play a greater role in forming the so-called “investment climate” of any given country, for example, political and economic stability, a judicial system perceived as impartial, the availability of a skilled workforce, and labour laws and social security costs that do not serve as unintended obstacles to the development of enterprise. It has been argued that fiscal incentives undermine the tax base and can lead to the damaging effects of tax incentive competition which then takes place between neighbouring States, as they try to outdo each other’s incentives and lend themselves to fiscal manipulation. Moreover, where “matching” credit provisions have been included in tax treaties, there have been examples of the artificial structuring of business transactions in order to take advantage of them, leading both to erosion of the tax base and to an unintended economic distortion in the process of investment decision-making.

On the other hand, the Commentaries on the UN Model59 also recognize positions that tax-sparing clauses are still present in many DTAs and continue to be negotiated in new agreements, although there is a tendency to impose restrictions, making such clauses cover only specific areas of economic activity or geographical regions, as well as limiting them by time (by including a “‘break’ or ‘sunset’ clause, providing for the provision to be terminated after, say, five years, unless the treaty partner States agree to an extension”). 57. See Julien, supra n. 49. 58. Paras. 3, 4 and 11 UN Model: Commentary on Article 23. 59. Para. 12 UN Model: Commentary on Article 23: “Where such clauses are included, it is the view of some experts from developing countries that the capital-importing country should provide, both in its domestic tax laws and in its treaties, some protection against a future decision by the treaty partner to refuse to extend the life of the tax-sparing provision. This might, for instance, take the form of a so-called ‘soak-up tax’, which consists of a tax or levy designed to reduce the benefit granted by means of the domestic tax incentive legislation, by the amount which would otherwise be transferred to the treasury of the treaty partner, in the absence of a tax sparing provision. Some countries do not, however, allow a foreign tax credit for soak-up taxes.”

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In a nutshell, among all these tax policies, methods and variables, it seems that few of them match with the relief pattern herein analysed. For instance, the deductibility method is only able to provide for partial relief of double taxation, and credit methods tempered with tax-sparing clauses leave room for double non-taxation desired by the source state as a matter of tax policy, which also occurs with the exemption method in the absence of any subjectto-tax provision.

4.3. Sources of law and evidence about international rights for tax relief The theories analysed in this chapter are mainly based on the understanding that states should be constrained to fulfil two alleged principles (single taxation and benefits), both of them adopted as an international tax relief pattern. This section investigates samplings of sources of international law, searching for evidence of the existence of that pattern.

4.3.1. Customary international tax law Thus, arguably preventing double taxation through a credit or exemption has become part of customary international law. Reuven S. Avi-Yonah60

Customs, not as habits but as a body of legal norms, are a binding source of international law, as recognized by article 38(1)(b) of the SICJ. Two conditions are required for the recognition of a binding rule of customary international law: (i) constant and uniform practice by states; and (ii) opinio juris, which means the recognition by states that such custom must be considered mandatory.61 According to Avi-Yonah,62 important parts of international tax law could be considered customary international law and, as such, be binding even in the absence of tax treaties. This thesis rests on the finding that similar rules are followed by states in reference to jurisdiction to tax, non-discrimination, transfer pricing and methods to avoid double taxation. Concerning the latter, Avi-Yonah emphasizes that, although many economists consider that 60. Avi-Yonah. supra n. 1, at pp. 2-7. 61. See Gardiner, supra n. 9, at p. 8. 62. Avi-Yonah, supra n. 1, at pp. 2-7.

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states should provide only a deduction for foreign taxes, “countries consider themselves in practice bound by the credit or exemption norm, and a country would feel highly reluctant to switch to a deduction method instead”.63 The recognition of this international tax relief pattern as customary law is far from an undisputed question.64 Nonetheless, this does not mean that no international relief right may be built from customary international law. Notwithstanding the fact that there are no guarantees for exemption or credit methods based on customary international law, one may find grounds for a lower intensity of relief. The deduction method may be considered a taxpayer right illuminated by the ability-to-pay principle, which governs income tax rules. Although it is not difficult to recognize that double taxation of income punishes the ability of a given individual to pay tax, it is controversial whether such evidence would render international double taxation prohibited.65 It seems to be a matter of which sovereign state would bear the international double tax relief. However, if the ability-to-pay principle represents domestic law of fundamental and manifest importance in respect of both states related to the income to be taxed, this may represent evidence that such principle would also be applied internationally. Most important, the ability-to-pay principle is accepted as a fundamental right by civilized nations, meaning its nonobservance would be incompatible with international law (article 38(1)(c) of the SICJ).66 One could then consider that international double taxation becomes irregular whenever it represents an excess of exaction in violation of the principle of equality and its ability-to-pay corollary. 63. Id., at p. 25. 64. See K. Vogel, Klaus Vogel on Double Taxation Conventions pp. 12-16 (Kluwer 1999); L.E. Schoueri, O princípio do não retrocesso como nova perspectiva à denúncia de acordos de bitributação, in Revista de Direito Tributário Atual n. 29, pp. 237-245 (IBDT/Dialética 2013); and L.E. Schoueri, Tratados e Convenções Internacionais sobre Tributação, in Revista de Direito Tributário Atual n. 17, p. 22 (IBDT/Dialética 2003); and Brauner, supra n. 3. 65. For positions against the recognition of such right in customary international tax law, see K. Tipke & J. Lang. Direito tributário (Steuerrecht) pp. 108-109 (Sergio Antonio Fabris Editor 2008); Vogel, supra n. 64, at p. 12; G.W. Rothmann, Interpretação e aplicação dos acordos internacionais contra a bitributação. Tese de doutorado pp. 2 and 71 (Faculdade de Direito da Universidade de São Paulo (USP) 1978); and G.W. Rothmann, A denúncia do acordo de bitributação Brasil-Alemanha e suas consequências, in Grandes Questões Atuais do Direito Tributário vol. 9 p. 146 (V. de Oliveira Rocha ed., Dialética 2005). 66. See Schoueri (2013), supra n. 64, at pp. 237-245; and Schoueri (2003), supra n. 64, at p. 22.

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The ability-to-pay principle explains why the single-tax theory is not about a “single assessment” (i.e. a formal approach). The relevant element is not the number of assessments but the effective tax burden. It deals with the single-tax theory only in its material approach: in the absence of an international treaty or a specific domestic rule, a court in a given state may be bound to relive international double taxation when it becomes confiscatory. Indeed, assessments by two countries connected to the same income have the potential to lead to a confiscatory burden, but this is not always the case. Supposing that the source and residence states adopt income tax rates around 20%, such a cumulated tax burden (about 40%) would not necessarily be confiscatory. However, the OECD67 states that 15 member countries have top marginal tax rates equal to or greater than 50%. In those cases, supposing that the source and residence states adopted these highest income tax rates, their sum would be more than 100%. If a taxpayer were to earn USD 100.00, he could be asked to pay, for instance, USD 120.00 in two states. Nevertheless, if double taxation leads to confiscatory effects and no DTA has been signed between the states involved, which sovereignty must be considered obliged by international tax law to assume the onus to relieve the over-taxation? Even those scholars68 who support the conception of the ability-to-pay principle as a customary international law recognizes that DTAs or multilateral instruments would be the instruments of public international law used by states to alleviate or eliminate the phenomenon of double taxation of income and to combat tax evasion through concessions from both parties. These international agreements share the taxation rights, establish relationships between the contracting states and the taxpayers subject to their norms, and preserve the ability-to-pay principle. If one intends to claim a customary international tax law relief by the exemption or credit methods, this scenario may lead to a Solomonic tax judge’s conclusion that double taxation is bad and its confiscatory effects cannot be tolerated, but, even so, a partial or full exemption or credit might not be provided by a particular state. It may sound a reasonable conclusion that such an issue must be solved by sharing the sacrifices of relief between the states involved. 67. OECD.Stat, Table I.7. Top statutory personal income tax rate and top marginal tax rates for employees, available at https://stats.oecd.org/index.aspx?DataSetCode=TABLE_I7. 68. See Schoueri, supra n. 24, at p. 409; and Schoueri (2013), supra n. 64, at p. 240.

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Nevertheless, other methods of tax relief may not lead to the same conclusion. In particular, the deduction method, characterized by Shaviro69 as “sacrosanct”, despite its deficiences, may present interesting outcomes. The ability-to-pay principle drives income taxation in most states, requiring the deductibility of costs and expenses necessary to the earning of income. For instance, if the source state only allows the distribution of dividends after the payment of a 35% withholding tax, it may be argued that only USD 65.00 of USD 100.00 would be the income effectively realized by the beneficiary and taxable in the residence state. Considering the foreign tax as a cost necessary to receiving such dividends, the ability-to-pay principle would allow a taxable base of USD 65.00.70 To sum up, considering the set of international customary tax law analysed, the positive side of the international tax relief pattern may only be confirmed partially. Although there is no guarantee for exemption or credit methods based on customary international tax law, reliance on the ability to pay taxes seems to be a constant and uniform practice, recognized by civilized states as mandatory, in such a way that the deduction method could be claimed by taxpayers. As a result of the deduction method, the income tax initially collected by the source state may be deducted from the income tax base accruing to the resident state.

4.3.2. Double tax treaty models: Have the OECD and UN adopted the international tax relief pattern? It is of primary importance to developing countries to ensure that the tax incentive measures shall not be made ineffective by taxation in the capital-exporting countries using the foreign tax credit system. This undesirable result is to some extent avoided in bilateral treaties through a “tax-sparing” credit, by which a developed country grants a credit not only for the tax paid but also for the tax spared by incentive legislation in the developing country. It is also avoided by the exemption method. Some members from developing countries considered it necessary to underline their understanding that either the exemption method or the tax-sparing clause is, for these countries, a basic and fundamental aim in the negotiation of tax treaties. Commentaries on the UN Model (2011)

69. Shaviro, supra n. 29. 70. Id.; and Shaviro, supra n. 33.

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As an era-of-treaties inheritance, the investigation proposed in this chapter moves on to another level of concretization through DTAs, the proliferation of which around the globe has been potentialized by double tax treaty models published by international institutions and even by states individually.71 The Commentaries on the OECD Model point out that, since its first version (1963), the instrument has assumed a broad influence on the negotiation, interpretation and application of DTAs72: it has facilitated bilateral negotiations and has lead to the harmonization of the network of international conventions.73 The broad influence of the OECD Model can be noted even among non-member countries and in the development of other models, like the UN Model, which reproduces many of its features.74 However, the legal qualifications of the OECD Model and its Commentaries have been a controversial topic amongst scholars and national courts. When the Commentaries on the OECD Model are somehow considered to be legally binding, these propositions find several qualifications in the literature, such as: multilateral agreement (article 31 of the VCLT); instruments established in connection with each DTA (article 31(2) of the VCLT); the context of the DTAs (article 3(2) of the OECD Model); special senses attributed to a term by the parties (article 31(4) of the VCLT); preparatory work (article 32 of the VCLT); the circumstances in which double taxation agreements are concluded (article 32 of the VCLT); subsequent practices or agreements (article 31(3) of the VCLT); doctrine of the most qualified publicists of different nations (VCLT, article 31(3)(c) of the VCLT and article 38(1)c of the SICJ); and even “soft law”.75 Putting this discussion aside and assuming the potential of commentaries on model conventions, it becomes relevant to inquire whether these documents require the referred-to international tax relief pattern. Starting on the positive side, the question arises whether international tax relief must be granted to avoid double taxation according to the benefit theory. Indeed, both the OECD Model and the UN Model suggest international tax relief by the contracting states to guarantee that the relevant 71. See L.F. Neto, Direito Tributário Internacional: “contextos” para interpretação e aplicação de acordos de bitributação (Quartier Latin/IBDT 2018); see also C. West, References to the OECD Commentaries in Tax Treaties: A Steady March from “Soft” Law to “Hard” Law?, 9 World Tax J. 1 (2017), Journals IBFD. 72. Para. 12 OECD Model: Introduction. 73. Para. 13 OECD Model: Introduction. 74. Para. 14 OECD Model: Introduction. 75. See Neto, supra n. 71; and West, supra n. 71.

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income would not be taxed twice, and the avoidance of double taxation of income is identified by the preambles of both the OECD Model and the UN Model as one of the main purposes of the conventions. However, these documents do not propose the elimination of all cases of double taxation, only situations that fall under their scope. One of the most important provisions of the OECD and UN Models for the present investigation is article 23. Addressing the intensity question, the OECD Model adopts the credit (article 23A) and exemption (article 23B) methods to avoid double taxation, which may match with the international tax relief pattern analysed in this chapter. Nonetheless, the Commentaries on the OECD Model also present suggestions for other types of relief, including indirect methods. The Commentary on Article 23 of the OECD Model states that the provisions “deal with the so-called juridical double taxation” and notes that “if two States wish to solve problems of economic double taxation, they must do so in bilateral negotiations”.76 The UN Model does not depart from this general concept. On the other hand, although these model conventions are mainly committed to avoiding juridical double taxation, it is also true that the suggested rules address some cases of economic double taxation. For instance, article 9 of both the OECD Model and the UN Model is mainly devoted to avoiding economic double taxation in transfer pricing situations,77 article 15 finds a way to avoid economic double taxation on short-term employments78 and article 23 proposes some options to avoid economic double taxation in the case of dividends.79 To sum up, the OECD and UN Models seem to confirm to some extent the first face of the single tax theory. The suggested rules lead to the avoidance of juridical international double taxation and, in some hypotheses, even economic international double taxation. The credit and exemption methods are ordinarily adopted, although other methods are also suggested. There is further evidence of the commitment of the OECD and UN Models to the avoidance of double taxation in the mutual agreement procedure (MAP) and arbitration clauses.80

76. Paras. 1-2 OECD Model: Commentary on Article 23. 77. Para. 1 et seq. OECD Model: Commentary on Article 9. 78. Para. 6.2 et seq. OECD Model: Commentary on Article 15. 79. Para. 49 et seq. OECD. Commentary on Article 23. 80. V. Arruda Ferreira & A. Perdelwitz, Tax Incentives and Tax Treaties, in Tax Incentives in the BEPS Era (M. Cotrut et al. eds., IBFD 2018), Online Books IBFD.

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The benefit theory represents a remarkable deviation between the OECD and UN Models. Although the OECD Model clearly assumes it as a principle when sharing taxing rights among the contracting states (favouring residence state taxation rights), the UN Model favours source state taxation rights in this equation.81 In other words, the UN Model does not fully follow the positive side of the international tax relief pattern regarding the benefit theory. On the other hand, the negative side of the international tax relief pattern does not seem to be entirely supported by the OECD and UN Models. Actually, the OECD does not – as the international tax relief pattern does – assume as a general rule that income must always be taxed at least once and at not less than an average effective rate. The preamble of the OECD Model (2017) indicates that its rules intend the “elimination of double taxation with respect to taxes on income and on capital without creating opportunities for non-taxation or reduced taxation through tax evasion or avoidance (including through treaty-shopping arrangements aimed at obtaining reliefs provided in this Convention for the indirect benefit of residents of third States)”. Although the earlier versions of the OECD Model only focused on the avoidance of double taxation, the 2017 preamble wording is coherent with an OECD tendency to address the problem of tax evasion and non-tolerated tax avoidance. To reflect the new wording of the preamble, the OECD Model (2017) contains a new article 29 (Entitlement to benefits), the intention and wording of which “correspond to the minimum standard that was agreed to as part of the OECD/G20 Base Erosion and Profit Shifting Project and that is described in paragraph 22 of the report Preventing the Granting of Treaty Benefits in Inappropriate Circumstances, Action 6 – 2015 Final Report”.82 However, several possibilities of low taxation or even double non-taxation resultant from the exemption and credit methods are not addressed by the new article 29 of the OECD Model. This new provision is mainly intended to deal with cases of tax avoidance or evasion, but it does not prevent the contracting states from adopting exemption methods or tax-sparing clauses (or even suggest such). Following the Final Report on Action 6 of the BEPS Project, the Commentary on Article 29 of the OECD Model (2017) even 81. See Julien, supra n. 49; and S.A. Rocha, Brazil’s International Tax Policy (Editora Lumen Juris 2017). 82. Para. 1 OECD Model: Commentary on Article 29.

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recognizes the existence of cases of under-taxation or non-taxation intended by the contracting states.83 It is not clear that the Commentaries on the OECD Model refuse international tax relief if the other state under-taxes or even fails to tax the related income. Dealing with articles 10 (Dividends),84 11 (Interest)85 and 12 (Royalties),86 the Commentaries emphasize that the OECD Model does not specify whether a given relief in the source state should be conditional upon the income being subject to tax in the residence state: “This question can be settled by bilateral negotiations.” Furthermore, the Commentaries on the OECD Model present their concern about under-taxation or non-taxation as a consequence of tax benefits provided by the state entitled to tax the income under a DTA. The Commentaries87 suggest the adoption of a provision on subsequent changes to domestic law to deal with cases in which “the overall tax rate that another State levies on corporate income falls below what they consider to be acceptable for the purposes of the conclusion of a tax treaty” or in which “a State that taxed most types of foreign income at the time of the conclusion of a tax treaty decided subsequently to exempt such income from tax when it is derived by a resident company”. Nevertheless, the Commentaries also highlight the fact that “the features of that provision would need to be restricted or extended in order to deal adequately with the specific areas of concern of each State”. The Commentary on the Article 23A (Exemption method) of the OECD Model assumes that “the State of residence must accordingly exempt income and capital which may be taxed by the other State in accordance with the Convention whether or not the right to tax is in effect exercised by that other State. This method is regarded as the most practical one since it relieves the State of residence from undertaking investigations of the actual taxation position in the other State”, subject to the exceptions of article 23A(2) (items of income which may only be subjected to a limited tax in the source state) and 4 (conflicts of qualification).88 According to the Commentaries, if the exemption hypothesis is applicable, “the obligation may be considered as absolute” by the state. If a given state wishes to deny 83. 84. 85. 86. 87. 88.

Para. 104 OECD Model: Commentary on Article 29. Para. 20 OECD Model: Commentary on Article 10. Para. 13 OECD Model: Commentary on Article 11. Para. 6 OECD Model: Commentary on Article 12. Para. 1010 OECD Model: Commentary on Article 1. Paras. 32-36 OECD Model: Commentary on Article 23.

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the treaty exemption benefit on income that the other state does not tax, the OECD considers it an issue to be properly negotiated and agreed upon between the contracting states: Occasionally, negotiating States may find it reasonable in certain circumstances, in order to avoid double non-taxation, to make an exception to the absolute obligation on the State of residence to give exemption in cases where neither paragraph 3 or 4 would apply. Such may be the case where no tax on specific items of income or capital is provided under the domestic laws of the State of source, or tax is not effectively collected owing to special circumstances such as the set-off of losses, a mistake, or the statutory time limit having expired. To avoid such double non-taxation of specific items of income, Contracting States may agree to amend the relevant Article itself (see paragraph 9 of the Commentary on Article 15 and paragraph 12 of the Commentary on Article 17; for the converse case where relief in the State of source is subject to actual taxation in the State of residence, see paragraph 20 of the Commentary on Article 10, paragraph 10 of the Commentary on Article 11, paragraph 6 of the Commentary on Article 12, paragraph 21 of the Commentary on Article 13 and paragraph 3 of the Commentary on Article 21). One might also make an exception to the general rule, in order to achieve a certain reciprocity, where one of the States adopts the exemption method and the other the credit method. Finally, another exception to the general rule may be made where a State wishes to apply to specific items of income the credit method rather than exemption (see paragraph 31 above).89

It is also interesting that the OECD Committee on Fiscal Affairs does not condemn tax-sparing clauses. This type of provision has been criticized by OECD for more than a decade from now,90 but “[t]he Committee concluded that member States should not necessarily refrain from adopting tax sparing provisions”, which “should be considered only in regard to States the economic level of which is considerably below that of OECD member States”, as well as advising the use of “best practices” to minimize cases of abuse.91 The Commentaries on the OECD Model92 do not oppose tax-sparing clauses, but the UN Commentators’ approach clearly differs in terms of receptivity. The Commentaries on the UN Model93 recognize that tax-sparing credit methods, as well as the tax exemption method without subject-to-tax clauses, are legitimate means adopted by developing countries (typically capital89. 90. 91. 92. 93.

Para. 35 OECD Model: Commentary on Article 23. See OECD, Report on Tax Sparing: A Reconsideration (OECD 1998). Para. 78.1 OECD Model: Commentary on Article 23. Paras. 6-9 UN Model: Commentary on Article 23. Paras. 3-4 UN Model: Commentary on Article 23.

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importing countries) willing to attract investment from developed countries (typically capital-exporting countries). Although the Commentaries on the UN Model address and disapprove of tax evasion or avoidance structures, they explain alternatives regarding “the most effective method of preserving the effect of the tax incentives and concessions extended by developing countries”, including domestic measures and DTA provisions, considering both valid. The UN Commentators do not even distinguish between exemption and credit methods in referring to tax-sparing provisions: Tax sparing provisions may take different forms, as for example: a) the State of residence will allow as a deduction the amount of tax which the State of source could have imposed in accordance with its general legislation or such amount as limited by the Convention (e.g. limitations of rates provided for dividends and interest in Articles 10 and 11) even if the State of source has waived all or part of that tax under special provisions for the promotion of its economic development; b) as a counterpart for the tax reduction by the State of [source] the State of residence agrees to allow a deduction against its own tax of an amount (in part fictitious) fixed at a higher rate; c) the State of residence exempts the income which has benefited from tax incentives in the State of source.94

Considering all these elements, it is reasonable to conclude that the negative side of the international tax relief pattern may be partially confirmed. Although the Commentaries on the OECD and UN Models adopt tax credit and exemption methods as rules, suggesting means to avoid under-taxation or non-taxation caused by tax evasion and tax avoidance (including subjectto-tax clauses), both also accept exemption methods (without any subjectto-tax clause) and tax-sparing clauses.

4.3.3. Tax treaties effectively signed: DTAs and multilateral instruments Keeping up the search for evidence about the international tax relief pattern, one may verify tax treaties effectively signed by states. If such a pattern is actually in effect, states would not deviate from it, and tax treaties would constitute instruments to regulate how it may be applied. However, if sovereign states are freely negotiating and agreeing to treaty clauses that deviate from this pattern, this may be considered as evidence that it does not constitute a general principle. 94.

Para. 74 UN Model: Commentary on Article 23.

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4.3.3.1. DTAs: The clearest evidence of international tax system(s) The first international agreements on direct taxation were instituted between Prussia and Saxony (1869), Austria and Hungary (1869/70), and Austria and Prussia (1899).95 Currently, there are thousands of DTAs signed by all states around the globe. Naturally, this chapter does not intend to endeavour a comprehensive analysis of this entire network; it merely presents a sampling analysis. This section addresses the question of whether DTAs harmonically impose international tax relief by one state to guarantee that the income will be taxed just once, as well as whether that state refuses international tax relief if the other state does not tax the related income. Based on the consensualist and fragmentation theories analysed in section 4.2.1., an agreement between two states based on the OECD Model or UN Model, and accordingly containing domestic approval procedures, is enough to establish an international tax regime.96 International conventions, whether general or particular, establishing rules expressly recognized by the contracting states are recognized sources of international law (article 38(1) (a) of the SICJ). In this scenario, DTAs have become the clearest evidence of particular and self-contained international tax regimes. Starting from the positive side of the international tax relief pattern, the clearest object and purpose of DTAs is the avoidance of international double taxation. In many DTAs ratified decades ago (and still in effect), the main discussions and negotiations likely involved the need to avoid double taxation, which was a pattern in international practice for a long time. However, as was already emphasized in respect of the model conventions (see section 4.3.2.), a DTA does not intend to avoid all conceivable instances of international double taxation. In particular, although those agreements broadly cover juridical double taxation, economic double taxation is covered 95. Vogel, supra n. 64, at p. 17. 96. For a different perspective, see Rosenbloom, supra n. 8. Rosenbloom denies the existence of an international tax system, even in terms of DTAs: “The difficulty with this hypothesis is that international tax conventions themselves usually make clear that they are elective: ‘The Convention shall not restrict in any manner any benefit now or hereafter accorded ... by the laws of either Contracting State’, in the words of the U.S. Model Treaty. This means, simply, that a taxpayer may reject a treaty and its contents and invoke instead its rights under domestic law, both in the United States and in the other country. Since international tax arbitrage generally (though perhaps not invariably) builds upon differences in domestic laws, not treaties, an election to rely on domestic law would leave the taxpayer with the same arbitrage opportunities as if the treaty did not exist at all. In other words, the treaties lack the leverage to implement an international tax system by striking at international tax arbitrage.”

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only in selected situations (or is not covered at all). Most importantly, critical mechanisms currently proposed by the OECD and UN Models have not to date been efficient. Although MAP provisions are generally present in DTAs, it is notable that these instruments have not achieved their purpose, as exposed in Action 14 of the BEPS Project. On the other hand, arbitration clauses are still rare in the DTA network.97 Moreover, although credit and exemption are the most popular methods adopted by DTAs, the relief’s intensity and extention actually varies treaty by treaty, and other methods can be adopted. For example, Hungary, Japan, Korea, the Philippines and Portugal, in their DTAs signed with Brazil, also adopt the imputation method (indirect credit) to relieve economic double taxation on business income distributed as dividends. Focusing on the Brazilian DTA network, the positive side of the international tax relief pattern may only be confirmed partially. The Brazilian DTAs are mainly based on ordinary credit and exemption methods, but some of them also provide for indirect credit. Regarding the benefit principle, it is notable that all agreements entered into by Brazil follow article 12 of the UN Model, which authorizes the taxation of royalties also by the source state, diverging from the OECD Model’s policy of exclusive taxation by the residence state. Nonetheless, because Brazilian treaty policy seems to be divergent regarding decisive topics, further sampling may reveal compliance with such pattern in a broader extension. On the other hand, the question of whether an international tax relief must be denied in order to avoid under-taxation or even non-taxation (the negative side of the international tax relief pattern) varies significantly. Although many DTAs may be out of date and their preambles not present a single word about tax evasion or tax avoidance, it does not appear that many states differ regarding the importance of combating abuse in international structures. States do not seem to differ much regarding intolerance of tax evasion, but they differ substantially regarding intended double non-taxation or under-taxation. The Dutch DTA network is remarkable for adopting different methods to relieve international double taxation. Exceptionally, when negotiating with capital-importing countries, the concession of tax-sparing credits seems to be common. Nonetheless, these benefits can be dependent on the fulfilment 97.

Arruda Ferreira & Perdelwitz, supra n. 80.

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of specific conditions, such as the requirement of a source state tax waiver related to investment incentives.98 The Dutch DTA network also presents a second deviation, related to the amount of tax-sparing credit to be provided by the Netherlands. At least two different answers can be found in Dutch DTAs. The first one does not differ from traditional tax-sparing clauses, where the source state tax credit is deemed to be a fixed amount, regardless of the withholding actually collected by the source state. For example, article 23(4) of the BrazilNetherlands DTA99 establishes a tax-sparing rule in which the source state tax credit may be deemed to be 20%, regardless of the actual value supported. A second solution follows a formulary approach, as included in the Korea-Netherlands DTA.100 Muller101 asserts that “under the DutchKorean tax treaty the tax sparing credit on interest or royalties could be the actual amount of withholding tax levied in Korea, plus twice the difference between this amount and 10% of the gross payment. E.g., if Korea were to reduce its source tax to 8%, the Dutch credit would equal (8 + 2 × (10 – 8) =) 12%. This in effect creates an incentive for Korea to lower its source tax. If it were to abolish it, the Dutch credit could be as high as (0 + 2 × (10 – 0) =) 20%”. Among other BRICS countries, China presents a relevant position on this issue. Li102 points out that, “in negotiating DTAs with OECD countries, China’s primary purposes are to attract FDI, protect China’s national interest as a source country and link China’s tax incentives with the treaty partner’s foreign tax relief system through tax sparing clauses”. Finally, Brazil also represents a consolidated position in respect of the adoption of provisions deviating from the international tax relief pattern analysed in this chapter. Austria, Belgium, the Czech Republic, Ecuador, France, Hungary, India, Luxembourg, the Netherlands, Norway and the Slovak Republic have signed DTAs with Brazil adopting the exemption method (without any subject-to-tax provision) when Brazil is the source state of certain types of income, generally passive income. Spain concluded a DTA with Brazil establishing an exemption on dividends received by Brazilian, as well as Spanish, residents (i.e. a reciprocal provision). 98. J.H. Müller, The Netherlands in International Tax Planning, Online Books IBFD. 99. Art. 23(4) Braz.-Neth. Income Tax Treaty (1990), Treaties IBFD. 100. Korea (Rep.)-Neth. Income Tax Treaty (1978), Treaties IBFD. 101. Müller,  supra n. 98. 102. J. Li, International Taxation in China: A Contextualized Analysis sec. 4.2.2. (IBFD 2016), Online Books IBFD.

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Brazil has also included tax-sparing provisions in DTAs negotiated with capital-exporting countries, which explains its reservations to the Commentaries on the OECD Model on this topic. Because of this tax policy, it is remarkable that the Brazil-United States DTA, signed in 1967, was rejected by the US Congress because of its tax-sparing clause.103 However, Canada and many other states concluded DTAs with Brazil accepting tax-sparing provisions, including the DTAs signed with Korea and the Philippines, providing for reciprocal matching credits. In this scenario, the negative side of the international tax relief pattern cannot be confirmed by the Brazilian DTA network at all. Adopting the exemption method (without any subject-to-tax provision), as well as tax-sparing clauses, and thus providing for under-taxation or non-taxation as a policy for attracting investment, Brazil and its DTA partners have manifested its sovereign decision that the single taxation theory has not been adopted in its full extension. On the other hand, it is necessary to consider that a different sampling could provide for other results. In adopting a pure foreign tax credit method, or even exemption methods with subject-to-tax provisions, many DTAs could better fit the international tax relief pattern, reducing the risk of undertaxation or non-taxation.

4.3.3.2.  Multilateral instruments: Is the MLI a game-changer? As demonstrated in section 4.2.1., a possible conclusion arising from the consensualism and fragmentation theories is that each agreement between two or more states is able to create a particular and self-contained international tax regime. Two states are enough to establish an international tax system. Nevertheless, a broader international tax system could be founded on multilateral instruments based on “a single set of international tax rules”104 (article 38(1)(a) of the SICJ). Theoretically, features such as the number of contracting states and the extension of topics covered play a key role in the process of production of the legal system: the more states that join the agreement and the more comprehensive it is (i.e. extending to cover the most important international tax fields), the more extensive and consolidated the international tax fragment becomes. 103. See Rocha, supra n. 81, at p. 151 and seq. 104. See Brauner, supra n. 3.

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A multilateral instrument could be a game-changing way to establish the international tax relief pattern hereby analysed. It could represent a legitimate source to establish the single-tax and benefit theories as principles binding on contracting states. If so, it would be clear evidence of the existence of the international tax relief pattern in a widely diffused international tax system. Indeed, the OECD and G20 have proposed a multilateral convention to implement measures to prevent base erosion and profit shifting (the multilateral instrument (MLI)). What international tax law will look like after the MLI depends on some prior issues, relating, for instance, to the DTAs’ contexts (the adaptation question), the MLI’s propositions (the qualitative question), states’ adherence (the quantitative question) and reservations (the agreement question), as well as a post-implementation question concerning how national courts will interpret and apply the MLI (the effectiveness question). The context in which a DTA has been contracted by two given states is relevant to understanding why one (or both) of those states does not enter into the MLI or, once having entered into it, why a given states enters a certain reservation. Doing so also helps to attribute coherence to the system, clearing the DTA content in an interpretational dispute. Finally, article 2(2) of the MLI establishes that “any term not defined herein shall, unless the context otherwise requires, have the meaning that it has at that time under the relevant Covered Tax Agreement”. Arising from the heart of the OECD BEPS Project, the MLI is mainly intended to establish certain standards for avoiding tax base erosion and profit shifting not tolerated by the contracting states. Some of these nottolerated operations have been well known in the tax literature and court cases in the last decades, among them treaty-shopping structures105 (the negative side of the international relief pattern). On the other hand, the MLI’s propositions also furnish means to improve mechanisms to avoid double taxation (the positive side of the international relief pattern), improving dispute resolution though the MAP (article 16), as well as providing for a mandatory binding arbitration (article 18 and seq.).

105. See A. Amatucci, International Tax Law (Kluwer Law International 2006); P. Reinarz, Treaty Shopping and the Swiss Withholding Tax Trap, 41 Eur. Taxn. 11 (2001), Journals IBFD; and L.E. Schoueri, Planejamento Fiscal Através de Acordos de Bitributação (Treaty Shopping) (Ed. Revista dos Tribunais 1995).

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As its preamble already indicates, the MLI does not embrace the single-tax principle in its pure form. Opening the instrument, the preamble expresses that the MLI is mainly devoted to addressing “aggressive international tax planning that has the effect of artificially shifting profits to locations where they are subject to non-taxation or reduced taxation”, “ensuring that profits are taxed where substantive economic activities generating the profits are carried out and where value is created”, preventing “treaty abuse” and “artificial avoidance”, interpreting existing agreements so as to “eliminate double taxation with respect to the taxes covered by those agreements without creating opportunities for non-taxation or reduced taxation through tax evasion or avoidance”, as well as improving dispute resolution. Furthermore, the MLI proposes different levels of commitment to certain tax policies and methods to achieve them: there is a list of mandatory and optional MLI clauses, leaving relevant room for reservations or even for non-acceptance by the contracting states. Article 5 of the MLI, dealing with the application of methods for the elimination of double taxation, naturally assumes great importance regarding the establishment (or not) of the international relief pattern. The provision follows the Final Report on Action 2 of the BEPS Project,106 addressing “problems arising from the inclusion of the exemption method in treaties concerning items of income that are not taxed in the State of source”. A state can choose between three options (options A, B and C), or even not adopt the provision at all. It is not a mandatory clause. If each of the contracting states of a given DTA chooses different options, or if one contracting state chooses to apply article 5 of the MLI and the other decides not to adopt this article, the option chosen by each contracting jurisdiction shall apply concerning its own residents.107 The first option (A) is based on article 23A(4) of the OECD Model,108 which represents the OECD’s solution for the residence state to refrain from exempting income in case of low taxation or double non-taxation arising as a result of conflicts of DTA interpretation. By changing terminologies and replacing some references in the DTA covered, the article in question 106. OECD/G20 BEPS Project, Neutralising the Effects of Hybrid Mismatch Arrangements – Action 2: 2015 Final Report (OECD 2015), paras. 442-444. 107. Para. 60 et seq. OECD Multilateral Convention to Implement Tax Treaty Related Measures to Prevent Base Erosion and Profit Shifting (MLI): Explanatory Statement (7 June 2017), Treaties IBFD. 108. It must be noted that the UN Model does not contain an equivalent to article 23A(4) of the OECD Model, but the Commentary on the UN Model presents an adapted and optional version of article 23A(4).

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becomes more comprehensive, allowing, for example, for “the application of withholding taxes to income other than dividends and interest, such as income from royalties”. If adopted, such an option “should not be read to apply to provisions that grant exclusive taxing rights to the Contracting Jurisdiction of residence concerning specific types of income, such as provisions that exempt dividends from source taxation”.109 The second option (B) addresses situations in which a residence state, in applying a covered DTA, would exempt dividend income derived by it, while the another contracting state (the source state), in applying the same DTA, would consider such dividends as a deductible payment. If option B is adopted, the exemption method will no longer be applicable in that situation.110 Finally, the third option (C) is based on article 23B of the OECD Model, updated in the course of the BEPS Project, which deals mainly with the credit method. Considering this latest version of the OECD Model, the changes proposed by article 5, option C, of the MLI are intended “to conform the terminology used therein to the terminology used in the Convention”.111 It is important to emphasizes that these “approaches are technically designed to apply only in very specific cases of unintended low or double non-taxation that arise due to different applications of the treaty and, therefore, usually, should not interfere with cases where the source State decides not to exercise its taxing right on the basis of domestic law” (emphases in the original).112 It is notable that option A of article 5 of the MLI applies to situations in which a contracting state exempts an item of income that the other contracting state would exempt or tax under a reduced rate “based on its application of the Covered Tax Agreement”. Option B also addresses the hypothesis of double non-taxation or under-taxation motivated by the DTA itself: it deals with mismatches in applying the DTA, but not with situations desired by a sovereign state according to its domestic law (tax benefits, for instance). Option C does not differ. Although none of the options provided by article 5 of the MLI deals with potential low or non-taxation consented to by the contracting states, addressing only situations where such an effect was achieved by way of tax avoidance schemes not consented to by the states, it is important to highlight 109. Para. 61 and seq. MLI: Explanatory Statement. 110. Para. 66 and seq. MLI: Explanatory Statement. 111. Para. 69 MLI: Explanatory Statement. 112. Julien,  supra n. 49.

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that article 11 (Application of Tax Agreements to Restrict a Party’s Right to Tax its Own Residents) deals with tax-sparing clauses. The Explanatory Statement to the MLI clarifies that article 11, replacing the phrase “relief of double taxation” with “tax credit or tax exemption” in the Commentaries on the OECD Model, intends to “ensure that provisions applying the credit method or exemption method would continue to apply as intended even where a Covered Tax Agreement provides for tax sparing”. This means that the MLI does not address situations where the source state does not tax an item of income, or taxes it at low rates, because of its own decision expressed in its domestic law (in the case of tax benefits, for instance). In other words, a country’s adherence to the MLI does not represent its acceptance of the single-tax theory. Arruda Ferreira and Perdelwitz indicate an opposite tendency, namely that “in particular, the envisaged introduction of LOB rules and PPT clauses into existing tax treaties has the potential to end identified abusive schemes that take advantage of tax sparing credit clauses. This development may result in more tax sparing credit clauses being included in future tax treaties, as the use of domestic tax incentives to attract FDI will continue”.113 It is still relevant to analyse other questions about the MLI referred to above. One may note that, once a treaty such as the MLI is concluded and legal relationships between a relevant number of states are established, such an instrument becomes susceptible to emendedation. After that, new international tax rules can be more easily spread around the world. If a smaller restriction provided by the original MLI were to be massively accepted by contracting states, there could be room for future emendations to cover a wide range of restrictions. For many reasons, the MLI has generated an intense adherence (quantitatively speaking), although a number of key countries have still not yet signed it. However, even if a given state signs and implements the MLI, it remains necessary to verify its reservations on specific provisions and to determine which DTAs are designated as covered by this instrument.114 Questions about reservations are generally related to multilateral agreements, losing their meaning in bilateral treaties. When only two states are involved, the content conveyed by them would only be that which is fully 113. Arruda Ferreira & Perdelwitz, supra n. 80. 114. It could be relevant to consider whether the other state (DTA partner) has also signed and implemented the MLI, as well as to take into account its reservations and the DTAs indicated as covered, which is itself a controversial discussion.

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accepted, there being no room for reservations on the propositions agreed to. Since international tax law has up to now basically consisted of DTAs, the international tax literature has not been required to discuss the effects of reservations. To be sure, scholars and practitioners have long discussed issues related to reservations to the OECD Model, as well as to its Commentaries, but not reservations to DTAs themselves. On the other hand, a clear feature of the MLI as proposed by the OECD and the G20 is its openness to reservations and the acceptance of different versions of clauses. This feature brings about the unavoidable possibility of rendering ineffective measures to implement the international tax relief pattern. For instance, article 19 of the MLI (Mandatory Binding Arbitration) represents an important means to improve the avoidance of double taxation, but, because of domestic issues, some states may feel obliged to make reservations to this article. Selecting a sampling to be analysed, it is possible to verify that most states that have contracted DTAs with Brazil adopting the exemption method do not intend to review it via the MLI. Ecuador has not signed the MLI. The Czech Republic, France, Hungary and India have signed the MLI but decided not to adopt its article 5 at all. Austria, the Netherlands and Norway have decided to apply article 5 of the MLI but did not include their DTAs with Brazil among those treaties covered by this MLI rule. Finally, the Slovak Republic and Spain have manifested their intention to adopt version C of article 5 of the MLI in regard to their DTAs with Brazil, while Luxembourg has manifested its intention to adopt version A of this article in regard to its DTA with Brazil. The variety of rules in the MLI does not seem to be an isolated situation. The instrument itself is designed to leave room for different tax policies and state preferences, while retaining certain standards considered essential by the OECD and G20. Indeed, the variety of policies adopted by states results in a complex of combinations and diversity of rules provided by the MLI. In this framework, the matrix of which states have signed (different stages of implementation of) the MLI and which DTAs have been designated as covered by the MLI must be kept in mind. This already represents a true challenge to practitioners and scholars, requiring sophisticated mechanisms to deal with complex variations and the monitoring of all situations and new developments as closely as possible.115 Finally, realistically, how national courts interpret and apply the MLI will determine its effectiveness. Time will tell. 115. See, for example, the IBFD MLI Country Monitor.

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4.3.4. What tax relief are tax authorities and tribunals applying? Monopoly over the last word belongs to the courts. Decisions made by a national high court may be considered clear evidence of a state’s consent to the relief provided by international tax law, especially if international agreements are involved. Indeed, a court decision is itself a source of international tax law, even as a “subsidiary means for the determination of rules of law” (article 38(1)(d) of the SICJ). Even a court decision that provides for an international tax relief that most scholars would disagree with is still binding. As a result, international tax relief may be granted by courts, and tax relief previously agreed to by means of a DTA may be refused by those same tribunals. The European Commission116 has recognized that instruments intended to relieve double taxation can also fail based on interpretational mismatches committed by national courts and that, “as a result, taxpayers may suffer double taxation, contrary to the objective pursued by the DTC”. This section deals with the positive and negative sides of the international tax relief pattern viewed through the lens of the courts. Starting with the positive side (an international double tax relief must be provided), court decisions do not consistently follow the international tax relief pattern. At least according to the sampling analysed, court decisions vary. The Court of Justice of the European Union (ECJ) provides clear evidence of the juridical non-existence of the single-tax theory on its positive side, the avoidance of double taxation. The European Union could be considered a particular case, a specific selfcontained system. Double taxation has consistently been addressed by multiple directives and agreements ruled upon by the European Commission, including the Parent-Subsidiary Directive,117 the Interest and Royalties Directive,118 the Arbitration Convention119 and the Common Consolidated

116. European Commission, supra n. 31. 117. Council Directive 2011/96/EU of 30 November 2011 on the Common System of Taxation Applicable in the Case of Parent Companies and Subsidiaries of Different Member States, EU Law IBFD. 118. Council Directive 2003/49/EC of 3 June 2003 on a Common System of Taxation Applicable to Interest and Royalty Payments Made between Associated Companies of Different Member States, EU Law IBFD. 119. Convention on the elimination of double taxation in connection with the adjustment of profits of associated enterprises (90/436/EEC), OJ L 225/10 (1990), EU Law IBFD.

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Corporate Tax Base (CCCTB) Directive.120 Nonetheless, the European Commission121 also recognizes that “existing instruments are insufficient to address many of the remaining double taxation situations” and that Member States “are not obliged to eliminate double taxation as a general rule”. The Commission has recognized that the avoidance of double taxation, and even double non-taxation, should be an urgent goal of the Member States, and it has proposed solutions to various problems. The Commission is also clear, however, that such tax policy as should be achieved has not become a general rule as of now. In Damseaux,122 the ECJ analysed an operation in which a Belgian resident received dividends from a company resident in France. Since those dividends would be taxed at the source (France) and also in the residence state (Belgium), the taxpayer claimed a tax credit for the French withholding tax. According to the Belgium-France DTA,123 in the case of dividends received by Belgian residents “which have actually been taxed at source in France, the tax due in Belgium on the amount net of the French tax at source shall be reduced by, first, the withholding tax imposed at the normal rate, and, second, a fixed percentage of foreign tax that is deductible under conditions fixed by Belgian law, provided that such percentage may not be lower than 15% of that net amount”. It happens that Belgian domestic law does not provide that tax credit that it was supposed to do. In this scenario, the ECJ was tasked with answering (i) whether the partial juridical double taxation on dividends received from France would be compatible with the free movement of capital; and (ii) whether Belgium would be obliged to renegotiate the Belgium-France DTA to abolish double taxation of dividends from shares of companies established in France. The ECJ held that the residence state would not be obliged to provide tax relief to prevent juridical double taxation based only on the EU Treaty. The Court ruled as follows: [I]n so far as Community law, in its current state and in a situation such as that at issue in the main proceedings, does not lay down any general criteria for the attribution of areas of competence between the Member States in relation to the elimination of double taxation within the European Community, Article 56 EC does not preclude a bilateral tax convention, such as that at issue in the main 120. European Commission, Proposal for a Council Directive on a Common Consolidated Corporate Tax Base (CCCTB), COM(2016) 683 Final. 121. European Commission, supra n. 31. 122. BE: ECJ, 16 July 2009, Case C-128/08, Jacques Damseaux v. État Belge, ECJ Case Law IBFD. 123. Belg.-Fr. Income Tax Treaty (1964), Treaties IBFD.

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proceedings, under which dividends distributed by a company established in one Member State to a shareholder residing in another Member State are liable to be taxed in both Member States, and which does not provide that the Member State in which the shareholder resides is unconditionally obliged to prevent the resulting juridical double taxation.124

The ECJ decision is clear evidence that a relevant number of states, as a bloc, consider that, in the absence of an instrument, the avoidance of double taxation could not be considered as a uniform practice recognized by the Member States as mandatory. On the other hand, a German case125 may be consider as an example that states are not always willing to avoid double taxation at all costs. If a DTA is in place, as proof of the consensus established between two sovereignties states, one state may not be claimed to guarantee the relief that would be supposed to be provided by another contracting state. This case involved a resident of Germany who lived close to the Swiss border and worked in Basel, Switzerland. His salary was at first considered covered by article 15(1) of Germany-Switzerland DTA,126 reserving to Switzerland the right to tax it and requiring Germany to exempt such income (article 24(1)). After some investigation, his situation was characterized by the German inspectors as that of a frontier worker, and thus, according to the Germany-Switzerland DTA, the income could only be taxed in Germany (article 15(4)). The reimbursement of the Swiss income tax was refused because of the statute-of-limitations rules. Finally, the German authorities were required to recognize the tax effectively paid to Switzerland as a credit to the German income tax assessed, and they decided to refuse all forms of tax relief on the double taxation. The German Court of First Instance (Baden-Württemberg) partially reformed the assessment: although the tax credit was still denied, it considered it necessary to allow the deduction from the German income tax base of the tax paid to Switzerland. However, the German Federal Tax Court denied the double tax relief on all possible levels, inter alia because no kind of credit could be provided for taxes wrongly collected by the other contracting state. Thus, in the second instance, this court understood that the

124. Damseaux (C-128/08), supra n. 122, at para. 35. 125. DE: BFH [Federal Tax Court], 1 July 2009, Case I R 113/08, Tax Treaty Case Law IBFD. 126. Art. 15(1) Ger.-Switz. Income and Capital Tax Treaty (1971), Treaties IBFD.

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Swiss income tax could not be credited against the German tax, nor could it be deducted from the German income tax base. On the other hand, a Brazilian case provides an example of the “monopoly of the last word” being used to enforce the international tax relief supported by a DTA. From 2000 to 2013, the Brazilian tax authorities held the position that payments for technical assistance and technical services without transfer of technology should not be understood in the sense of the term “business profits” referred to in article 7 of Brazilian DTAs but in line with article 21 (Other income). According to the tax policy adhered to in all Brazilian DTAs, article 21 grants the right to tax to the source state.127 Other contracting states raised concerns regarding this Brazilian interpretation: because it would not be shared and followed by the other contracting states, the outcome would certainly be double taxation, and the DTAs in question would prove ineffective, to say the least. Although some lower Brazilian courts had considered the tax authorities’ interpretation correct, the Superior Court of Justice (Superior Tribunal de Justiça) held that denying the international tax relief provided by article 7 in this situation would turn the relevant DTA into a “dead letter” (letra morta). The court expressly considered that the DTAs’ purpose of avoiding double taxation would be frustrated by adopting the interpretation assumed by the tax authorities, and that this would be unacceptable. Addressing the negative side of the international tax relief pattern, courts have also decided in various ways. One court decision is useful for illustrating that, once the credit method is adopted by the DTA, the effective payment of foreign tax, as a matter of proof, has been considered an elementary feature of granting international double tax relief. The case involved an English football player who was hired by a French team and maintained residence status both in the UK and in France. Although he was supposed to pay income tax in France (i.e. was liable to tax), he did not fulfil this obligation.

127. See BR: Ato Declaratório Cosit no. 1/2000; Parecer PGFN/CAT no. 776/2011; Parecer PGFN/CAT no. 2363/2013.

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In this scenario, an English court128 was required to decide whether the term “payable” in article 24(a) of the France-United Kingdom DTA129 should be interpreted as having the meaning of effectively paid, and not potentially payable. The court rejected the application of the France-United Kingdom DTA, considering the absence of evidence regarding the effective taxation of the football player’s income by the French state. The court ruled that such DTA would have been concluded for the purpose of preventing more than one state from effectively taxing the same income, so that the legal protection of its rules would not preclude taxation, but rather ensure the fulfilment of such responsibility by payment. Moreover, as the purpose of the France-United Kingdom DTA would also be to prevent tax evasion, the taxpayer’s interpretation should be rejected, as it would lead to the facilitation of evasive acts. One of the most controversial topics related to the negative side of the single-tax principle (and thus to the international tax relief pattern) involves national courts applying tax-sparing clauses. While some jurisdictions have taken the position of preserving tax-sparing clauses, even in cases of potential double non-taxation, and this has been respected by tax authorities and courts, other jurisdictions have raised issues regarding them. Some cases may be presented as a sampling. The Belgian Supreme Court130 addressed a case in which a Belgian company had received interest from a Korean company related to bonds issued 128. UK: CHMRC, 23 Sept. 1998, Sportsman v. Commissioners of Inland Revenue, Tax Treaty Case Law IBFD. 129. Art. 24(a) Fr.-UK Income Tax Treaty (1968), Treaties IBFD. 130. BE: CdA Liège [Court of Appeals of Liège], 13 Sept. 2000, 2001/28, Tax treaty Case Law IBFD: “The taxpayer, a Belgian company, invested in bonds issued by a company established in Korea. The taxpayer received interest payments from the Korean company in respect of these bonds. Under Korean tax law, these interest payments were exempt from withholding tax in Korea. Pursuant to the tax sparing credit of Art. 22(1)(b) of the treaty, the taxpayer was entitled to a tax credit of EUR 200,000. The tax authorities did not contest that the Belgian company was entitled to this credit but argued that an amount equal to the tax credit should be added to the taxable base of the company. The arguments of the tax authorities were based on the unilateral relief measures provided for by Art. 285 et seq. of the Belgian Income Tax Code (hereinafter: ITC). At the material time, Art. 285 ITC provided for a tax credit equal to the (withholding) tax actually levied by the foreign tax authorities (limit 1). Moreover, this tax credit was capped at 15/85 of the net interest (limit 2). The notion ‘net interest’ referred to the gross interest after deduction of foreign (withholding) tax. In order to mitigate the effect of this tax credit, the Belgian legislator introduced a ‘gross-up system’ by the law of 7 December 1988 which inserted a second clause in Art. 37 ITC. This ‘gross-up system’ consisted of adding an amount equal to the tax credit to the taxable base of the Belgian company. In the case at hand, the tax authorities took the position that the tax credit provided under Art. 22(1)(b) of the treaty should be followed by a corresponding gross-up with the result that the taxable base of

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by it. According to the tax-sparing clause contracted in the Belgium-Korea DTA,131 the resident state (Belgium) would be required to provide for an exemption on this income (article 22(1)(b)), which could be taxed only by the source state (Korea). On the other hand, according to Korean domestic tax law, such interest payments would be exempt in Korea. Although this equation would result in double non-taxation, the taxpayer’s relief right was not contested by Belgium: even the Belgian tax authorities recognized the tax sparing clause previously agreed to. Based on domestic law provisions, however, the Belgian tax authorities demanded a gross-up on the taxable base of the Belgian company equal to the credit provided by that tax credit-sparing relief. The Liège Court of Appeals, followed by the Belgian Supreme Court, decided in favour of the taxpayer, denying such gross-up. Similarly, an Indian court132 (as residence state) addressed a case in which the Indian tax authorities held that the exemption method provided by article 25(4) of the India-Oman DTA133 could not be applicable, because the dividend income was not taxable according to Omani domestic tax law (as source state). The court decided that such dividend income should be qualified for the tax-sparing credit provided by the DTA. A case heard by the Administrative Tribunal of Luxembourg134 dealt with the extension of the tax-sparing credit provided by the Germany-Luxembourg the Belgian company increased by EUR 200,000. [...] The Supreme Court further held that the gross-up provided for in Art. 37 ITC had to be calculated in accordance with Art. 285 et seq. ITC. As a result, this gross-up was limited to the amount of the foreign withholding tax. In the present case, there was no Korean withholding tax. Accordingly, there was no gross-up to be included in the taxpayer’s taxable base”. 131. Belg.-Korea (Rep.) Income Tax Treaty (1977), Treaties IBFD 132. IN: ITAT New Delhi, 9 Mar. 2016, Krishak Bharati Cooperative Ltd v. ACIT, Tax Treaty Case Law IBFD: “The taxpayer company was tax resident of India. It had a branch office in Oman for overseeing investment in a joint venture there. That branch office was also independently registered as a company under the Omani laws. The tax authorities had accepted that the branch office amounted to a permanent establishment (PE) for the purposes of Art. 25 (Avoidance of double taxation) of the treaty. Through that branch office, the taxpayer company had received dividend income, which was exempt from taxation in Oman by virtue of an amendment in the Omani tax law that was effective from the year 2000. Originally, the Indian tax authorities had allowed tax credit for the (deemed) Omani tax on the dividend income in accordance with the tax sparing provisions contained in Art. 25(4) of the treaty. Subsequently, however, the tax authorities reopened the tax assessment and disallowed the foreign tax credit. As per the tax authorities, the exemption from the Omani tax did not amount to ‘incentive’ and, therefore, it was not obliged to apply the aforesaid tax sparing provisions.” 133. Art. 25(4) India-Oman Income Tax Treaty (1997), Treaties IBFD. 134. LU: TA [Administrative Tribunal], 29 Apr. 2003, Case 15343 and 15344, Tax Treaty Case Law IBFD: “A German bank carried out activities in Luxembourg through a permanent establishment (PE), to which interest on bonds sourced in Spain was attributed. In

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DTA135 to a non-resident entity of the source state (a Luxembourg PE of a German bank). Considering article 43 of the EC Treaty, the court decided that, whether “the tax sparing credit is not granted to a Luxembourg PE of an EU company, the latter is placed in an unfavorable situation compared to a Luxembourg subsidiary of a German company. Accordingly, the holding of Spanish bonds through a Luxembourg PE is less attractive than that through a Luxembourg subsidiary”. One more example may be adduced to demonstrate how tax-sparing clauses have been treated differently in cases of potential double non-taxation. While the Belgian case referred to above is situated at one extreme (with the tax authorities and the court accepting the tax-sparing credit method), and the Luxembourgian and Indian cases are situated in the middle (with the tax authorities denying the tax-sparing credit method and the court reversing this position), there is a French case that may be situated at the opposite extreme (with the tax authorities denying the tax-sparing credit method and court agreeing with this position). The case136 involved a taxpayer, resident in France, that derived interest income from Brazil (as source state) subject to a 0% income tax at source because of the Brazilian domestic rules. The taxpayer claimed the matching credit relief based on articles 11(3)(b) and 22(2)(d) of the BrazilFrance DTA.137 Nevertheless, the French tax authorities refused to provide the matching credit relief without minimum effective taxation in Brazil. 1995 the Luxembourg PE included the Spanish-sourced interest into its taxable income. Pursuant to Art. 24(1)(f) of the Luxembourg-Spain tax treaty of 3 June 1986 (the tax treaty), the bank requested the application of a tax sparing credit of 15% on part of the interest received. The Luxembourg tax authorities rejected the claim, arguing that a PE does not fall within the scope of tax treaties as it is not a resident for tax treaty purposes. It concluded that the PE could not benefit from the tax sparing credit connected to the interest received under the tax treaty. The bank argued that although the tax authorities were correct in their interpretation of the treaty, the tax authorities had to extend the benefits of the tax sparing credit provided under the tax treaty to Luxembourg PEs’ of EU companies by virtue of the principle of freedom of establishment set out in Art. 43 of the EC Treaty. The bank invoked the application of the ECJ cases in Avoir Fiscal (C-270/83 Commission des Communautes europeennes v. Republique Francaise) and Saint-Gobain (C-307/97 Compagnie de SaintGobain, Zweigniederlassung Deutschland v. Finanzamt Aachen-Innenstadt). In substance, the bank argued that denying the benefit of the tax sparing credit provided by Art. 24 of the tax treaty to the Luxembourg PE of a German bank would result in taxing more heavily the income of a Luxembourg PE as opposed to that of a Luxembourg company, thereby leading to a difference of treatment incompatible with Art. 43 of the EC Treaty.” 135. Ger.-Lux. Income and Capital Tax Treaty (1958), Treaties IBFD. 136. FR: CE [Supreme Administrative Court], 26 July 2006, case 284930, Tax Treaty Case Law IBFD. 137. Arts. 11(3)(b) and 22(2)(d) Braz.-Fr. Income Tax Treaty (1971), Treaties IBFD.

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Such ruling was confirmed by the Supreme Administrative Court, apparently endorsing the idea that a given item of income must be taxed not less than once. Considering the above, one may not affirm that national courts have adopted harmonic guidelines regarding either the negative or the positive side of the international tax relief pattern.

4.4.  Is there a process of harmonization in progress? An international tax relief pattern has been proposed based on the interaction between the single-taxation and benefit theories. Such pattern was analysed in this chapter through the sources of international law. The fragmentation approach proposed by the author does not deny the importance of conducting a process of harmonization, but it does reflect the current s tatus of international law. Considering that a DTA is enough to establish a particular and self-contained international tax regime, the question of whether taxpayers have a right to effective international tax relief must be verified according to each particular regime. Neither the positive nor the negative side of the international tax relief pattern could be entirely confirmed based on the several samplings considered. Undoubtedly, a different sampling could provide different results. Because consent drives the ties between contracting states, the single-tax and benefit theories could certainly be elected as principles in a given DTA. However, the variety of tax policies and economic goals among states around the globe results in several differents possible decisions regarding international double taxation. As a result, the single-tax and benefit theories cannot be considered general principles that govern all international tax regimes. In the future, perhaps, the world may become a highly connected tax environment, regulated by a common system and governed by a single set of rules and principles. Nevertheless, in the current, fragmented stage of international tax law, these common rules and principles still need to be established.

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5.1. Introduction If there is such a thing as a single taxation principle in international tax law, it seems intuitively correct that taxpayers must have a right to double tax relief (DTR) in every instance in which they are subject to double taxation. Looking at the issue from the opposite angle, one could maybe argue that being able to support the right to DTR demonstrates the existence of the single taxation principle. This chapter therefore explores the possible foundations of the right to DTR and discusses the implications of its findings for the debate on single taxation.

5.2.  Effective DTR An initial issue has to be raised that there is little point in discussing a right or entitlement to DTR unless it is effective DTR. This point can be illustrated with the AMID case decided by the Court of Justice of the European Union (ECJ).1 AMID was a company resident in Belgium, with a permanent establishment (PE) in Luxembourg. The PE realized a profit in one year, whereas the company’s head office in Belgium suffered a loss in the same year. Belgian domestic law granted DTR for the PE profit using the exemption method, but it also required the Luxembourg profit to be set off against the Belgian loss. This loss set-off meant that there was no PE profit left that could be exempted in that year, and under Belgian law, there was also no possibility of claiming a compensatory exemption in a later year. The DTR was, in effect, “lost”, as the domestic law brought the PE profit into the domestic tax charge by using it to reduce the loss available for carryforward within Belgium. In contrast, if the head office had also realized a profit, the DTR exemption would have kept the PE profit out of reach of the domestic tax charge. The ECJ did not have to consider specifically

1. BE: ECJ, 14 Dec. 2000, Case C-141/99, Algemene Maatschappij voor Investering en Dienstverlening NV (AMID) v. Belgische Staat, ECJ Case Law IBFD.

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whether the taxpayer had a right to DTR, although it did hold this aspect of the Belgian law to be incompatible with the fundamental freedoms of the European Union.2 Similar results can occur in a credit system of DTR as a consequence of other design issues. Suppose, for example, that a company resident in State R has a PE in State S and that State R taxes the worldwide profit of resident companies and employs the ordinary credit method of DTR.3 Both states impose tax on corporate profits at the rate of 20%. Assume that the PE profit is 50 in years 1 and 2 and that the head office result is a loss of 50 in year 1 and a profit of 50 in year 2. The overall profit of the company is therefore nil in year 1 and 100 in year 2. In year 1, the company pays tax of 10 in State S but is unable to claim a foreign tax credit because no tax is payable in State R. In year 2, the company again has a foreign tax credit of 10, which it can use to reduce its tax bill in State R from 20 to 10, but no further. If, in future years, the fact pattern of year 2 remains essentially unchanged, the company will never benefit from the foreign tax credit of 10 that was potentially available in year 1. In other words, the division of the profits by reference to years leads to part of the credit being irretrievably “frozen”. In contrast, if all the amounts mentioned in this example had been realized in the same year, the overall profit for that year would have been 100, which would be the amount representing the PE profit, and the credit would have been fully available. Both examples illustrate the importance of the domestic law details in the design of a DTR system and the extent to which a single feature can limit the benefit of the taxpayer. As the source state in both examples is assumed to impose its own taxation on the same PE profit, the result would seem to be a clear breach of the single taxation principle. But what exactly is the friction with the single tax notion in these examples? Or, to put the question another way, what is required of a DTR system in order is to achieve compliance with the single taxation principle?4 2. The Belgian law was held to breach the freedom of establishment; see Treaty Establishing the European Community of 25 March 1957, art. 43, EU Law IBFD; and Treaty on the Functioning of the European Union of 13 December 2007, OJ C(115), art. 49 (2008), EU Law IBFD. 3. The author wishes to thank Mattia Calabrese, a member of the 2017/2018 class of the University of Amsterdam/IBFD LL.M. advanced programme, for providing this example in a question he posed during the programme. 4. Compliance with the single taxation principle is only one possible objective of double tax relief (DTR). There is a great deal of literature on the policy justifications for a residence state to provide DTR; see, for example, the articles listed infra in n. 5, n. 10, n. 11, n. 15, n. 25, n. 26 and n. 27 for just a small portion of this literature.

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The point is not whether the overall tax burden remains excessive; the single taxation principle does not require the overall burden to remain within any particular numerical margin. Conversely, even if both taxes are levied at such a low rate that the aggregate burden barely inconveniences the taxpayer, there is no element of the principle that takes this situation outside the notion of double taxation. The point is also not that the taxpayer has to pay some tax in both states on one amount of income; the need for DTR is predicated on the overlapping of two states’ tax claims, and the argument is not that this overlap has to be removed by eliminating one of the taxing claims entirely. It is submitted that the essential point is, rather, that the overall tax burden is higher than it would have been in the absence of the overlap of states’ taxing claims. In order to be effective in accordance with the single taxation principle, the DTR must take the overall burden down to what it would have been if the facts were all within the taxing jurisdiction of one state only; the damage wrought by the overlapping of two states’ taxing claims has to be undone. The concept of single taxation does not imply any preference between the two taxing claims, and indeed, the very concept of DTR accepts that the taxing claims of both states are legitimate. The concept of single taxation is generally argued not to imply anything about the level of taxation in either state. The classic example in this respect is a final withholding tax on gross income, which may be too high to be fully creditable in the residence state, where the income is taxed on a net basis. Yet, it is often argued that there is only one tax suffered in this case, i.e. in the source state, and the unsatisfactory result has nothing to do with the notion of single taxation and everything to do with the characteristics of a withholding tax on gross income. However, one could argue that it is a breach of the single taxation principle because the overall tax burden is quite probably higher than it would be if source of the income and the residence of the taxpayer were in the same state. This possible breach of the principle does not, however, point to a problem with the granting of DTR, unless one were to go so far as to argue that a taxpayer’s right to DTR is so strong that it obliges the residence state to make amends for the excess of the source state, but this is an argument that is not pursued further in this chapter. In granting DTR, a residence state has to make a multitude of policy choices about the design of its DTR system, which may have a substantial impact

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on the value of the relief granted to the taxpayer.5 Some choices have an impact on whether relief is granted at all, such as the conditions for personal eligibility, the foreign taxes that give entitlement to DTR6 and the domestic taxes against which relief is granted.7 Other choices have a direct impact on the amount of relief, such as limitations on the amount of the relief (such as foreign tax credit limits), whether it is possible to average income from different sources (geographical or characterization) and the corresponding foreign tax and whether the amount of relief can be averaged over time. Yet other choices have an indirect impact on the amount of relief, such as the rules for computing the amount of income, whether expenses are set off against domestic income or foreign income and the timing of the recognition of income.8 This latter set of choices is particularly important in respect of business profits.9 The many choices affecting the amount of relief complicate the comparison between the actual tax burden in a cross-border situation and the burden that would have applied in the absence of the cross-border element. For example, should the comparison be made by reference to a single item or source of income, or by reference to the taxpayer’s total income? What is the most appropriate period for the comparison? Nevertheless, it is clear that the design of a DTR system has a substantial impact on the extent to which it achieves a result that approximates a single levy of taxation. It is also worth noting that the way in which DTR is generally granted in the current international tax order is not an immutable law of nature. The current system, with the exemption method and the credit method, has a basic philosophy that opts for the rate of tax in either the source state or the residence state. However, one could, for example, also imagine a system 5. See, for example: A. Nikolakakis, Credit Versus Exemption – An Evolving Constellation of Constellations, 66 Bull. Intl. Taxn. 6 (2012), Journals IBFD. 6. For just one well-known example of a case in which this was an issue under domestic law, see US: Supreme Court, 20 May 2013, No. 12–43, 15 ITLR 986, PPL Corp. et al v Commissioner of Internal Revenue. 7. For an example of a case in which this was an issue, see LU: Administrative Court of Appeals, 17 Jan. 2006, Case 20316 C, Tax Treaty Case Law IBFD. 8. See, for example: C.M. Black, The attribution of profits to permanent establishments: Testing the interaction of domestic taxation laws and tax treaties in practice, British Tax Review 2, pp. 172-203 (2017). Black concludes that the gaps are more troubling than the overlaps because the mutual agreement procedure is available to resolve the overlaps, but this conclusion is valid only in the treaty context that is the subject of her article. 9. For an extensive discussion of the issues relating to the taxation of business profits, see G. Blanluet & P.J. Durand, Key Practical Issues to Eliminate Double Taxation of Business Income, General Report, IFA Cahiers de Droit Fiscal International, vol. 96b (Sdu Fiscale & Financiële Uitgevers 2011), Online Books IBFD.

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that aims to achieve an overall burden falling in between the two. This point has been made by Shaviro, who argues that treating single taxation as a normative principle blinds policymakers from alternative possibilities and discusses other principles that would, in his opinion, better inform the design of a DTR system.10 It is also apparent from the history of the DTR system of the United Kingdom, for example, that its original design was guided by many factors other than the desire to achieve a total burden resembling that of one state based on the notion of single taxation.11

5.3.  Possible foundations of a right to DTR A claim cannot be labelled as a right unless it is possible to set out various elements relating to its enforcement. In order to assert a right, it must be possible to (i) identify the legal or moral foundation of the right; (ii) state the nature of the right and any limitations to it, for example, due to competing rights that may take priority; (iii) identify the person who has the right and who should be able to enforce it; and (iv) in the case of a breach, identify which person(s) are acting in breach of the right and whose action (or inaction) needs correction. The discussion that follows examines various grounds that could justify a claim that there is a right to DTR in the light of these elements. It starts by considering whether the current international tax order has force of law, which would mean that the DTR that is an integral part of the current order also has force of law. It then investigates various other legal principles that could be possibly used to found a claim that DTR is a right.

10. D. Shaviro, The Crossroads Versus the Seesaw: Getting a “Fix” on Recent International Tax Policy Developments, 69 Tax Law Review 1, pp. 1-42 (2015). 11. This history has been traced in J. Avery Jones, Sir Josiah Stamp and Double Income Tax, in Studies in the History of Tax Law, vol. 6, pp. 1-29 (J. Tiley ed., Hart Publishing 2013). Some of the ideas put forward included (i) designing the system to divide tax revenue between the United Kingdom and its dominions and colonies; (ii) distinguishing between origin taxation (following the benefits principle) and residence taxation (following the ability-to-pay principle); and (iii) both the source and the residence states granting some measure of relief. There was resistance to granting foreign tax credits, but in the end, the United Kingdom was, in effect, compelled to adopt the credit system in order to be able to conclude a tax treaty with the United States, and thereafter, it had little choice but to do the same for other countries.

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5.3.1. Current international order One possibility is that taxpayers have a right to DTR as a basic principle of the current international tax system. This argument accepts that the current order is a compelling system of customary law, as argued by Avi-Yonah, and that DTR is an integral and necessary part of that order.12 Whether or not there is a system of customary international law in respect of taxation has been hotly contested,13 but if there is indeed such a system, it would have to accept the imperfections of the current order, which tolerates source-state taxation on a gross basis for passive income and does not compel residence states to go any further than giving up their own taxing claims. Avi-Yonah has also gone a step further and has argued not only that there is an obligation on residence states to grant DTR to their residents, but also that the obligation is to offer specifically either an exemption or a credit. His argument is against the deduction method, which is the favoured option of many economists,14 but is generally considered to grant only a partial measure of DTR, as it results systemically in an overall tax burden that is higher than it would be if there were no cross-border element. Avi-Yonah’s argument is based on the current predominance of the exemption and credit methods, and it is not clear whether he would also accept other possibilities, provided that the method adopted affords DTR that is at least as effective as a foreign tax credit or exemption. The counter-argument to the idea of DTR as a right under customary international law is that the current system provides nothing more than a set of expectations, albeit strong ones. This is the position of Genschel and Rixen, who have analysed DTR as a transnational legal order (TLO).15 They describe the TLO of DTR as a normative settlement, stating that “the OECD’s rules on double tax relief have been diffused widely as takenfor-granted guidelines for international taxation”.16 Their analysis of the growth and development of this TLO describes how the practice of granting DTR took hold internationally and became entrenched, but it also suggests 12. R.S. Avi-Yonah, International tax as international law, 57 Tax Law Review 4, pp. 483-501 (2004). 13. For a list of some subsequent articles by leading academics discussing this notion, see the opening section of R.S. Avi-Yonah, Who Invented the Single Tax Principle?: An Essay on the History of US Treaty Policy, 9 N.Y.L. Sch. L. Rev. 305 (2014/15). 14. Id., at p. 500. 15. P. Genschel & T. Rixen, Settling and Unsettling the Transnational Legal Order of International Taxation, in Transnational Legal Orders, pp. 154-183 (T.C. Halliday & G. Shaffer eds., Cambridge U. Press, 2015). 16. Id., at p. 155.

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strongly that DTR is founded on an economic policy choice of states rather than on any inherent entitlement of taxpayers.17 The fact that the system of DTR has become so widespread and entrenched is explained by the self-reinforcing network effect of the OECD Model Tax Convention (OECD Model)18 and the resulting disincentives for states (such as the sunken costs in the existing system) to consider alternative ways of dealing with competing taxing claims in cross-border situations.19 This effect of the current entrenched system has also been studied by Dagan, who concludes that tax treaties operate as a network product, rather like a technical standard or a social network on the Internet that has become dominant.20 The essence of a network product is that the size of its membership is crucial: it gains new members and retains existing ones simply because new networks start out with too few members to enable them to compete. DTR, as one of the core features of the current tax treaty network, has, through this mechanism, gained an entrenched place in the current international tax order. As a network product, the large and increasing number of tax treaties, with its system of DTR, also has a lock-in effect, which makes it very difficult to change the standards embodied in the network even though those standards may not be (or are no longer) optimal. However, it is not only the network effect of tax treaties that leads states to grant DTR. Using game theory, Dagan has also argued that DTR will be granted by states anyway, even in the absence of treaties.21 She examines various scenarios to demonstrate that states will always grant DTR, as all the possible “games” among states in the design of their national policies “will yield in a stable equilibrium in which double taxation is prevented”.22 Although her conclusion is based on an analysis of the DTR methods that are generally in current use, these methods are only examples, and the conclusion holds, regardless of the mechanism chosen. Even without the benefit of game theory analysis, it was already argued, in 1927, by Adams (the man 17. For example, at id., pp. 158-159, stating that “[t]he [first world] war had undermined the nationalistic justification of double taxation as a protective wall around domestic economic resources and increased the normative appeal of double tax relief as a means of cultivating international peace by facilitating cross-border trade and investment”. 18. Id., at p. 164; see OECD Model Tax Convention on Income and on Capital (2017) [hereinafter OECD Model 2017]. 19. Id., at p. 169. 20. T. Dagan, Tax Treaties as Network Product, 41 Brooklyn Journal of International Law 3, pp. 1081-1106 (2016). 21. T. Dagan, International tax policy: Between competition and cooperation, ch. 3 (Cambridge U. Press 2018). 22. Id., at p. 98.

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generally recognized as the father of the foreign tax credit), that “[e]ach State should be eager, for selfish and economic reasons, to relieve its own nationals and residents from that measure of double taxation which is due to its own legislation”.23 Furthermore, as Dagan points out, the vast majority of states in the current order do indeed grant unilateral DTR when they tax on a worldwide basis. These studies, in other words, support the argument that the reasons for states to grant DTR are found in history and in the practical constraints on their economic policies. The result may be an expectation on the part of taxpayers that they will be granted DTR, but an expectation, however strong, remains an important step away from an enforceable right.

5.3.2. Fairness If one accepts that the current international order does not have force of law but merely creates expectations, are there other sources of law that could be used to found a claim for DTR as a right? One possibility is the principle of fairness. Graetz and O’Hear, for example, in analysing what motivated Adams to propose the foreign tax credit, conclude that “[a]t bottom, Adams objected to double taxation because it offended his sense of fairness”.24 Fairness is commonly accepted as one of the requirements of a good tax system,25 but fairness – perhaps even more than beauty – is in the eye of the beholder. When the foreign tax credit was being proposed in both the United States and the United Kingdom, for example, there was already disagreement with the proposition that it was fair for a residence state to cede its

23. T.S. Adams, Draft Convention Proposed by Professor Adams, League of Nations Doc. D.T.120, p. 2 (1927), available in T.S. Adams Papers, Yale U. (Box 16 Apr. 1927 folder), cited in M.J. Graetz & M.M. O’Hear, The “Original Intent” of US International Taxation, 46 Duke L. J., p. 1051 (1997). 24. Graetz & O’Hear, id., at p. 1047. 25. See, for example, D. Shaviro, The Case Against Foreign Tax Credits, 3 Journal of Legal Analysis 1, pp. 65-100 (2011).

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taxing claim to a source state.26 Subsequent literature has also questioned the fairness of this mechanism.27 Therefore, where exactly does the alleged unfairness lie that has to be remedied by granting DTR? Adams was not concerned so much about double taxation per se; his concern did not extend to the economic double taxation of dividends or the overlap of state and federal taxation. His concern was rather the double taxation resulting from the concurrent exercise of taxing jurisdiction by two states, or in other words, the discriminatory element of double taxation arising in a cross-border investment by comparison with a purely domestic investment.28 This argument to support DTR implies that it is up to the residence state to ensure fairness and a lack of discrimination in the overall tax burden. However, one can question why it is necessarily up to the residence state to take care of relieving double taxation – is this obligation simply a corollary of a residence state claiming taxing rights over the worldwide income of its resident taxpayers? Furthermore, if there is such an obligation, how far does it extend? Does the obligation to achieve fairness for the taxpayer mean that a residence state is required to absorb the inconsistencies of the current international order? Or is a right to DTR based on fairness limited by an expectation that taxation in the source state tax will be fair or reasonable, immediately raising questions about the fairness and reasonableness of the current international order as a whole? This latter issue is becoming an issue of increasing concern as the character of the world economy changes and states attempt to shore up their claims to taxing jurisdiction to cope with new business models. Kirsch, for example, discusses the phenomenon of states claiming taxing rights on the grounds that their tax base is being eroded in the context of the taxation of services delivered without the service provider having a physical presence in the

26. See Graetz and O’Hear, supra n. 23, at p. 1043, citing Senator Curtis, Internal Revenue: Hearings Before the Committee on Finance of the United States Senate on H.R. 8245, 67th Cong. 256 (1921) (statement of Senator LaFollette), reprinted in Internal Revenue Acts of the United States 1909-1950: Legislative Histories, Laws, and Administrative Documents, vol. 95A (B.D. Reams Jr. ed., 1979); and J.F. Avery Jones, Avoiding Double Taxation: Credit versus Exemption – The Origins, 66 Bull. Intl. Taxn. 2, footnote 56 (2012), Journals IBFD. 27. A. Gupta, In Praise of Non-Conformity, 73 Tax Notes International 4, p. 277 (2014) describes the foreign tax credit as an “extraordinarily generous benefit”. See also Shaviro, supra n. 25, at p. 70, who describes it as a selfless act of the residence state. 28. Graetz and O’Hear, supra n. 23, at footnote 108.

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country of delivery.29 He posits an example of a business executive who is employed by a business resident in one state, travels to another state and takes legal advice there about an issue that is domestic in the state visited, such as a question about the extension of an entry visa into that state. The residence state of the executive’s employer may impose a withholding tax on the fee for this service because it is paid to a non-resident service provider.30 In this case, there is an expectation that the residence state of the service provider will give a foreign tax credit for the tax withheld and, in all likelihood, lose its taxing right in practical terms.31 This result, Kirsch argues, is difficult to justify, given that the service provider’s engagement with the residence state of the business is entirely “accidental” or, at the very least, not consciously sought. Similarly, Wilson and Roth place a question mark next to the revised UK withholding tax regime in respect of royalties.32 The changes they discuss concern the rules on the connection with the United Kingdom, which deem royalties paid by a non-resident to have a UK source if they are connected with a UK PE, including a deemed PE under the diverted profits tax regime. These changes are “[u]ltimately … intended to apply source taxation to ‘nowhere income’ where that can be justified through a connection to U.K. activities”.33 They conclude on a more general note by observing:34 In some respects, the U.K. changes and the shift to source-based taxation that they evidence tell the story of a global tax system that is coming full circle, from one where a source/residence compromise was developed to avoid double taxation through to a system where attempts to address double non-taxation have produced new instances of double taxation, as one country’s source regime begins to impinge on another’s source and/or residence regime. […] While cooperation between governments is critical in avoiding this risk, in the absence of such cooperation and a BEPS program that has been plagued

29. M.S. Kirsch, Tax Treaties and the Taxation of Services in the Absence of Physical Presence, 41 Brooklyn Journal of International law 3, pp. 1143-1155 (2016). 30. The discussion by Kirsch, id. relates specifically to the possibility that there is a treaty between the two states that includes an article on technical service fees allowing the state of the payer to tax. The same issue could also arise in the absence of a treaty, although in this case, there would be no implied source rule, and therefore there might be a question under the law of the residence state of the service provider as to the geographical source of the payment and whether it qualifies for DTR in that respect. 31. Kirsch, supra n. 29. at p. 1153. 32. J. Wilson & T. Roth, Whose Tax is the UK Withholding?, 18 Tax Planning International: European Tax Service 12 (2016). 33. Id., at p. 2. 34. Id., at p. 4.

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by unilateral action the responsibility may ultimately fall on [multinational enterprises] caught in the crossfire to avoid double taxation through careful restructuring.

The concerns expressed in these articles illustrate one of the major limitations on the notion of DTR as a right against the residence state: that right cannot be justified if there is disagreement about one of the fundamental premises on which DTR is based, namely the entitlement of another state to tax the income. A similar issue can arise in respect of part of the income if the two states have different computational rules and the source state sees a larger amount of income having its source there than the residence state does. Questions about the justification for DTR can also arise in the opposite situation, in which DTR is granted even though there is no (or very little) taxation in another state. The Commentary on Article 23 of the OECD Model Convention, for example, is ambivalent towards the granting of DTR if the source state chooses not to tax under its domestic law even though full taxing rights are allocated to it by the treaty. On the one hand, it states unequivocally that an obligation under article 23A to grant an exemption applies even if the income is not taxable under the domestic law of the source state, but on the other hand, it is rather cautious about states that employ the credit method granting tax sparing credits in respect of income that is not taxable under the domestic law of the source state.35 The latter concern has been highlighted by the BEPS Project, which, as one of its primary aims, endeavours to prevent states from granting DTR in the absence of effective source-state taxation.36 A rather different consideration of fairness in respect of cross-border taxation is offered by Fleming, Peroni and Shay in a discussion of US tax policy.37 They argue that if fairness for taxpayers were the only consideration,38 the United States should grant only a deduction for foreign taxes (rather 35. OECD Model Tax Convention on Income and on Capital: Commentary on Article 23 paras. 56.2. and 72-78.1. (11 Nov. 2017), Models IBFD [hereinafter Commentary on Art. 23]. 36. Many of the proposals in respect of hybrid entities and instruments are directed towards ensuring that no DTR is granted if there is no taxation in another state; see OECD, Neutralising the Effects of Hybrid Mismatch Arrangements – Action 2: 2015 Final Report (OECD 2015). 37. J.C. Fleming, R.J. Peroni & S.E. Shay, Perspectives on the worldwide vs. territorial taxation debate, 57 Tax Notes International 1, pp. 98-99 (2010). 38. And in the absence of a tax treaty which, if it had been concluded by the United States, would require the United States to grant a foreign tax credit.

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than an exemption or credit), because US taxpayers would then pay the same rate of tax on their US and foreign-source income. This analysis takes fairness as a concept relating to one state only, with the authors asserting that “[e]ach country has the right to decide the notions of tax fairness that will prevail for members of its society”.39 This is clearly a different conception of fairness than a concept based on international single taxation as a guiding principle, which requires one to look at the combined tax burden of all the states claiming taxing jurisdiction in any given situation. Fleming, Peroni and Shay do, however, recognize that their proposal “leaves international double taxation substantially in place as a barrier to its residents’ foreign business and investment activities”. They acknowledge the undesirability of that double taxation, but for the reason expressed by the aforementioned authors rather than on the basis of fairness.40 Similarly, Shaviro, arguing against a system of foreign tax credits for the United States, bases his argument on considerations of efficiency rather than on any notion of fairness towards taxpayers that requires the avoidance of double taxation.41 Dagan also argues that, in designing their system for the taxation of cross-border income, states should act strategically rather than basing that system on any notion of fairness.42 There is, in other words, significant opposition to the argument that fairness demands DTR as an entitlement of taxpayers.

5.3.3. Ability to pay A different manifestation of the notion of fairness is the principle that taxation should be imposed according to the ability to pay. This principle justifies the imposition of progressive rates on individuals so that individuals with a higher income pay proportionately more tax than those with a lower income, but it also requires a state to take into account circumstances that diminish a taxpayer’s ability to pay. The ability-to-pay principle is enshrined in the constitution of some states,43 and Fleming, Peroni and Shay characterize it as the “prevailing fairness dogma” of the US tax system,44 adding 39. Fleming, Peroni & Shay, supra n. 37, at p. 92. 40. Id., at p. 99. 41. D. Shaviro, The Case Against Foreign Tax Credits, 3 J. Legal Analysis 65, pp. 8792 (2011). 42. Dagan, supra n. 21, at p. 60, sec. 2.3. 43. F. Vanistendael, Legal Framework for Taxation, in V. Thruonyi (ed.), Tax Law Design and Drafting, vol. 1, p. 8 (International Monetary Fund 1996). 44. Fleming, Peroni & Shay, supra n. 37, at p. 88.

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that “[t]here is no reason why it should not receive similar deference when international tax provisions are being scrutinized”.45 In applying the ability-to-pay principle, states have to make policy choices as to which circumstances they take into account in this respect and how far they take account of the diminution of a taxpayer’s ability to pay. One of the circumstances diminishing a person’s ability to pay could be the obligation to pay tax to another state, as the foreign tax is a necessary cost of obtaining the income, and most states do indeed make the policy choice to take account of this by granting DTR. Yet, if the ability to pay is the basis for taking into account foreign tax liabilities, there is no obvious reason for treating those liabilities differently from any other unavoidable expenditure, which suggests that the DTR should be limited to a deduction for the foreign tax. Similarly, Fleming, Peroni and Shay reason that “[t]he source of net income is irrelevant to ability to pay”, and accordingly, they conclude that “an exemption or territorial system, under which foreign source income is excluded from the tax base, is fundamentally inconsistent”.46 In the current international tax order it is indeed true that exemption systems of DTR do not comply with the ability-to-pay principle. Even an exemption with a progression system, which takes into account worldwide income when determining the rates applicable to domestic income, fails to comply because it is only the residence state that takes the worldwide income into account; if the source state applies progressive rates to the taxpayer, it looks only at the income from its own sources. Traditional wisdom is that a source state cannot fully apply the ability-topay principle; only the residence state can do that because it is only the residence state that can see the entirety of the taxpayer’s circumstances. This handicap of the source state in connection with the ability-to-pay principle is, however, based on practical considerations rather than on any inherent principle of fairness towards taxpayers. In a world with a rapidly growing system regarding the exchange of information among states, this argument might also be losing force. From a principled point of view, one could easily envisage an alternative system in which all taxing jurisdictions take into account the taxpayer’s ability to pay. In this system, each country with taxing jurisdiction would tax only income from a source in that country, but all of them would determine 45. 46.

Id., at p. 90. Id., at p. 91.

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the rates (and personal exclusions, etc.) by looking look at the taxpayer’s worldwide income and applying their progressive rates proportionately to their slice of the income. One might name this a “territoriality with progression” system. A “territoriality with progression” system, however, is not a method of granting DTR, but rather a restructuring of the international order in a way that requires no DTR at all. It would achieve both general observance of the ability-to-pay principle and single taxation, although the single layer of taxation would be fragmented among all of the states with taxing jurisdiction. If implemented fully, it would also mean that states would no longer apply flat-rate withholding taxes, with all the distortionary effects they cause including, very often, a clear breach of the ability-to-pay principle. Such a system is not without substantial difficulties. The practical difficulties include the need to provide all states with the information necessary in order to implement this system and that the system would sometimes require states to carry out a complex assessment in order to collect a very small amount of tax. One of the greatest substantive difficulties would be the division of the tax base among states in order to ensure that the total of the portions allocated to states equals the taxpayer’s worldwide income, no more and no less. A system of territoriality with progression has no concept of residual income that is allocated by default to the residence state, which is an important difference from the current order, although the current ability of many taxpayers to manipulate their tax residence makes this difference less significant than it might appear at first sight. Losses would also cause a considerable substantive difficulty in a system of territoriality with progression, especially if a taxpayer consistently suffers only losses in one state while deriving positive income in other states. Nevertheless, as a thought experiment, this idea illustrates how closely DTR is tied to the current order or, rather, to an international order based on a foundation that allows concurrent taxing claims. If the ability to pay can be used as an argument to support DTR as a right, it can equally be used as an argument to support a rethinking of the current international order in which the ability-to-pay principle is observed in every state according to its own interpretation of the principle.

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5.3.4. Right to peaceful possession of property The best-known expression of the right to the peaceful possession of property is in article 1 of the Protocol to the European Convention on Human Rights, which states:47 Every natural or legal person is entitled to the peaceful enjoyment of his possessions. No one shall be deprived of his possessions except in the public interest and subject to the conditions provided for by law and by the general principles of international law. The preceding provisions shall not, however, in any way impair the right of a State to enforce such laws as it deems necessary to control the use of property in accordance with the general interest or to secure the payment of taxes or other contributions or penalties.

The second paragraph of this provision does not mean that tax issues are, by definition, outside the scope of this article; it allows states to impose tax, but limits that power by prohibiting regimes that go so far as to breach the right to peaceful possession. The European Court of Human Rights (ECHR)48 has, however, traditionally allowed a wide margin of discretion to states in shaping their tax policies and has been reluctant to find that a provision of domestic tax law is outside that margin.49 Baker poses the question of whether this provision imposes a duty on states to relieve double taxation.50 He refers to the case law of the ECHR, which has stated on several occasions that there may be an infringement of the right to peaceful possession of property if a state’s taxation is so excessive that it fundamentally interferes with a person’s financial position. If the cumulative effect of the tax law of two (or more) countries has this effect, he states that there may be “at least some obligation on states to include unilateral provisions for relief of double taxation in their laws or to seek to enter into a network of double taxation conventions”. Baker’s first suggestion, i.e. that there may be an obligation to provide unilateral DTR, suggests that it is up to the residence state to take care of the 47. Convention for the Protection of Human Rights and Fundamental Freedoms of 4 November 1950 (20.III.1952), Protocol, art. 1. 48. And, formerly, the European Commission on Human Rights. 49. P. Baker, Double Tax Conventions, Introductory Topics, p. I-2 (Sweet & Maxwell 2018); P. Baker, Taxation and the European Convention on Human Rights, 50 Eur. Taxn. 6, pp. 259-261 and (especially) 302 (2010); C. Endreson, Taxation and the European Convention for the Protection of Human Rights: Substantive Issues, 45 Intertax 8/9, pp. 508-526 (2017). 50. Baker (2018), id., at p. I-7.

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problem. Yet, the possible breach of this right is caused by a mismatch of tax systems developed by two sovereign states rather than an egregious act of one state, and there is nothing in the European Convention on Human Rights pointing to one state or the other as the guilty party that is obliged to provide a remedy. Baker’s second suggestion does place responsibility on both states, but the issue here is whether the Convention can confer a right on taxpayers if the enforcement of that right requires two sovereign states to come to an agreement with each other. This provision, in other words, does not seem to be a very promising foundation for a claim to DTR as an enforceable entitlement of taxpayers. A prohibition of excessive or confiscatory taxes can also be found in, or derived from, the constitutions of some states.51 Could such a prohibition found a claim for DTR as a right? This argument requires such a provision to take account of an excessive aggregate burden caused by the concurrent exercise of taxing jurisdiction by two states. It is much more likely, however, that the prohibition would be interpreted by a court as being limited in its application to the amount of tax due in the state of which the constitution is being applied, bringing the issue back to the domestic rates of tax in that state. Such a provision may seem much more relevant in respect of a source state that applies a high rate of withholding tax to outgoing gross income, as the withholding tax often constitutes an excessive burden when compared with the net income represented by the payment. On the other hand, constitutional provisions of this type generally require the overall tax burden on a person to be taken into account rather than the tax burden on specific items of income.

5.3.5. Constitutional commercial principles Agreements among states to regulate their economic relations may limit the ability of those states to design their tax systems exactly as they please. Two of the most prominent agreements of this kind are the treaties founding the European Union and the Constitution of the United States, both of which prohibit their member states from adopting measures that interfere with commerce among them. In both jurisdictions, there is also case law that is directly relevant to the issue of DTR. In the US Constitution, the relevant provision is known as the “dormant commerce clause”. This clause has been interpreted judicially to prohibit 51. Vanistendael, supra n. 43, at p. 9.

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the states from discriminating between transactions on the basis of some interstate element, for example, by taxing interstate transactions more heavily than intrastate transactions. Its application to DTR was considered in the Supreme Court case Comptroller v. Wynne.52 This case was originated by residents of Maryland, who earned income from other US states; Maryland taxed that income and granted the taxpayers a credit against its state tax, but not against the county tax that was also imposed. In assessing whether this system breached the dormant commerce clause, the majority of the court applied what it called the “internal consistency test”. This test requires the court to determine what would happen if every state adopted the same system. If the overall result would be that the tax burden on interstate commerce were no higher than on intrastate commerce, the system would be in compliance with the dormant commerce clause. The Maryland system did not pass this test because, in the reverse situation, when taxing as a source state, it applied a “special non-resident tax” in lieu of the county tax. Maryland defended its system by arguing that it collected less tax from the taxpayer than it would have done had the taxpayer been engaged exclusively in intrastate commerce,53 but the court dismissed this argument as a red herring and looked at the combined tax burden on the taxpayers. However, although the court found the Maryland system to be in breach of the dormant commerce clause, it did not hold that the taxpayers were entitled to DTR. Indeed, it stated quite clearly that “while Maryland could cure the problem with its current system by granting a credit for taxes paid to other States, we do not foreclose the possibility that it could comply with the Commerce Clause in some other way”.54 The court also did not hold that the taxpayers had an absolute right to single taxation; it explicitly accepted the possibility that states could act in conformity with the dormant commerce clause by adopting an internally consistent system, yet at the same time collectively impose double taxation due to the differences or disparities among their respective systems.55 The court was, however, deeply divided; the decision was made by a 5:4 majority. The dissenting judges not only expressed severe doubts about the validity of the dormant commerce clause, but also, more germane to the 52. US: Supreme Court, 18 May 2015, docket no. 13-485, Comptroller (Maryland) v. Wynne. 53. Id., at p. 24. 54. Id., at p. 28. 55. Id., at p. 19.

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discussion here, were not willing to interfere with the policy choices of the individual states on the reach of their tax systems. Justice Ginsburg summarized the dissent as follows:56 This case is, at bottom, about policy choices: Should States prioritize ensuring that all who live or work within the State shoulder their fair share of the costs of government? Or must States prioritize avoidance of double taxation? As I have demonstrated ... achieving even the latter goal is beyond this Court’s competence. Resolving the competing tax policy considerations this case implicates is something the Court is even less well equipped to do. For a century, we have recognized that state legislatures and the Congress are constitutionally assigned and institutionally better equipped to balance such issues. I would reverse, so that we may leave that task where it belongs.

Within the European Union, it is the fundamental freedoms (the freedom of the movement of goods, persons, services and capital) that are the foundation of the law prohibiting impediments to commercial activity, and the ECJ has developed rich case law on the implications of the fundamental freedoms for the tax law of the Member States. The Treaty Establishing the European Community also includes a provision directing the Member States to enter into negotiations with each other with a view to securing, inter alia, the abolition of double taxation within the European Union.57 In Gilly,58 the ECJ did not need much time to decide that this provision did not confer enforceable rights on individual taxpayers. In the terminology of EU law, it was not directly applicable, which is a conclusion that seems to follow directly from the very wording of the provision. In Gilly, the court did, however, consider the effect of the overlapping taxing jurisdictions on an individual worker, who, in this case, was a resident of France who worked in Germany. The treaty between the two states included a complex set of rules and exceptions,59 which resulted in Mrs Gilly being subject to taxation in Germany on her employment income and being entitled to a foreign tax credit in France. The rates of individual income tax in Germany were higher than in France, leaving her with an excess foreign 56. Id., dissenting judgment of US Supreme Court Justice Ginsburg, at p. 19. 57. Treaty Establishing the European Community (as amended), art. 293 (previously art. 220). 58. FR: ECJ, 12 May 1998, Case C-336/96, Mr and Mrs Robert Gilly v. Directeur des Services Fiscaux du Bas-Rhin, ECJ Case Law IBFD. In settling this aspect of the decision, the court was, however, aided by an earlier decision concerning a different subsection of the provision in question, namely BE: ECJ, 11 July 1985, Case C-173/84. Ministère Public and Robert Heinrich Maria Mutsch. 59. There was also an issue in the case in respect of whether these provisions constituted prohibited discrimination, but that issue is not relevant to the discussion here.

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tax credit. Moreover, in Germany, as a non-resident taxpayer, she was not entitled to personal deductions and exemptions, but she was entitled to them in France, lowering the French tax bill on her household60 and increasing the household’s excess foreign tax credit. She asserted that this result was in breach of the freedom of movement of workers and that she should have been able to credit the German tax in full to reduce the French tax bill on her household. The ECJ dismissed this claim, finding the higher tax burden to be the consequence of a disparity between the systems of the two states. In the absence of any EU legislation on this issue, the court held that it remained within the sovereignty of the Member States to determine their own policies in respect of rates and personal allowances. The court also considered whether the tax treaty between the two states might assist Mrs Gilly, but held that “the object of a convention such as that in issue is simply to prevent the same income from being taxed in each of the two States. It is not to ensure that the tax to which the taxpayer is subject in one State is no higher than that to which he or she would be subject in the other”.61 It is indeed correct that the point of DTR is not to make a comparison between the tax burdens in two states in order to give the taxpayer the benefit of the lower burden, but there is an argument that the comparison that the court seems to be making here is the wrong one. Looking at the case in the light of the single taxation notion as analysed above, a more appropriate comparison would have been between the tax burden actually imposed in Germany and the tax burden that would have been imposed in Germany had that country allowed Mrs Gilly to take personal allowances and deductions. This was an element of over-taxation in Germany that was no different in character from the over-taxation caused by a withholding tax on gross income; in effect, only one levy of tax was imposed, but that levy was higher than it would have been without the cross-border element. This issue was raised by the EU Commission and addressed by the Advocate-General, who referred to Schumacker,62 in which exactly this point had been decided by the court in favour of the taxpayer. The Advocate-General distinguished Schumacker, however, as in that case, the taxpayer did not have enough 60. French domestic law taxed the Gilly household rather than taxing the individual members of the household separately. 61. Gilly, supra n. 58, at para. 46. 62. DE: ECJ, 14 Feb. 1995, Case C-279/93, Finanzamt Köln-Altstadt v. Roland Schumacker, ECJ Case Law IBFD. In this case, the ECJ held that an individual taxpayer who derived almost all of his income in a Member State that was not his state of residence should be granted personal allowances in the state where he derived the income.

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other income to be able to benefit from personal allowances in his residence state, whereas Mrs Gilly’s household did. Kerckhaert-Morres63 concerned a couple resident in Belgium who received dividends from a company resident in France. A treaty was in force between the two states, which provided that individuals resident in Belgium were entitled to a credit in respect of dividends received from a company resident in France, according to a certain provision of Belgian domestic law. By the time the dividends in question were distributed, however, that provision of Belgian law had been abolished, and the taxpayers were refused the credit. The taxpayers argued that the abolition of the tax credit was a breach of the freedom of movement of capital because it resulted in dividends from a company resident in France being subject to a heavier tax burden in the hands of Belgian-resident individuals than comparable dividends received from a company resident in Belgium. In this case, in contrast to the majority decision in the US Wynne case, the court looked only at the tax burden in Belgium, observing that there was no difference in treatment between domestic dividends and foreign-source dividends. It then stated that the French withholding tax on the dividends was not necessarily a relevant difference in respect of the taxation in the residence state and concluded that64 “[i]n circumstances such as those of the present case, the adverse consequences which might arise from the application of an income tax system such as the Belgian system at issue in the main proceedings result from the exercise in parallel by two Member States of their fiscal sovereignty”. The court then said that the current state of EU law “does not lay down any general criteria for the attribution of areas of competence between the Member States in relation to the elimination of double taxation within the Community”,65 and that therefore it was “for the Member States to take the measures necessary to prevent situations such as that at issue in the main proceedings by applying, in particular, the apportionment criteria followed in international tax practice”.66 There is an element of contradiction in these two citations, as the court first stated that EU law does not provide any criteria for the allocation of taxing competence, but then seemed to endorse the criteria prevailing in international practice, by which it presumably meant 63. BE: ECJ, 14 Nov. 2006, Case C-513/04, Mark Kerckhaert and Bernadette Morres v. Belgische Staat, ECJ Case Law IBFD. 64. Id., at para. 20. 65. Id., at para. 22. 66. Id., at para. 23.

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the standard pattern of tax treaties. It was clearly not willing, however, to set out the specifics of how double taxation should be prevented. In conclusion, although both the US Supreme Court and the ECJ see the concern about double taxation arising from the overlapping of two taxing jurisdictions, they are not able to provide a solution. The furthest they have been prepared to go is to hold that a taxing jurisdiction should at least be consistent in its own policy (the US Supreme Court) or that states should endeavour to allocate their taxing jurisdiction in a way that avoids double taxation (the ECJ). Ultimately, neither court has been prepared to say that taxpayers have an enforceable right not to be subject to double taxation; they remain at the mercy of disparities caused by exercise of the sovereign right of states to determine their own tax policies. More recently, in late 2017, the European Union adopted a directive67 that extends the EU dispute resolution mechanism in the Arbitration Convention68 to disputes among Member States on the interpretation of tax treaties. The second, sixth and seventh recitals of the Preamble all name disputes leading to double taxation as being in particular need of resolution. The first recital focuses on the negative impact of differing interpretations of tax treaties on businesses, but the fifth recital states clearly that the directive will benefit all taxpayers. This directive, in other words, recognizes a policy obligation on the Member States to prevent double taxation, which has to be balanced against the need to prevent tax avoidance “in the spirit of a fair taxation system”.69 On the other hand, it does not introduce a general right of taxpayers within the European Union to remain free of double taxation. It applies only if there is already a tax treaty in place that provides for the relief of double taxation, and all it does is introduce a mechanism for resolving disputes relating to those agreements, first through the mutual agreement procedure and then, if that fails, through arbitration in order to ensure that the treaty is effective in practice.

67. Council Directive (EU) 2017/1852 of 10 October 2017 on Tax Dispute Resolution Mechanisms in the European Union, OJ L 265 (2017), EU Law IBFD [hereinafter Dispute Resolution Directive]. 68. Convention 90/436/EEC of 23 July 1990 on the Elimination of Double Taxation in Connection with the Adjustment of Profits of Associated Enterprises, OJ L 225, p. 10 (1990), EU Law IBFD. This Convention deals with transfer pricing disputes that can cause (economic) double taxation. 69. Id., at fourth recital.

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Entitlements to DTR have been adopted by the European Union in the specific cases of intercorporate payments of dividends,70 interest and royalties71 and in the proposals for the common corporate tax base.72 However, there is no general, directly enforceable right of taxpayers to be free of double taxation within the European Union.73

5.3.6. Broader human rights principles Finally, the foundation of a right to DTR might be found in broader human rights principles – not the right to the peaceful possession of property that was explored in section 5.3.4., but rather in the basic rights expressed in the Universal Declaration of Human Rights74 and related documents. These rights include the entitlement of an individual to “necessary social services” and to “security in the event of unemployment, sickness, disability, widowhood, old age or other lack of livelihood in circumstances beyond his control” (article 25) and the right to free education at primary level (article 26). Article 28 provides, furthermore, that individuals have a right to a social and international order in which the rights and freedoms set out in the declaration can be fully realized. These rights have been elaborated in subsequent documents, for example, in articles 13 and 14 of the International Covenant on Economic, Social and Cultural Rights75 in respect of the right to free primary school education. Although these rights are vested in individuals, it is clear that important considerations at the state level have to come into play if they are to be observed. As explained by Balakrishnan, analysing human rights as a purely individual issue fails to reveal the processes at a macro level that affect the 70. Council Directive 2011/96/EU of 30 November 2011 on the Common System of Taxation Applicable in the Case of Parent Companies and Subsidiaries of Different Member States, OJ L 345/8 (2011), EU Law IBFD. 71. Council Directive 2003/49/EC of 3 June 2003 on a Common System of Taxation Applicable to Interest and Royalty Payments Made Between Associated Companies of Different Member States, OJ L 157 (2003), EU Law IBFD. 72. Proposal for a Council Directive on a Common Consolidated Corporate Tax Base (CCCTB), COM(2016) 683 final (25 Oct. 2016), EU Law IBFD. 73. In this respect, see also M. Nieminen, Abolition of Double Taxation in the Treaty of Lisbon, 64 Bull. Intl. Taxn. 6 (2010), Journals IBFD. 74. Universal Declaration of Human Rights (1948), available at http://www.ohchr.org/ EN/ProfessionalInterest/Pages/CoreInstruments.aspx (accessed 19 Sept. 2018). 75. International Covenant on Economic, Social and Cultural Rights, adopted and opened for signature, ratification and accession by General Assembly Resolution 2200A (XXI) of 16 December 1966, available at http://www.ohchr.org/EN/ProfessionalInterest/ Pages/CESCR.aspx (accessed 19 Sept. 2018).

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extent to which the rights are observed.76 Many of these rights impose positive duties on the state to make provision for individuals. In order to do so, the state needs resources, and therefore, the observance of human rights requires that states be able to obtain those resources. The principal source of resources for states is taxation, and the relationship between human rights and taxation has been analysed by Christians, who makes a convincing case for the relevance of human rights considerations to tax policy.77 As she observes,78 “[an examination of these documents reveals that none contain any explicit strictures on tax policy per se. But it is equally clear that the realization of several of their provisions will depend on laws that regulate the allocation of resources within society.” That being said, if there is an inextricable link between the human rights of individuals and the tax policy of states, there are clearly also important considerations at play in respect of the international tax order, which sets the practical constraints within which states operate in determining their tax policy. As Christians also points out,79 “[s]uch obligations prevent rulers from denying rights on grounds that the requisite revenues have not been or cannot be collected, no matter how much international tax competition might pressure the state to lower its spending”. One could maybe argue that the only absolute requirement set out by these documents is that states obtain the resources to ensure the human rights of their citizens and that it does not matter how they obtain those resources. Following this reasoning, the international community could fulfil its obligations in this respect by making monetary transfers to those states that are unable to raise enough revenue by themselves, provided that these transfers are made as a matter of an entitlement of needy states rather than on a discretionary basis. Indeed, Dagan, in her analysis of the interaction between competition and cooperation in the international tax order, has suggested that such transfer payments might be necessary in order to ensure that poorer states are able to ensure justice for their citizens.80 She does, however, acknowledge that such a system is utopian.

76. R. Balakrishnan, D. Elson & R. Patel, Rethinking Macro Economic Strategies from a Human Rights Perspective (Why MES with Human Rights II), available at: http:// www.rightingfinance.org/wp-content/uploads/2012/10/MES-HumanRights.pdf (accessed 19 Sept. 2018). 77. A. Christians, Fair Taxation as a Basic Human Right, 9 International Review of Constitutionalism 1, pp. 211-230 (2009). 78. Id., at p. 224. 79. Id., at pp. 225-226. 80. Dagan, supra n. 21, at pp. 206-212.

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However, there is also a legal argument against such a solution, as it does not respect the fundamental responsibilities of states set out in the Declaration on Social Progress and Development.81 Article 8 of this declaration lists as one of its principles that “[e]ach Government has the primary role and ultimate responsibility of ensuring the social progress and wellbeing of its people”. A system of monetary transfers among states, even one founded entirely on the entitlement of poorer states rather than on the goodwill of richer ones, does not respect this principle because it shifts to the richer states the responsibility for collecting the funds necessary to enable the poorer states to provide the minimum facilities to their citizens. The Copenhagen Declaration supports this principle with a series of commitments made by states to promote social development; Commitment 9 sets out actions intended to assist poorer states in developing their economy and building up their own resources.82 Both of the aforementioned documents also recognize that an international effort is necessary in this respect. The Copenhagen Declaration, for example, states that “while social development is a national responsibility, it cannot be successfully achieved without the collective commitment and efforts of the international community”.83 The Declaration on Social Progress and Development expresses the principle that84 “[s]ocial progress and development are the common concerns of the international community, which shall supplement, by concerted international action, national efforts to raise the living standards of peoples”. Therefore, although each state is responsible for ensuring the basic welfare of its own citizens, all states are responsible for supporting other states in their efforts to do so. Translated to the realm of international tax law, the latter obligation means that, at the very least, states should not adopt policies that prevent other states from collecting the revenue they need. Maybe here there is an argument for an obligation on richer states to grant DTR in respect of the returns on investment flowing to them from poorer states in order to not impede the 81. Declaration on Social Progress and Development Proclaimed by General Assembly Resolution 2542 (XXIV) of 11 December 1969, available at http://www.ohchr.org/EN/ ProfessionalInterest/Pages/ProgressAndDevelopment.aspx (accessed 19 Sept. 2018). 82. United Nations, Copenhagen Declaration on Social Development, A/CONF.166/9, Commitment 9, available at http://www.un.org/en/development/desa/population/migration/generalassembly/docs/globalcompact/A_CONF.166_9_Declaration.pdf (accessed 19 Sept. 2018). 83. Id., at para. 26(c). 84. See Declaration on Social Progress and Development, supra n. 81, at art. 9.

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investment and trade that allows poorer states to raise their own revenue. This right to DTR would not be not a right of taxpayers; it would be a right founded on the basic human rights of the citizens of poorer states (who probably have no tax liability at all), which translates into obligations at the interstate level. Christians argues that global human rights considerations should indeed be taken into account in shaping national tax policy.85 Shaviro, in contrast, argues that state policy should focus on national welfare.86 His argument is based on more practical considerations, namely: (i) the natural behaviour of human beings,87 which feeds into the mandate of voters; (ii) the inconsistency of arguing for a global view in this respect, but not going to the logical conclusion of richer countries making large transfer payments to poorer countries; and (iii) the tendency of proponents of the global view to believe that such a view is also the best domestic policy in the long term.88 If one does accept, however, that global human rights considerations should inform national policy choices, the next question is how that should be done. The ways in which state policies react to each other, and the effect on the economy of the states, is a complex issue, and the design of a DTR system is a complex subset of that issue. It is not the intention here to enter into this discussion in detail, save for noting what some writers have argued in respect of the specific question of how DTR systems affect the ability of poorer states to collect revenue. These conclusions accord with each other in broad terms, although it is difficult to know to what extent this agreement is determined by them all focusing on one country, namely the United States. Fleming, Peroni and Shay, for example, have a general policy preference for a credit system of DTR. This preference is determined by a compromise between the grounds of fairness (respect for the ability-to-pay principle) and efficiency (not structuring the system in such a way that it discourages useful foreign investment).89 They further argue that “the tax competition strategies of impoverished countries do not establish a case for compromising the ability-to-pay principle by maintaining the current deferral system or by adopting a generally applicable exemption system for foreign-source in85. Christians, supra n. 77. 86. Shaviro, supra n. 41, at p. 72. 87. “[I]f self-interested behavior is acceptable in practice for individuals, then surely it is permissible as well for countries.” See Shaviro, id., at p. 72. 88. See also D. Shaviro, Why Worldwide Welfare as a Normative Standard in U.S Tax Policy?, 60 Tax Law Review 3, pp. 155-178 (2007). 89. Fleming, Peroni & Shay, supra n. 37, at p. 99.

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come of U.S. residents”.90 If, within this framework, it is decided to support poorer countries specifically, they argue that this is best done by granting tax sparing credits on a bilateral, negotiated basis (in other words, in treaties).91 This proposal is made on the basis that tax sparing credits are a form of aid and should therefore be granted on a discretionary basis; in other words, they do not regard this aspect of their proposal as an entitlement of poorer states. Christians notes that the design of the foreign tax credit system of a richer, more developed country affects the room for manoeuvre of a country seeking to attract investment.92 The possibility that is available in the United States of cross-crediting foreign taxes, for example, puts pressure on impoverished countries seeking investment to lower their tax rates, because investors from high-tax, developed countries seek low-tax income to absorb the tax imposed by other high-tax, developed countries. This phenomenon in turn leads to the perverse end result that it is the richer countries that benefit. Focusing on a different aspect of the US foreign tax credit, Avi-Yonah93 and Gupta94 have both argued that the United States, in determining eligibility for the credit, should be rather accepting of taxes imposed by other countries even though they do not conform to the strict US criteria for net income tax. Gupta’s argument is made partly on social policy grounds; he argues95 that the strict US conditions for creditability are wrong as a policy matter in relation to developing countries, as those countries often struggle to collect tax revenue and, for practical reasons, have to use taxes that are not imposed on a strict notion of net income. Avi-Yonah’s argument is made on more general policy grounds; his article’s title (Should the US Dictate World Tax Policy?) speaks volumes. He does, however, also observe96 that “[i]t seems that creditability depends on the economic clout of the country you are dealing with”.

90. Id., at p. 103. They note that the United States has traditionally been opposed to tax sparing credits and that the cost-effectiveness of tax sparing credits is highly questionable. 91. Id., at p. 102. 92. A. Christians, Global Trends and Constraints on Tax Policy in the Least Developed Countries, 42 U.B.C. L. Rev., pp. 267-268 (2009-2010). 93. R. Avi-Yonah, Should the U.S. Dictate World Tax Policy? Reflections On PPL Corporation v. Commissioner (University of Michigan Public Law Research Paper no. 308 (2013), available at https://papers.ssrn.com/sol3/papers.cfm?abstract_id=2208524 (accessed 21 Sept. 2018). 94. A. Gupta, In Praise of Non-Conformity, 73 Tax Notes International 4, pp. 277-281 (2014). 95. Avi-Yonah, supra n. 93, at p. 281. 96. Id., at p. 762.

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In conclusion, if human rights considerations are accepted as a factor that should shape the design of the tax systems of richer, more developed countries, their importance is much more complex than a simple yes/no answer to the question of whether DTR should be granted.

5.4.  Other types of double taxation Overlaps of source and residence taxing claims may be the primary cause of the double taxation of income, but they are not the only one; double taxation can also result from overlapping source claims and overlapping residence claims. In these cases, it is, in the current international order, much more difficult for the taxpayer to obtain DTR, as the DTR regimes of countries are generally based on the source/residence paradigm, and the conditions for relief reflect that limitation. Tax treaties are similarly based on a source/ residence paradigm; they do resolve some other overlaps, for example, by including implied source rules, but these rules apply only within the confines of the specific bilateral relationship. Tax treaties also resolve the dual residence of a taxpayer who is resident in the two signatory states at the same time, but these are not the only overlaps of residence taxing claims that can cause double taxation. That income can have two sources due to differing source rules under the domestic laws of different states was explicitly accepted by a US district court in Proctor & Gamble.97 This case concerned royalties paid to a company resident in the United States that had been subject to source taxation in both Japan and Korea (Rep.), both of which had a tax treaty with the United States. In refusing a credit for both of the foreign taxes, the US Internal Revenue Service (IRS) argued that the income could not be sourced in both Japan and Korea, but the judge found that “[i]t may well be that multiple countries can claim tax on a single source of income and that the IRS is required to grant credits for these claims”.98 In this case, there was no suggestion that the taxing claim of either source state was contrary to the terms of the applicable treaty. If there is a clash of legitimate source taxing claims such as this, the only solution offered by 97. US: District Court for the Southern District of Ohio, 7 June 2010, 106 AFTR 2d 2010-5311, Proctor and Gamble Company & Subs v. U.S. The case was decided on the basis that the taxpayer had not fully exhausted all possible options to reduce the creditable foreign tax, and the credit was limited to, in effect, the higher of the two source state taxes. 98. Id., at sec. V.A.

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the OECD Model is the mutual agreement procedure (MAP).99 The OECD Commentaries do not specify which states should be included in the procedure, but in order for it to reach a satisfactory result, it would seem necessary to include both source states rather than one source state and the residence state. There would then be a difficult issue of which source claim takes precedence. Many treaties do, of course, follow the implied source rules in the OECD Model, thereby creating a uniform network in this respect. Outside that network, however, there is little recourse for a taxpayer who suffers double source taxation, and certainly nothing that could be described as an entitlement to relief in one source state in respect of income that is also taxable in a second source state. Double residence taxation has a greater variety of causes than double source taxation, and a great deal more has been written about this issue. The classic case is a taxpayer who is resident in two states at the same time under their domestic laws; this issue is generally resolved by tax treaties.100 The growing trend against providing a substantive treaty solution for companies, which was adopted in both the 2017 version of the OECD Model Convention and the Multilateral Instrument (MLI),101 should not be seen a trend against resolving double taxation in these cases. It is rather spurred by concerns about tax avoidance and the need to limit this treaty protection to genuine cases of double taxation. However, what has become more prominent in recent years is a variety of other situations leading to double residence taxation that generally remains unresolved. The most prominent of these is undoubtedly the case of a hybrid entity, in which the differing views of states as to which party is the taxable person leads to the simultaneous residence taxation of the entity in one state and of its members in another state.102 The 2017 version of the OECD Model Convention (and the parallel provision in the MLI)103 now makes it quite clear that neither party has any entitlement to DTR to the extent that 99. Para. 11 Commentary on Art. 23. The taxpayer would have to rely on art. 25(3), which provides that the competent authorities “may also consult together for the elimination of double taxation in cases not provided for in the Convention”. 100. Art. 4(2) OECD Model Convention 2017 and Art. 4(3) OECD Model Convention 2014. 101. Id., at art. 4(3); and Multilateral Convention to Implement Tax Treaty Related Measures to Prevent Base Erosion and Profit Shifting art. 4 (24 Nov. 2016), Treaties IBFD [hereinafter MLI] both reflect this trend in concluded treaties and provide that the dual residence of persons other than individuals is be resolved through the mutual agreement procedure rather than providing a substantive treaty test to resolve the dual residence. 102. The reverse case, in which no state sees a taxable person, is not considered here. 103. Art. 3(2) MLI.

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the double taxation is based solely on the residence of the two parties,104 although the Commentary on this provision states that this was also the case on the basis of the previous wording.105 In contrast with the text of the OECD Commentary on double source taxation discussed above in this section,106 there is no suggestion that the MAP should be used to resolve this double taxation. A comparable result in which two persons are taxed on a residence basis at the same time can arise if two states apply different principles for the attribution of income to a person. Here, the overlap is caused by differing views of the qualitative connection between income and a taxpayer rather than differing views as to which party is a taxable person. A brief discussion of this issue is hidden away in the Commentary on Article 10 of the OECD Model,107 which deals with disguised dividends, such as a benefit granted by a company to a relative of an individual shareholder. If the shareholder is resident in one state and the shareholder’s relative is resident in another state, it is possible for both states to tax the dividend in the hands of their own resident. The Commentary observes that this type of conflict may also affect other types of income and that a solution can be found only through the MAP. A similar overlap of residence taxing jurisdictions can revolve around what is commonly called a personal services company, which is a company of which the business consists exclusively or almost exclusively of providing the services of one individual who is often also a substantial shareholder. Many countries have a regime in their domestic law that attributes to the individual the fees or profits that are legally due to the company. If such a rule applies to the individual in his residence state and the company is resident in a different state, it is possible that both states regard the same income as taxable income of their own resident. This seemed to be the situation in

104. This is made clear by the addition of the words “except to the extent that these provisions allow taxation by that other State solely because the income is also income derived by a resident of that State or because the capital is also capital owned by a resident of that State”; see arts. 23A(1), 23A(2) and 23B(1) OECD Model Convention 2017; and paras. 11.1 and 11.2 Commentary on Art. 23. This addition to the OECD Model puts a substantial gloss on the statement in the OECD’s Partnership Report that, in this situation, tax imposed on the partnership should be “flowed-through” to the partners for the purposes of granting a foreign tax credit. See OECD, The Application of the OECD Model Tax Convention to Partnerships, p. R(15)-55, example 18 (OECD 2017). 105. Para. 11.1 Commentary on Art. 23. 106. Id., at para. 11. 107. OECD Model Convention on Income and on Capital: Commentary on Article 10 paras. 29-30 (2017), Models IBFD.

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the Australian Russell case,108 but the court decided the case on the basis that the individual and the company were receiving different items of income.109 Although one would usually expect domestic legislation like this to prevent double taxation, by taking account of a possible tax liability on the company when it imposes tax on the individual, the decision in Russell illustrates that the boundaries of the concept of double taxation are not always crystal clear. Finally, double residence taxation can arise in respect of the same person but at different times. This is one of the issues addressed in the OECD’s Stock Option Report in connection with the application of tax treaties.110 States can make very different choices as to the time at which the benefit of an employee stock option should be taxed in the hands of the employee. If the employee is resident first in one state and then in another, it is therefore possible that he is taxable in both states on the same benefit (although the overlap would usually affect only a portion of the benefit). The Stock Options Report suggests that the MAP be used to resolve the double taxation and provides guidelines to the competent authorities for adjusting their tax claims in order to do so.111 It is apparent from these examples that the lack of coordination among the domestic laws of states can give rise to a variety of cases of double taxation for which the current international order offers no structural solution. There seems to be general unease about this result, as witnessed by the suggestions in the OECD Commentaries to use the MAP in some cases. However, even this unease faded away in the provisions in the 2017 OECD Model and the MLI in respect of hybrid entities with their unreserved acceptance of double residence-based taxation.112 If it is difficult to substantiate an entitlement to DTR in the classic source/residence overlap of taxing claims, there seems to be even less hope for substantiating an entitlement in other cases. One could maybe argue that some of the examples discussed in this section constitute economic and not juridical double taxation, because the income is 108. AU: Federal Court of Australia, 4 Feb. 2011, [2011] FCAFC 10, Russell v. Commissioner of Taxation. 109. The issue in the case was whether treaty protection was available rather than an issue related specifically to DTR. The individual was resident in Australia, the company was resident in New Zealand and most of the fees were derived in Australia. The court held that the treaty between Australia and New Zealand did not apply, because under the Australian domestic legislation, the situation was a purely domestic one. 110. OECD, The Taxation of Employee Stock Options, Tax Policy Studies No. 11, sec. 3.5 (OECD 2005). 111. Id., at pp. 99-100. This part of the report suggests additional text that is now found in paras. 4.1-4.3 of the Commentary on Art. 23. 112. Art. 3(2) MLI. See also references in supra n. 104.

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not taxed twice in the hands of the same person at the same time and there is no right to DTR for that reason. Yet, these examples also illustrate that the line between these two types of double taxation is not a very thick one.

5.5. Conclusion In conclusion, it proves to be rather difficult to establish a strong basis for the entitlement of taxpayers to DTR unless one accepts the current international order as compelling customary law. Even then, the entitlement to DTR found in the current order is not complete. This chapter focuses on the taxation of income, but if there is such a thing as a single taxation principle implying a right to DTR, one would expect it to apply across the board to all taxes or groups of taxes. Yet, taxes on gifts, estates and inheritances, for example, are notorious for producing double (or more) taxation in crossborder situations.113 If an entitlement to DTR is to be found in the current international order as customary law, it is clearly not based on a universal principle of single taxation.114 The notion of single taxation is appealing, but as demonstrated by De Lillo (see chapter 1 of this book), it tends to unravel rather quickly when one starts examining it in detail. Yet it still hovers above the current order, creating uneasiness about the mismatches of domestic law that lead to double tax liabilities and raising questions about the contours of DTR as a means of relieving that uneasiness. It does, in other words, have a useful role to play, but as a source of questions rather than of answers.115

113. See, for example, European Commission, Directorate-General for Taxation and Customs Union, Ways to tackle inheritance cross-border tax obstacles facing individuals within the EU, Report of Expert Group (December 2015), available at https://publications. europa.eu/en/publication-detail/-/publication/faa0871d-ca40-11e5-a4b5-01aa75ed71a1/ language-en (19 Sept. 2018); F. Sonneveldt, General report: Avoidance of multiple inheritance taxation within Europe, 10 EC Tax Review 2, pp. 81-97 and, in particular sec. 4 at pp. 90-93 (2001). 114. Brauner, in another context, has written: “[S]omewhat ironically the international tax regime is rarely about ethical claims or any related natural law issues but rather about the division of tax bases among nations. This division is based merely on negotiation and in this sense it is arbitrary and based very much on powers that states can lord over one another.” See Y. Brauner, An Essay on BEPS, Sovereignty, and Taxation, in Tax Sovereignty in the BEPS Era p. 77 (S.A. Rocha & A Christians eds., Wolters Kluwer 2017). 115. Shaviro describes the single taxation principle as, at best, a useful coordinating device, but he sees its usefulness as being limited to relationships between peer countries with sufficiently similar economies and tax systems. See Shaviro, supra n. 10, at p. 6.

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Asking those questions about DTR inevitably leads to questions about the current international order as a whole. If granting DTR is accepted as the appropriate response of a residence state to pure juridical double taxation caused by overlapping source and residence tax claims, should DTR not also be extended to overlapping residence claims and overlapping source claims, and, if so, how should a priority be determined between the overlapping claims? In granting DTR, how much deference should a residence state afford to the sovereignty of a source state in designing its tax system? Does the notion of single taxation require the relief of all forms of economic double taxation, given that the opposite phenomenon of economic double non-taxation is one of the targets of the BEPS Project?116 Perhaps even more importantly, what exactly is it that DTR is intended to relieve? The 2017 EU Dispute Resolution Directive, for example, attempts to define double taxation, but struggles to achieve a clear notion of what it means by that phrase.117 Whether (and how) DTR is granted is not only an issue of eliminating double taxation for the benefit of taxpayers, but it is also (maybe primarily) a means of allocating taxing rights among states, and its importance therefore reaches beyond the concerns of specific taxpayers to the broader human rights considerations discussed in section 5.3.6. The single taxation notion may be an inspiring source of discussion points in respect of issues such as DTR, but it has to viewed against the wider context of taxation that touches the most fundamental issues of the current international order, such as the nature of the relationships among states and the responsibilities of states in shaping their own tax systems.

116. See also M. Herzfeld, News Analysis: Understanding Treaty Abuse Double Nontaxation, 81 Tax Notes International 3, pp. 201-204 (2016). 117. See art. 2(c) Dispute Resolution Directive, which defines double taxation as follows: “(c) ‘double taxation’ means the imposition by two or more Member States of taxes covered by an agreement or convention referred to in Article 1 in respect of the same taxable income or capital when it gives rise to either: (i) an additional tax charge; (ii) an increase in tax liabilities; or (iii) the cancellation or reduction of losses that could be used to offset taxable profits.” This definition does not confine itself to pure juridical double taxation, as it does not refer to the imposition of two tax charges on the same person, and therefore it leaves open the question of which types of economic double taxation it covers. It also provides no benchmark for the determination of whether a tax charge is additional, whether a tax liability is increased or whether losses have been cancelled or increased in the way envisaged by the directive.

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Part 3

Single Taxation in the EU Internal Market

Chapter 6 Single Taxation in a Single Market? Frans Vanistendael

6.1.  What is meant by single taxation in a single market? The concept of a single market, which was omnipresent a quarter of a century ago,1 has been out of fashion in favour of the concept of the internal market. However, over time, the two concepts have become almost interchangeable and are now used as such. The essence of the single market is like a smooth, green snooker table on which goods, services and persons roll like balls from one end to the other without any friction or obstacle. In the end, the single market of the European Union in its final stage will, from a regulatory point of view, not differ from a national market. If that is the essence of the single market, it is a legitimate question whether the single market should result in single taxation as well. However, even in national markets, single taxation is not universal, and there are also instances of double taxation. Most civilized countries do exempt some categories of income so that there is no taxation at all and also eliminate double juridical taxation, but occurrences of double economic taxation within the same national tax system are not infrequent. Historically, the classical system of double taxation of companies and their shareholders, which has been in use in many developed countries, bears witness to the fact that double (economic) taxation is acceptable. Therefore, the first question that needs to be addressed is: What does one mean by “single taxation”? Is it only the absence of double taxation, or is it at the same time the absence of double non-taxation, which means that there must always be effective taxation, some time, somewhere? As formulated by its main proponent, Professor Reuven Avi-Yonah, the principle of single taxation means that “whenever the country that has primary jurisdiction under the benefits principle refrains from taxing cross-border income, the other country (residence for active, source for passive) should tax it instead”. He immediately concedes, however that “[t]his seemed to fly in the face of observed reality because residence countries typically exempt or defer active income, and source 1. See the discussion of the difference in M. Monti, A new strategy for the single market, Report to the President of the European Commission José Manuel Barroso, ch. 1, footnote 1 (9 May 2010).

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countries refrain from taxing many forms of passive income unilaterally without regard to whether it is taxed at residence”.2 This explanation seems to imply that either income produced as active income or the same economic income received as passive income should be taxed in any case, and also seems to establish a logical and consistent link between the elimination of double (economic) taxation and the elimination of double non-taxation.

6.2. Applying the single taxation principle in the European Union In applying such a concept of single taxation (eliminating double (economic) taxation and double non-taxation) in the European Union, one should be aware that the dominating principle in the Treaty on the Functioning of the European Union (TFEU) is the non-discrimination principle and not the principle of single taxation. Although physical border obstacles have been abolished since the single market was established in 1993, there are still the invisible obstacles of different national legal systems and, in particular, of different tax systems that are applied when goods, services or persons cross these invisible national borders, and the crossing of these invisible obstacles sometimes results in cumulative double taxation. The Court of Justice of the European Union (ECJ) has repeatedly confirmed that the TFEU only permits the tackling of these forms of double cross-border taxation when they constitute discrimination in comparison to purely domestic situations. When double taxation is the result of the application of different tax systems (what the Court calls “disparities”), there is nothing that the ECJ can do under the present treaty rules.3 The impossibility of tackling double economic taxation when its root is the cumulative application of non-discriminatory national tax rules raises the legitimate question of whether the TFEU can provide a legal basis for tackling issues of double non-taxation, precisely because disparities in taxation between different Member States are off limits for the ECJ.

2. R.S. Avi-Yonah, Full Circle? The Single Tax principle, BEPS and the New US Model, 12 Global Taxation 1, pp. 12-13 (2016). 3. BE: ECJ, 14 Nov. 2006, Case C-513/04, Mark Kerckhaert and Bernadette Morres v. Belgische Staat, paras. 22-23, ECJ Case Law IBFD: “Community law, in its current state … does not lay down any general criteria for the attribution of areas of competence between the Member States in relation to the elimination of double taxation within the Community … no uniform or harmonisation measure designed to eliminate double taxation has as yet been adopted at Community level. Consequently it is for the Member States to take the measures necessary to prevent situations such as that at issue … by applying … the apportionment criteria followed in international tax practice.”

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One should also make a distinction between the application of the principle of single taxation in the European Union as a single market and the application of the principle of single taxation in the European Union as an Economic and Monetary Union (EMU), to which 19 of the 27 Member States adhere. Because the answer to the second distinction is easier to formulate than the first, this chapter will start with the distinction between the single market and the EMU.

6.3.  Single taxation in the EMU Like the single market, the current EMU with the 19 euro states is not in its final stage. That situation of a transitional stage in the currency union is a dangerously unstable situation, and many experts have been warning either to abandon the euro construction4 or to strengthen the euro system as soon as possible. Since the euro states have chosen to continue the experiment, the question is that of what reforms are necessary to save the system. One of the essential features of the final solution is a (limited) common budget for the eurozone. This (limited) common budget will only be effective if this budget is financed separately and independently from any interference by the Member States. The most efficient way to reach this goal is to finance this budget by a tax that would be common to and uniform in all euro states. The common corporate tax base (CCTB), with a common tax base but also a common tax rate throughout the eurozone, would perfectly do the job. In such a system of single taxation with the same base and rate in all Member States of the eurozone, the concept of a single tax would have no role to play in the relationship between euro states. Ultimately, the tax legislator in the eurozone, who would impose this uniform tax, would make his decisions like a tax legislator in the national tax system of a Member State. The consequence would be that juridical double taxation most likely would be completely eliminated, like it is in most national tax systems, but that some instances of double economic taxation would still be possible, depending on the decisions of the euro legislator. Instances of non-taxation might also occur, as they do in national tax laws. The concept of single taxation as a 4. One strong voice for abandoning the euro project has been that of J.E. Stiglitz with his book, The Euro and its Threat to the Future of Europe (Norton & Company 2016). In an edited extract published on 10 August 2016 by Allen Lane in the Guardian Bookshop, he wrote: “While there are many factors contributing to Europe’s travails, there is one underlying mistake: the creation of a single currency. Or more precisely the creation of a single currency without establishing the set of institutions that enabled a region of Europe’s diversity to function effectively.”

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concept regulating double taxation or double non-taxation between two different tax jurisdictions does not make sense for uniform taxes that finance the common budget of the EMU, because the whole eurozone would function as one single tax jurisdiction with one single treasury. However, even in the EMU, with a (limited) common budget, there still would be important national budgets of the euro states financed by personal income taxes, corporate income taxes applicable to other taxpayers than multinationals subject to the CCTB, social security charges, VAT, inheritance and gift taxes. Within the EMU, Member States would retain their competences for all of these taxes, and issues of double-taxation and double non-taxation would continue to exist. In all of these cases, the concept of single taxation would continue to be relevant, like the issues of single taxation in the single market for those Member States that remain outside the eurozone. In the relations between the EMU and third countries with respect to the taxes financing the common EMU budget (CCTB), issues of double taxation and double non-taxation would also continue to be relevant, and the problems would be similar to those of the application of single taxation for the EU Member States limited to the single market.

6.4.  Double and single taxation and basic tax principles 6.4.1. The benefits principle permits double taxation Generally speaking, there are two very basic principles of taxation: the benefits principle and the ability-to-pay principle. The benefits principle justifies the levying of taxes because of the benefits derived by the taxpayer from the goods and services provided for by the government that levies those taxes. Unlike a market where there is a direct supplier-customer relationship and goods and services are provided in exchange for the price agreed upon and paid by the customer, there is no supplier-customer relationship between the government and the taxpayer. The government provides its goods and services regardless of whether the taxpayer pays the price. The distribution mechanism for government goods and services is totally different and not determined by supply and demand, but the fact that persons or entities potentially can benefit from the goods and services provided by the government is the economic justification for taxing these persons or entities.

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The benefits principle justifies two different types of countries taxing income: (i) the country where the income is produced; and (ii) the country where the income is enjoyed by the recipient of the income. Since economic or professional activities cannot be undertaken without some form of legal or economic framework provided for by government authorities, business or professional activities are, as a matter of principle, always subject to some form of taxation in the country in which they undertake their activities. That is the economic justification of taxation in the country of source. However, in a developed society, the person entitled to receive the profits from business or professional activities or income from investments cannot enjoy his benefits without a legal framework provided for by government authorities. In addition, in developed societies, individuals benefit in many ways from all kinds of social and cultural services provided for by the government. The government providing these goods and services, justifying taxing that person, is mostly the government of the country of residence of that person. The conclusion is that the benefits principle justifies double taxation when the production of income and the receipt and enjoyment of the income are in two separate tax jurisdictions by two different taxpayers. In theory, this double taxation will take the form of double economic taxation on behalf of two different taxpayers or in the form of two different taxes. In practice, however, many source countries will tax the beneficiaries of investment income in the form of interest, dividends and royalties also at source even though the beneficiary of the income is not a resident of that country. The benefit argument for taxation of the non-resident is that without the legal order in the source country protecting the capital and the patents of the foreign investor, he would not be in a position to receive and enjoy his income, and therefore, double juridical taxation at source is also justified.

6.4.2. The ability-to-pay principle limits double taxation Unfortunately, the benefits principle does not provide any indication about the amount of tax that is due. There is no connection or reasonable relationship between taxable income and the amount of government benefits received. The ability-to-pay principle determines that when there is no income, no tax needs to be paid, and when there is more income, more tax need to be paid proportionally or even progressively, regardless of whether the taxpayer receives benefits from the government. Loss companies and taxpayers below the poverty line receive government benefits, but effectively 187

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do not pay income tax. The ability-to-pay principle establishes very broad guideposts for the range of the amount of taxes due. In income tax, the ability-to-pay principle trumps the benefits principle because taxpayers that do not pay any income tax on the ground of their liability to pay are still entitled to receive government benefits. On the other hand, the ability-topay principle also limits instances of double taxation when the cumulative burden of source and residence taxation imposed in accordance with the benefits principle is considered excessive. The benefits principle may still be applied indirectly because the taxpayers who do not pay income taxes often pay other taxes, like consumption taxes or environmental levies, so overall, the benefits principle is respected, but in the realm of income tax, the benefits principle does not indicate with certainty which jurisdiction is entitled to tax.

6.4.3.  The role of fiscal sovereignty Apart from the benefits principle, there is an even more fundamental concept that plays a role in international law, and that is the concept of national sovereignty, which, in tax matters, translates into the concept of national fiscal sovereignty. According to this concept, states determine, in a sovereign way and without any international consensus, whether and what to tax, the tax base and the tax rate, and of course, also whether to double-tax or not to tax at all. In addition, sovereign states use their systems of income tax and other taxes to promote their economic interests to attract economic activities by foreign taxpayers or to stimulate economic activities abroad that benefit their own taxpayers. National fiscal sovereignty provides the solid legal ground for states to pursue such fiscal policies, which, at the international level, results in a highly unlevel playing field for similar taxpayers and similar economic activities. Finally, the budgetary needs and/or the budgetary resources of sovereign states may be quite different. In some states, there is only very low income tax or no income tax at all. As a result of the pursuit of these policies, at the international level, some categories of taxpayers and some types of income may escape any form of income tax.

6.4.4.  Conclusion as to double or single taxation The conclusion is that, on the basis of the most fundamental principles of taxation, there are no clear and overriding rules prohibiting double taxation or double non-taxation in income tax. The interplay of these principles and – above all – the principle of national fiscal sovereignty and the national 188

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fiscal policies pursued on the basis of this sovereignty make it difficult to draw any decisive conclusion. This means that the only instruments available to determine taxing priorities between source and residence jurisdictions and to avoid double taxation and double non-taxation are instruments of positive law (such as bilateral or multilateral tax conventions concluded by sovereign states) or unilateral domestic rules in national tax systems to avoid double taxation. Since the first World War, an international consensus has been growing that double income taxation is detrimental to international trade and, more generally, to global economic development. This consensus is not a real principle of taxation, but rather an overriding policy objective. That consensus has been translated into the OECD Model Tax Convention on Income and on Capital and into more than 3,000 bilateral treaties for the avoidance of double taxation. The rules in these bilateral conventions either eliminate double taxation or, in most cases, distribute the taxing powers between the two contracting states so that the overall tax burden remains within the limits of the ability to pay of taxpayers in cross-border situations. This has resulted in a patchwork in which double taxation has been eliminated in some cases and mitigated in a lot of other cases, but instances of double taxation still continue to exist, as well as instances of double non-taxation. For a few years, as a result of a series of international tax scandals of very low taxation or no taxation at all, an international consensus has been emerging that there should be no untaxed income as a result of international tax rules and that if, as a result of international tax law, there is no tax, the international tax rules should be amended so as to allow at least a single tax somewhere. That consensus has crystallized into the OECD BEPS Action Plan of October 2015 and the Multilateral Convention to Implement Tax Treaty Related Measures to Prevent BEPS, opened for signature as of 1 January 2017. However, the measures proposed in the BEPS Action Plan sometimes place the incidence of taxation arbitrarily on taxpayers, not taking into account the benefits and ability-to-pay principles.5 The reason for this arbitrary distribution of taxing powers is that there may be a consensus on the principle of single taxation, but no consensus on the jurisdiction that should have taxing priority in such cases of single taxation.

5.

See the analysis of the examples in 6.5.4.

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6.5.  Double and single taxation in the single market 6.5.1. Difference between the EU and international tax communities The problem with the BEPS Action Plan is that there is no international legislator who has the authority to determine the taxing rights of contracting states. Such rights are determined by international conventions to which the contracting states must agree. Without agreement, there is no rule, but only academic concepts and theories. In the European Union, article 115 of the TFEU authorizes the EU Council of Ministers to issue directives for the approximation of laws that directly affect the establishment of the internal market. That procedure requires the unanimity of the Member States, and in that respect, like in a bilateral treaty, there can be no directive without agreement of all of the Member States involved. However agreeing to a directive is not the same thing as negotiating a bilateral treaty, because many interests are at stake, and coalition of Member States with common interests is possible. Also, the initiative of the text lies with the Commission and not with a national government. However, when the national budgetary interests of the Member States are at stake, it is not so difficult to obtain unanimous approval, as the record speed with which the anti-abuse measures in the EU directives have been adopted has illustrated. Basically, the directive can regulate – like a national legislator – whether it will allow double taxation and how it will relieve double taxation. However, in addition to a national legislator, an EU directive can also determine which Member State will have to relieve double taxation or exercise the single taxing right in cases of double non-taxation. The European Union has already exercised this legislative authority in the income tax directives with respect to cross-border dividends, interest and mergers.

6.5.2. Limits on the legislative powers of income taxation in the European Union However, there is one big brake on the tax legislative power of the European Union, and that is the fact that the directive has to directly affect the internal market, i.e. the directive must be indispensable for the achievement of the internal market. The question is whether single taxation in the sense of AviYonah, meaning that “whenever the country that has primary jurisdiction under the benefits principle refrains from taxing cross-border income, the other country should tax it instead”, is essential for reaching the final stage of the single market. 190

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6.5.3. Single taxation is no justification of national anti-abuse measures The ECJ has rejected the principle of single taxation as a justification for national counterbalancing tax measures imposed by Member States. In Eisenstadt, the Court held that “in several cases … in which a Member state has attempted to counterbalance its inability to impose tax on another taxpayer … the Court considered … the argument that national legislation was intended to issue single taxation of certain income in the Member State. In none of these cases, however, did the Court recognise the principle of single taxation as a distinct justification”.6 The reason why the Court rejected single taxation as a justification for national anti-abuse measures was (and is) obvious. Invoking the principle of single taxation as justification for a national anti-abuse measure is primarily a base erosion argument with budgetary implications. However, the principle of single taxation is wider and more fundamental than a mere policy of base erosion. The objective of the fight against base erosion is to maximize (or perhaps to optimize) the budgetary objectives of the national tax system, regardless of whether any income tax has been levied in another state. Base erosion is a policy for applying national tax systems; it is not in itself a principle of taxation. The principle of single taxation, on the other hand, applies regardless of whether base erosion is effectively taking place. On the basis of this distinction, the principle of single taxation seems to fulfil the role of an overarching limitation of the national tax sovereignty with the purpose of establishing an international level playing field by eliminating double taxation and double non-taxation. In cases of double non-taxation, that goal is pursued without taking into account which jurisdiction is entitled to tax under the generally accepted international tax rules.7 The base erosion considerations, aimed at maximizing or optimizing a national tax system, are clearly budgetary considerations. The Court has always rejected national tax measures that were inspired by budgetary 6. DE: ECJ, 17 Sept. 2015, Case C-589/13, F.E. Familienprivatstiftung Eisenstadt v. Unabhängiger Finanzsenat, Außenstelle Wien, para. 73, ECJ Case Law IBFD. 7. See OECD, Public Discussion Draft – BEPS Action 2: Neutralise the effects of hybrid mismatch arrangements (Recommendations for domestic laws), p. 10 (OECD 2014): “The Action Plan calls for the elimination of the [double deduction and double/no inclusion] outcomes without requiring the jurisdiction applying the rule to establish that it has ‘lost’ tax revenue under the arrangement … This approach also avoids the practical and conceptual difficulties in distinguishing between acceptable and unacceptable mismatches or trying to allocate taxing rights based on the extent to which a country’s tax base has been eroded through hybrid mismatch arrangements.”

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considerations. If the Court would ever accept budgetary considerations of the Member States as a justification for restricting the fundamental freedoms, it would be the end of the TFEU for tax purposes. The single taxation argument is not a budgetary argument per se, but accepting the argument of establishing a level playing field in cases of cross-border economic double non-taxation is inconsistent with the position of the Court rejecting any intervention in cases of cross-border double economic taxation, which is not discriminatory. In other words, for single taxation to play a role as a principle of EU law in the single market in the same way as the non-discrimination principle, it needs to be incorporated into the TFEU. However, that may not be impossible, as will be illustrated by the discussion of the controlled foreign company (CFC) rules in the Anti-Tax Avoidance Directive (ATAD)8 in section 6.5.4. In Eisenstadt, the Court rejected national tax measures by individual Member States. Such national measures may not only have a discriminatory effect, but they almost certainly affect the level playing field between Member States. That is different for EU-wide anti-abuse measures based on the principle of single taxation in a directive, in particular when all Member States unanimously agree to these measures with the avowed purpose of preserving a level playing field in the internal market. If all Member States apply the same base erosion measures imposed by a directive, there is no distortion of competition between the Member States. The only remaining question then is whether the measure constitutes an obstacle to intra-community trade in violation of one of the fundamental freedoms.

6.5.4. Single taxation in CFC rules: Overruling national fiscal sovereignty The CFC rules of the ATAD9 are an implicit illustration of the importance of the functioning of the internal market. Member States like Ireland have been adamant in defending their fiscal sovereignty by maintaining a low general tax rate of 12.5% in corporate income tax. Determining the rates of personal and corporate income tax has always been considered the cornerstone of fiscal sovereignty. However, to any corporate tax expert, it has also always been clear that a low corporate tax rate is the instrument par excellence of tax competition to lure in foreign investors. The successful 8. Council Directive (EU) 2016/1164 of 12 July 2016 laying down rules against tax avoidance practices that directly affect the functioning of the internal market, OJ L 193/1 (2016), EU Law IBFD [hereinafter ATAD]. 9. Id., at art. 7.

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performance of Ireland in hosting foreign investors confirms this point of view. Yet, neither the EU Directorate of Competition nor the ECJ have ever dared to attack the low Irish tax rate. When Estonia became a Member State of the European Union, even the zero tax rate on undistributed profits in its corporate income tax system could be maintained during a transitional period on the basis of any absence of EU competence with regard to ordinary tax rates in the TFEU. Article 7 of the ATAD contains a CFC provision to which all Member States have agreed. It provides that when the tax rate in the Member State of the CFC is less than half of the tax rate in the Member State of the parent company, the CFC rules will apply. These rules allow the state of the parent company to impose additional corporate income tax up to an amount of 50% of its own regular tax rate. That means that for a country like Ireland, CFC rules will apply in its relations with other Member tates in which the ordinary corporate income tax rate exceeds 25%. If Bulgaria is the CFC state, the tax rate is increased in the other Member State if the tax rate exceeds 20%. The operation of this CFC rule means that the EU legislator has now accepted that there is a minimal tax rate that will be applied to certain categories of passive income in cross-border relationships and that this minimal tax rate will vary, depending on the tax rate in the state of headquarters of a permanent establishment or of the parent company of a subsidiary in another Member State. This means that for certain categories of (passive) income, there is now a minimum tax rate above zero in every Member State and that these specific categories of income to which article 7 of the ATAD applies are now subject to a variable minimum tax that will be due in the state in which the headquarters of a permanent establishment or the parent of a subsidiary are located. It goes without saying that these CFC provisions directly affect the functioning of the internal market because they reduce the competition in tax rates between high and low-tax Member States for specific categories of income, and in that sense, they improve the level playing field in the European Union between high-tax and low-tax states. The fact that they affect the functioning of the internal market does not mean, however, that these new CFC rules are also in agreement with the fundamental freedoms, but, as already stated in section 6.5.3., that is another question. The important point is that, within the European Union, there is now a rule of law that states that the national fiscal sovereignty of Member States to determine their own tax rates is not untouchable. If national fiscal sovereignty can be limited to imposing minimum levels of taxation in cross-border relationships between Member States under CFC rules, the next question is whether EU law can impose 193

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an obligation to tax on a Member State that does not tax income under its domestic law.

6.5.5. Single taxation and hybrids in the ATAD One way to avoid single taxation and to achieve double non-taxation is the use of hybrid constructions. Article 9 of the ATAD introduces two simple rules to eliminate these cases of double non-taxation: (i) when a payment results in a double deduction, the deduction shall be given only in the Member State where the payment has its source; and (ii) to the extent that a hybrid mismatch results in a deduction in one jurisdiction without inclusion in the tax base of the other jurisdiction, the Member State of the payer shall deny the deduction. These rules have been extended to relationships with third countries and complicated by ATAD 2,10 but basically, they reflect the recommendations in BEPS Action 2. One of the problems with these recommendations and the ATAD rules on the treatment of hybrids is that the result sometimes is effective taxation somewhere, but not necessarily in the tax jurisdiction that is missing out on the revenue, nor in the jurisdiction that is entitled to tax on the basis of the benefits principle.11 This problem can be illustrated by the following case (see figure 6.1) and the solutions provided in article 9 of the ATAD for eliminating double nontaxation between companies resident in the European Union. As illustrated in figure 6.1, Parent company A in state X owns partnership B in state Y. Partnership B is opaque in X. Partnership B is transparent in Y. Partnership B owns holding company C in state Y. Holding company C pays interest to B in Y. Holding company C owns subsidiaries in states NOP. Subsidiaries in NOP pay interest to C.

10. Council Directive (EU) 2017/952 of 28 May 2017, amending Directive (EU) 2016/1164 as regards hybrid mismatches with third countries, OJ L 144/1 (2016), EU Law IBFD. 11. The original BEPS Action 2 discussion draft already foresaw this objection (see OECD, supra n. 7). This resulted also from an unpublished LL.M paper by De Lillo, a post-graduate student of the University of Amsterdam, who participated in this seminar. His hybrid case study has been used to illustrate this contribution. See ch. 1 of this book.

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Figure 6.1. Parent company A in state X

Partnership B in state Y

Holding company C in state Y

N

O

P

Subsidiaries of holding company C in states NOP

The interest paid by the subsidiaries to holding company C is tax deductible in jurisdictions NOP because the interest is, in principle, taxable to the holding company in state Y. The application of the Interest and Royalties Directive12 prevents any withholding tax being applicable to those interest payments in jurisdictions NOP. The interest paid by holding company C to partnership B is deductible in state Y and wipes out the taxable profit of holding company C arising from interest payments by its subsidiaries. The interest received by partnership B in state Y is not taxable to the partnership because, under the tax law of state Y, partnership B is transparent. The same interest is also not taxable to the parent company in state A because, to state A, partnership B is an opaque entity, and the chain of interest payment stops with partnership B. As long as the profits of partnership B are not effectively 12. Council Directive 2003/49/EC of 3 June 2003 on a common system of taxation applicable to interest and royalty payments made between associated companies of different Member States, OJ L 157 (2003), EU Law IBFD [hereinafter Interest and Royalties Directive].

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distributed, because that partnership is treated as an opaque company, the profits are not under the tax jurisdiction of state X. In this way, the same interest can be accumulated in partnership B and redeployed in loans to companies downstream. The remedy provided by the BEPS Action 2 recommendations and article 9 of the ATAD in this case is to deny the deductibility of the interest payment by holding company C to partnership B. This remedy guarantees taxation of the interest in accordance with the tax rules applicable to the holding company in state Y, and therefore fulfils the objective of imposing an effective layer of single taxation. The problem, however, is whether the holding company is the right taxpayer and whether state Y is the right jurisdiction to tax. In order to find that out, it is necessary to analyse which jurisdiction loses tax revenue, which, under its national tax system, it does not want to tax. State Y does not lose corporate income tax from the partnership because domestic as well as foreign partnerships are not subject to tax. It may lose withholding tax on interest income, provided that there is withholding tax in the domestic law and that the power to impose withholding tax has not been given away in bilateral tax conventions. However, for some EU jurisdictions that consistently eliminate all source taxation in their tax conventions, the hybrid character of the construction does not result in any loss of tax revenue on the interest payment. The recipient of the interest income is the partnership, which should normally be taxed on this income in state Y. Only in that sense is state Y losing revenue in theory, but not under its positive law. However, state X is also losing revenue to the extent that the income crossing the border is an interest payment, and that income should be taxed to parent company A in state X. Because of the opaque nature of the partnership and the fact that the chain of interest payments stops at partnership B, the qualification of interest income changes into dividends, which are only taxable at the time of effective distribution. The adequate remedy against undue deferral of taxation of the undistributed profits in partnership B would not be the denial of interest deductions in state Y, but the application of CFC rules by state X. The conclusion of this analysis as to the tax jurisdiction that should be entitled to tax the interest income shows that both the source and the residence jurisdiction qualify to tax the income. If both jurisdictions would effectively tax the income, the final question is not one of avoidance of double non-taxation, but rather of avoidance of double economic taxation of two 196

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different taxpayers on each side of the border. Double tax conventions do not deal with this form of double taxation, but the EU Parent-Subsidiary Directive13 could do it, provided that its application would be extended to these particular cases of double corporate income tax. The problem, however, is that in both cases, either parent company A in state X would be taxed or the partnership in state Y would be taxed, while in the anti-hybrid rule of BEPS Action 2 and the ATAD, it is holding company C that is subject to tax. That is the company for which the interest is not income at all, but a real deductible expense. Provided that the construction has a solid business purpose and is not a mere conduit, the deduction of that expense is entirely legitimate. It is only the disparity in the tax laws between two Member states with respect to the tax status of the partnership that results in the double non-taxation. This opens the question of whether, in a case of double non-taxation, the only function of an anti-abuse measure is to impose a tax assessment somewhere in the European Union, regardless of where the income is realized and regardless of which taxpayer realizes the income, in particular when the construction that results in this double non-taxation fully corresponds to business imperatives. The anti-hybrid rule applies unconditionally, even to constructions that make eminent business sense. It is a legitimate question as to whether the ECJ will accept this solution as a proportional measure to fight tax avoidance on cross-border operations. There is a real risk that the budgetary base erosion justification will be considered by the Court as the most important policy reason for the measure, and for that reason, the measure will be held to be incompatible with EU law.

6.5.6. Single taxation and barriers to interest deduction in the ATAD Finally, article 4 of the ATAD contains an automatic limitation of interest deductions that is framed in BEPS Action 4:14 “In an effort to reduce their global tax liability, groups of companies have increasingly engaged in BEPS, through excessive interest payments. The interest limitation rule is necessary to discourage such practices by limiting the deductibility of 13. Council Directive 2011/96/EU of 30 November 2011 on the common system of taxation applicable in the case of parent companies and subsidiaries of different Member States, OJ L 345/8 (2011), EU Law IBFD [hereinafter Parent-Subsidiary Directive]. 14. OECD, Limiting Base Erosion Involving Interest Deductions and Other Financial Payments – Action 4: 2015 Final Report (OECD 2015), International Organizations’ Documentation IBFD.

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taxpayers’ exceeding borrowing costs.”15 The problem with these automatic limitations is that they may not only restore effective single taxation in the source state, but also may result in effective double economic taxation, which should be relieved on the basis of the principle of single taxation. The question that should be raised is whether this anti-abuse measure, when it is applied to solid business transactions, does not violate the fundamental freedoms of establishment and capital movement if there is clearly no intention to avoid taxes. The standard answer to that question is that the fundamental freedoms do not apply because the limitation applies to domestic transactions as well as to cross-border transactions, and therefore, there is no discrimination, and the fundamental freedoms do not come into play. Apart from the foregoing question regarding the fundamental freedoms, however, there is the question of whether the interest limitation rule does not violate the Interest and Royalties Directive. The interest limitation rules are copies of domestic limitation rules that have been implemented in some Member States following decisions by the ECJ striking down some thin capitalization rules of the Member States.16 This non-discriminatory way of dealing with thin capitalization rules that were exclusively applied to cross-border transactions was supposed to be fool proof, because it was generally held that the Interest and Royalties Directive only applied to interest payments and not to payments that, by national law, were disqualified as interest payments for corporate income tax purposes and recharacterized as income from equity capital. In other words, in national income tax law, the interest payments were not treated as interest payments, and therefore, the Interest and Royalties Directive did not apply. That may be true for payments that, under national tax law, are qualified as profit distributions. The question is whether the same disqualification can apply to payments like those described in the ATAD, which are explicitly qualified as “borrowing costs”, which can be nothing else but interest payments. Article 4 of the ATAD deals with “borrowing costs”, which are not a distribution of profits, but have to do with loans and interest. Article 1 of the Interest and Royalties Directive prohibits any form of taxation, provided that the beneficial owner of the interest is a company or a permanent establishment in another Member State and is effectively subject to tax on that interest 15. Preamble no. 6 ATAD. 16. DE: ECJ, 12 Dec. 2002, Case C-324/00, Lankhorst-Hohorst GmbH v. Finanzamt Steinfurt, ECJ Case Law IBFD; UK: ECJ, 13 Mar. 2007, Case C-524/04, Test Claimants in the Thin Cap Group Litigation v. Commissioners of Inland Revenue, ECJ Case Law IBFD.

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in that other Member State. The question is whether the fact that, under article 4, part of that interest is not tax deductible disqualifies that payment as an interest payment under the Interest and Royalties Directive. There is no doubt about the taxation in the other Member State. The disqualification as an interest payment under the arm’s length and thin capitalization rules have always had to do with the notion of abuse, i.e. the interest rate was not commercial interest at arm’s length or the interest payment was made by a company that was undercapitalized. Both situations always had a flavour of abuse. Article 4 does not qualify the part of the non-deductible interest as interest paid abusively. At best, one can suppose that the limitation of the interest deduction means that the non-deductible part of the interest is deemed to always be abusive, but it is known that the ECJ has always rejected this type of irrefutable presumption of abuse. The conclusion is that article 4 results in a partial taxation of borrowing costs, which cannot be described as anything other than interest, while that interest is effectively taxed to the beneficial owner established in another Member State. The question is whether that conclusion of double taxation is sufficient to state that article 4 of the ATAD is incompatible with the Interest and Royalties Directive. Prima facie, the ECJ has given the definitive answer to that question in the Scheuten Solar Technology17 decision. The crux of that decision is the consideration that the Interest and Royalties Directive prohibits double juridical taxation of the person that is the beneficial owner of the interest, but does not prohibit double economic taxation when, in addition to the beneficiary, the payer of the interest is also subject to tax, because he is denied the deduction of the interest payment. The Court held that taxation of the payer does not reduce the income of the payee, and the Interest and Royalties Directive is only concerned with the position of the creditor, not the debtor.18 The main argument for the Court’s decision is a reference to article 1(10) of the Interest and Royalties Directive, which refers to an optional anti-abuse measure imposing a holding period of a maximum of 2 years to the creditor company that is associated with the debtor company. The reasoning of the Court is as follows: “There is no reference in that provision to the payer of the interest. It therefore follows from that derogation that it is the beneficial 17. DE: ECJ, 21 July 2011, Case C-397/09, Scheuten SolarTechnology GmbH v. Finanzamt Gelsenkirchen-Süd, ECJ Case Law IBFD. 18. Id., at para. 28: “Article 1(1) of Directive 2004/49 … aims to avoid legal double taxation of cross-border payments of interest by prohibiting the taxation of interest in the source Member State to the detriment of the actual beneficial owner. That provision thus concerns solely the tax position of the interest creditor.”

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owner of the interest or the royalties in another Member State which is concerned by the derogation, not the entity which owes the interest or the royalties.”19 That is a very literal reading of the text of the Interest and Royalties Directive. The condition for the application of the benefit of this directive is a parent-subsidiary relationship in direct line20 or subsidiaries sharing a common parent. The only entity in a position to decide not to fulfil the association relationship prescribed in the Directive is the creditor company, not the debtor company. The debtor company, being in a subsidiary position, has no say in maintaining (or not maintaining) the association relationship. Preamble 2 of the Interest and Royalties Directive states that “national tax laws, coupled, where applicable, with bilateral or multilateral agreements may not always ensure that double taxation is eliminated”. The reference to double taxation does not specify whether it concerns juridical double taxation or economic double taxation. The fact that the Directive does not specifically deal with economic double taxation caused by the denial of the interest deduction in the source state can be fully explained by the fact that all genuine and non-abusive interest payments generally are always tax deductible in the state of source, and the only “regular” tax applicable to such interest payments in the source state are withholding taxes and, in exceptional cases, some forms of taxation by assessment. Interest payments, as a rule, are never subject to corporate income tax, and therefore, there was no need to deal with this situation in the Interest and Royalties directive. Article 4 of the Directive itself lists payments that are excluded as interests and royalties and states that “the source state shall not be obliged to ensure the benefits of this Directive in the following cases: a. payments which are treated as a distribution of profits or as a repayment of capital”.

The question is what the sense of this provision in the Directive is, in the light of the decision in Scheuten Solar Technology that interest payments that are recharacterized as non-interest payments (distribution of profits) are, at any rate, out of the scope of the Directive, and therefore, there cannot be any obligation for the source state under the Interest and Royalties Directive with regard to these payments that are recharacterized as distributions of profits. The sanction for a distribution of profits is taxation in the form of corporate income tax on behalf of the payer of the interest and not 19. 20.

Id., at para. 29 in fine. Including lower tier subsidiaries.

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taxation of the beneficial owner of the interest. In the original proposal of the Directive, there was a last paragraph providing that the part of the interest that would be recharacterized as a distribution of profit would benefit from the Parent-Subsidiary Directive. That provision has not been maintained in the final version of the Interest and Royalties Directive,21 but it is clear that the elimination of double economic taxation was also in the minds of the framers of the Interest and Royalties Directive. That double taxation occurs not only by way of recharacterization of interest as profit distributions, but also by simply denying the deduction of the interest payment as an expense for the corporate income tax. It is significant in that respect that only the anti-abuse measures that were current at the time have been taken into account and discussed with the idea to avoid double economic taxation. The double cross-border taxation of interest regardless of any abusive intention, as described in the ATAD, was simply not on the radar of the framers of the Interest and Royalties Directive, and for that reason did not manifest as prohibited taxation in the Directive. In any case, it is clear that article 4 of the ATAD violates the logic of the principle of eliminating double economic taxation and double non-taxation because the interest barrier results into double economic taxation. Such double taxation can be justified by the policy of fighting base erosion in the framework of the BEPS Action Plan, which does not have to take into account the existence of the EU single market. However, that type of double economic taxation cannot be justified on the basis of the concept of tax avoidance or tax evasion. Yet, it is precisely this justification of tax avoidance and tax evasion that is the sole basic legal justification for the measures imposed by the ATAD.22

21. Proposal for a Council Directive of 22 April 1998 on a common system of taxation applicable to interest and royalty payments made between associated companies of different Member States, COM (98)0067 final, OJ C 123, p. 9. See also the extensive discussion of the avoidance of double economic taxation in the Parent-Subsidiary and Interest and Royalties Directive in G. Kofler, The relationship between the Arm’s Length Principle in the OECD Model Treaty and EC Tax Law, 16 Journal of International Taxation 1/2, pp. 36 and 63-64 (2005). 22. Preamble ATAD, no. 2: “It is essential for the good functioning of the internal market that, as a minimum, Member States implement their commitment to BEPS”; and no. 5: “It is necessary to lay down rules against the erosion of tax bases in the internal market and the shifting of profits out of the internal market. Rules in the following areas are necessary in order to contribute to achieving that objective: limitations to the deductibility of interest, exit taxation, a general anti-abuse clause, controlled foreign company rules and rules to tackle hybrid mismatches.”

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6.6.  General conclusions For further discussion, it is necessary to determine the role of the concept of single taxation as defined by Avi-Yonah (see section 6.1.) as a principle of taxation or as a policy to be pursued. If single taxation is only a principle to be applied as an argument in the policy of the fight against base erosion, it may be a nice theoretical ornament of that policy, but it cannot be accepted as a real principled rule of international taxation. Therefore, it is necessary to agree on whether single taxation is a principle or only an argument of principle to back up a policy. If the concept of single taxation is merely used as an argument to back up base erosion objectives, its main purpose is of a budgetary nature, and in that case, the concept cannot be used as a justification for anti-abuse measures. Within the framework of national tax systems, single taxation certainly is not accepted as a principle of taxation. Only the part of the concept of single taxation that eliminates double juridical taxation is accepted as a principle, because it is the consequence of another old principle, i.e. non bis in idem, but even that principle is not always enforced as a rule in the framework of national positive tax law. Within a national tax system, instances of double non-taxation may be tolerated on the basis of national fiscal sovereignty. If single taxation would be accepted as a principle of international taxation in the sense that income that has not been taxed should be taxed at least once, that principle must be made compatible and consistent with the international tax principles that govern the distribution of taxing power between tax jurisdictions. The present application of the principle of single taxation within the framework of the base erosion policy shows that the application of single taxation is not made in a way that is consistent with jurisdictional international tax rules. If it is not possible to achieve such consistent and compatible application, it is necessary to determine which principle has priority in international tax law, i.e. the principle of single taxation or the basic rules allocating tax jurisdiction. Single taxation cannot be considered a principle of EU law in the single market because it is nowhere to be found, even indirectly, in the TFEU. However, because of its mitigating capacities in eliminating, on the one hand, double taxation and, on the other hand, double non-taxation, it could play a role in EU law as a principle establishing a level playing field between competing national tax jurisdictions in the EU single market. Achieving a level playing field is indeed an objective that is consonant with the concept of the single market. In order to achieve this result, however, the European 202

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Union should also resolve the question of which jurisdiction is to apply the missing level of single taxation, and the question is whether the European Union has the legal power to do so, because the ECJ has repeatedly held that interstate allocation of taxing powers, which will determine which Member State will exercise the missing layer of taxation, belongs to the Member States and not the European Union.

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Chapter 7 Double (Tax) Jeopardy Peter J. Wattel

7.1.  Single taxation or equitable taxation? As De Lillo pointed out in his UvA-IBFD Advanced LL.M thesis,1 referring to other authors, mere single taxation is not the issue. Everyone will prefer being taxed twice at a very low rate over once at a very high rate. The issue is how to establish which overall tax burden on the same income derived by the same person is reasonable, i.e. how to reach a level of taxation comparable to the tax burden suffered by comparable persons deriving comparable income. There are many instances of double or at least non-single taxation that are not at all unreasonable. For instance, the division of taxing power between the source and the residence state as regards passive income is clearly not single taxation, but parallel and simultaneous exercise of taxing power by two jurisdictions that share and divide their tax competence by (i) lowering their gross withholding taxes in their capacity as source states; and (ii) (net) crediting of that withholding tax against the income tax of their residents in their capacity as residence states. Prevention of international double taxation by way of a credit system is not single taxation either, as both states involved tax the same income of the same taxpayer; they ensure, however, that in principle, the total burden will not be higher than the rate of the highest taxing state. Even a tax exemption system (exemption with progression) is not genuine single taxation, as both states involved take account of the source-state income, if only for the rate applied to the residence-state income. Only base exemption (territoriality taxation) is single taxation, but that has the drawback of compartmentalizing the income into two noncommunicating boxes, which is detrimental in the case that the income in one of the states involved is negative. As that loss cannot be set off in the other state with the positive income, in effect, overtaxation ensues, at least temporarily. Therefore, what we are really looking for is not so much single taxation as it is the wish for equity. In legal terms: the equality principle, i.e. comparable, effective overall taxation in comparable ability-to-pay circumstances, especially avoiding both non-taxation and excessive taxation. We are therefore looking not only at a principle of good taxation, but also at a 1. F. De Lillo, In Search of Single Taxation – Twilight of an Idol?, Thesis, Advanced Master in International Tax Law, University of Amsterdam (2017), see ch. 1 of this book.

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principle of competition law: companies that are in competition with each other should support a tax burden comparable to that of their competitors that make comparable net profits. The EU Commission therefore correctly started State aid investigations in respect of multinationals paying only negligible amounts of tax despite huge reported profits, and the French government and the Commission correctly wonder whether the usual (territorial) tax connecting factors are still adequate for equitable taxation of big tech companies like Apple, Google, Amazon and Facebook (AGAF).

7.2. Ne bis in idem: Parallels between double taxation and double punishment2 There is a striking similarity between the problems and (proposed) remedies of (international) double taxation and those of double jeopardy in criminal matters. Therefore, an overview will be provided of the application of the ne bis in idem principle in criminal law, both within one jurisdiction and internationally within the European Union. One rather fundamental difference between double taxation and double punishment is that double taxation is not prohibited, whereas double punishment is prohibited. Within one single jurisdiction it is prohibited by Protocol 7, article 4 of the European Convention of Human Rights (ECHR). That provision does not prohibit international double jeopardy, but within the European Union, cross-border double jeopardy is prohibited by article 50 of the EU Charter of Fundamental Rights (the EU Charter), provided that the case is within the scope of application of EU law. A prohibition of double taxation, national or international, would make little sense, because, as observed in section 7.1., it is not the number of taxes that matters, but the overall burden (including the administrative burden) they result in. That overall tax burden may be excessive, in which case it may be prohibited by Protocol 1, article 1 of the ECHR and article 17 of the EU Charter (both protecting the right to property), as will be shown in section 7.3. The ne bis in idem principle in criminal law may mean two things: (i) ne bis puniri (no double punishment); or (ii) ne bis vexari (no double prosecution). Obviously, if one adheres to ne bis vexari, then ne bis puniri is a mere corollary. Bis puniri (double punishment) may be compared to double taxation; 2. Parts of this paragraph are drawn from P.J. Wattel, Ne Bis in Idem and Tax Offences in EU Law and ECHR Law, in B. van Bockel et al., Ne Bis in Idem in EU Law, pp. 167217 (Cambridge U. Press 2016).

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the same facts are punished/taxed twice (same taxable event). Bis vexari (two proceedings) may be compared to the double administrative burdens necessary to undo double taxation, namely (i) having to ask and wait for a refund of the tax withheld at source at a higher rate than provided for in the tax treaty; (ii) having to ask and wait for a foreign tax credit for the source tax withheld on passive income; and (iii) the gross withholding in the source state and the net crediting of that source tax in the residence state. If one wants to prevent double punishment, there are two ways of putting the ne bis in idem principle into practice: (1) The previous penalty may be credited against the subsequent second penalty. The court adjudicating the second charge should – if it considers that charge to be proven and punishable – take account of the previous penalty already imposed for the same offence when determining the second penalty for that offence (credit system, or Anrechnungsprinzip). Several EU Member States, such as Germany, Spain and Sweden, apply this system in respect of, inter alia, tax offences, or at least did so until the Court of Justice of the European Union’s (ECJ’s) judgment in Åkerberg Fransson.3 Such a credit system cannot be applied if the first and second penalty are different in character; a pecuniary fine cannot be deducted from a detention sentence or vice versa. This system of preventing double jeopardy may be compared to the direct and indirect credit systems of prevention of juridical and economical double taxation. (2) By contrast, the offence may also be tried a second time as if no previous penalty had been imposed for the same offence. If the (second) trial then ends in a conviction or an acquittal, the previous penalty may simply be cancelled. Such cancellation is only possible in respect of pecuniary penalties (fines), which may be refunded (with interest). A prison sentence cannot be cancelled retrospectively unless it has not been served yet. If, by contrast, one wants to avoid double criminal proceedings (ne bis vexari, or no second charge),4 again, there are two ways of operationalizing the principle (and ne bis puniri is automatically realized as well): 3. SE: ECJ, 26 Feb. 2013, Case C-617/10, Åklagaren v. Hans Åkerberg Fransson, ECJ Case Law IBFD. 4. B. Van Bockel, The ne bis in idem principle in EU law: A conceptual and jurisprudential analysis, ch. 4 (Ipskamp 2009), concluded that the (EU) ne bis in idem principle prohibits double prosecution and that the prohibition of double punishment is therefore

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(1) The una via (one way) system: No fines may be imposed anymore – and proceedings with a view to imposing punitive fines must be permanently discontinued – as soon as a criminal indictment is issued for the same (tax) offence. Vice versa, if the tax administration has imposed a punitive surcharge (a fine), then – even if it is not yet final because it may be appealed – the public prosecutor is permanently precluded from bringing any subsequent criminal charges against the same person for the same tax offence. Such una via system is applied in Finland, the Netherlands and Sweden. (2) The finality system: Subsequent punitive proceedings (whether criminal or administrative) must be discontinued (or may not be initiated) once previous punitive proceedings for the same conduct have become final, i.e. have resulted in an irrevocable punitive administrative sanction or criminal sentence (or acquittal). This system of preventing double jeopardy may be compared to the exemption system of preventing juridical or economical double taxation. The latter system (finality) is the ne bis in idem system of Protocol 7, article 4 of the ECHR, which reads as follows: “No one shall be liable to be tried or punished again in criminal proceedings under the jurisdiction of the same State for an offence for which he has already been finally acquitted or convicted in accordance with the law and penal procedure of that State.” (Emphasis added) The European Court of Human Rights (ECtHR) held in, inter alia, Maresti5 and the landmark Grand Chamber decision in Zolotukhin6 that this provision implies ne bis vexari. Therefore, the Court did not consider the crediting of the first conviction against the second conviction sufficient. Such crediting “does not alter the fact that the applicant was tried twice for the same offence”. A credit system was therefore not good enough.7 The ECHR calls for the finality system (in taxation terms, for an exemption system). In Zolotukhin, the Grand Chamber of the ECtHR (17 Justices) unanimously considered the following:

a mere corollary of the first prohibition. 5. HR: ECtHR, 25 June 2009, Appl. No. 55759/07, Maresti v. Croatia. 6. RU: ECtHR, 10 Feb. 2009, Appl. No. 14939/03, Sergey Zolotukhin v. Russia. 7. See also HR: ECtHR, 18 Oct. 2011, Appl. No. 53785/09, Tomasovic v. Croatia, concerning a “minor offence” fine, followed by proceedings on indictment for possession of 0.21 grams of heroin, resulting in a fine that was reduced by the amount of the previous fine and a suspended 4-month imprisonment sentence (violation of Article 4 of Protocol No. 7 to the ECHR).

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107. The Court reiterates that the aim of Article 4 of Protocol No. 7 is to prohibit the repetition of criminal proceedings that have been concluded by a “final” decision […]. […] 110. […] the Court reiterates that Article 4 of Protocol No. 7 is not confined to the right not to be punished twice but extends to the right not to be prosecuted or tried twice […]. Were this not the case, it would not have been necessary to add the word “punished” to the word “tried” since this would be mere duplication. Article 4 of Protocol No. 7 applies even where the individual has merely been prosecuted in proceedings that have not resulted in a conviction. The Court reiterates that Article 4 of Protocol No. 7 contains three distinct guarantees and provides that no one shall be (i) liable to be tried, (ii) tried or (iii) punished for the same offence […].

The fact that Protocol 7, article 4 uses the term “criminal” does not imply that a final “administrative” punitive measure, such as a final tax surcharge, would not preclude a subsequent criminal indictment for the same offence. The national legal characterization of the offence, i.e. (i) “criminal” or “administrative”; or (ii) “minor” or “serious”, and a possible difference in legal interests protected between the two charges are of little importance to the ECtHR. What matters is whether both sanctions are punitive and whether the same factual behaviour is prosecuted twice, regardless of its legal classification and regardless of the legal interest protected by the punitive provisions. This finality system (the exemption system, meaning that subsequent punitive proceedings, whether criminal or administrative, must be discontinued once previous punitive proceedings for the same conduct have become final) is also the system of article 54 of the Convention Implementing the EU Schengen Agreement of 14 June 1985 (CISA), as well as the system of article 50 of the EU Charter. Article 50 of the Charter reads as follows: “No one shall be liable to be tried or punished again in criminal proceedings for an offence for which he or she has already been finally acquitted or convicted within the Union in accordance with the law.” (Emphasis added) This provision in the EU Charter is almost identical to article 4 of Protocol 7 of the ECHR quoted above, with the major exception of the term “within the Union”, which replaces the term “under the jurisdiction of the same State” in article 4 of Protocol 7. This highlights that the application of the ne bis vexari rule of the ECHR Protocol is limited to one national jurisdiction (it does not prevent two sentences for the same act imposed by two different national jurisdictions), whereas the EU Charter’s ne bis vexari rule applies 209

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EU-wide, meaning that whichever Member State is first in (finally) convicting a person bars punitive proceedings by any other Member State for the same act against the same person (first come, first served). Article 54 of the CISA also applies cross-border in the entire Schengen area, but it adds an extra requirement before barring a second charge: not only must the first punitive sanction have become final, but it must also have been effectuated or have become statute-barred: “A person whose trial has been finally disposed of in one Contracting Party may not be prosecuted in another Contracting Party for the same acts provided that, if a penalty has been imposed, it has been enforced, is actually in the process of being enforced or can no longer be enforced under the laws of the sentencing Contracting Party.” (Emphasis added) This effectuation requirement reflects the reluctance of EU Member States to mutually recognize the adequacy of each other’s punitive systems. Interestingly, it is conceptually identical to a rule of international tax law: in double tax conventions and in national tax law, the state obliged to prevent double taxation (usually the residence state) often requires effective taxation in the source state to which the income is allocated. Especially the credit method for the prevention of double taxation is geared towards effective overall taxation at home state level (capital export neutrality), but also, exemption states apply switchover clauses, i.e. the foreign-source income will not be exempt if it has not been subject to effective taxation in the source state at a specified minimum level, but only a credit will be extended for the amount effectively paid. Also, article 1(1) of the EU Interest and Royalties Directive8 requires effective taxation in the creditor state as a condition for the debtor state to waive its withholding tax on the outbound interest and royalty payments. Article 54 of the CISA does exactly the same; it only requires the second prosecuting state to abstain if the penalty imposed in the first prosecuting state has become final and is effective, in the sense that it has been enforced, is actually in the process of being enforced or can no longer be enforced due to the statute of limitations (which is a parallel between tax law and criminal law as well: even though effectively levied, also tax cannot be collected anymore after the expiry of the statutory time limit for recovery. At any rate, in criminal matters, it is clearer than in tax matters as to which EU Member State must yield under the ne bis in idem principle: first come, first served. The jurisdiction of the first conviction or acquittal to become 8. Council Directive 2003/49/EC on a common system of taxation applicable to interest and royalty payments made between associated companies of different Member States, OJ L 157/49 (2003), EU Law IBFD.

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final prevails over the other jurisdiction, which then must fully abstain. However, in competition fine cases, especially those involving third states, the European Union takes the same position as national taxing jurisdictions in the absence of tax treaties; it sees no reason why it should yield to the jurisdiction assumed by any third state. However, in a recent punitive tax surcharge case, the Grand Chamber of the ECtHR changed direction, derogating from Zolotukhin, in the case of A. and B. v. Norway,9 concerning two taxpayers who were first fined for underpaying tax and subsequently criminally charged for serious tax fraud on the basis of the same deliberate underpayment of tax. Under certain conditions, that Court now also accepts the credit system (ne bis puniri) instead of the finality (exemption) system (ne bis vexari) for the prevention of double jeopardy, at least in tax (fraud) cases, but probably in many more types of cases, especially economic offences. In principle, “dual” punitive proceedings for the same offence against the same person are acceptable if the following conditions are met: – the criminal court takes into account the administrative penalty already imposed for the same tax offence (credits it); – the “dual proceedings” fit into an “overall scheme” (apparently a system of percentage fines for run-of-the-mill fiscal irregularities supplemented by criminal prosecution of more serious fiscal fraud); – the “dual proceedings” (one in respect of the punitive tax surcharge and one in respect of the criminal charge for the same offence) run “in parallel and interconnected”; and – the same evidence is used. One dissenting ECtHR judge argued in his dissenting opinion that the Court should not have yielded to the pressure of the Council of Europe member states applying such a “dual” system. Interestingly, Advocate-General Campos Sánchez-Bordona of the other European Court, the ECJ advised the ECJ not to follow the ECtHR in this matter. In the pending case Garlsson Real Estate,10 the Advocate-General explicitly advised the ECJ to stick to its Åkerberg Fransson judgment,11 in which it interpreted, in a comparable Scandinavian case of deliberate underpayment of tax, the ne bis in idem principle contained in article 50 of the EU Charter as referring to the finality (exemption) system of preventing double jeopardy. 9. NO: ECtHR, 15 Nov. 2016, Appl. No. 24130/11 and 29758/11, A. and B. v. Norway. 10. Opinion of Advocate-General Sánchez-Bordona of the Court of Justice of the European Union (ECJ) of 12 Sept. 2017 in Case C-537/16, Garlsson Real Estate. The same issue arises in the pending ECJ Case C-597/16, Consob v. Zecca. 11. Åkerberg Fransson, supra n. 4.

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7.3.  Single taxation as a human right? As observed, it is not the number of taxes that count, but the overall burden they create. If that burden is excessive as compared to other taxpayers and is caused by one jurisdiction, it may amount to (fiscal) discrimination against the taxpayer involved. If it is (also) excessive in absolute terms, it may amount (also) to a violation of the right to property. A combination of these violations (both of property and equal treatment) was at issue in the ECtHR cases N.K.M. v. Hungary,12 R.Sz. v. Hungary13 and Gáll v. Hungary,14 concerning Hungarian civil servants who were laid off and subsequently taxed on their severance payments at effective rates four times the normal effective rate for that type of income. Two double taxation cases merit discussion here, one on national double taxation (caused by one single taxing jurisdiction) and one on international double taxation (caused by a parallel exercise of two national taxing powers with no effective mechanisms to prevent international double taxation), both leading to an excessive tax burden. The UK case of Fessal v. HMRC15 concerned Mr Fessal, who was a barrister. Like other self-employed persons in the profession, he was required to change, for tax return filing purposes, from a receipt system of profit accounting to a declaration system. He made a mistake in applying the transitional system, resulting in him overpaying tax in year 1 and underpaying the same amount of tax in year 2. Overall, therefore, the correct amount of tax was paid: the overpayment compensated for the underpayment. HMRC issued an additional assessment for year 2, but refused to refund the tax paid but not due in respect of year 1, relying on the expiration of a statutory time limit for amending the year 1 tax declaration. The result was, obviously, full double taxation of Mr Fessal’s profits. Two observations may be pertinent: (i) it is difficult to think of a better way to make enemies for life; (ii) it may not have been the best idea for HMRC to select precisely a barrister to test this interesting legal argument. The First Tier Tribunal, referring to the UK Supreme Court decision in R v. Waya,16 decided that although HMRC had the power to issue an additional assessment, the relevant section of the law only authorized HMRC to issue an assessment compensating for the loss of 12. HU: EctHR, 14 May 2013, Appl. no. 66529/11, N.K.M. v. Hungary. 13. HU: EctHR, 2 July 2013, Appl. no. 41838/11, R.Sz. v. Hungary. 14. HU: EctHR, 25 June 2013, Appl. no. 49570/11, Gáll v. Hungary. 15. UK: First Tier Tribunal (tax), 13 May 2016, [2016] UKFTT 0285 (TC), I. Fessal v. Her Majesty’s Revenue and Customs. 16. UK: Supreme Court, [2012] UKSC 51, R v. Waya.

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tax after taking into account a connected overpayment arising from the same circumstances that caused the underpayment. The power to assess should be exercised in a manner not breaching the taxpayer’s property rights under article 1 of Protocol I of the ECHR. It was clear that a double charge of income tax on the same profits of the same taxpayer could not reasonably be considered to pursue a legitimate aim in the public interest or to strike a fair balance between the demands of the general interest and the protection of individual rights. Therefore, the overpaid tax for year 1 had to be taken into account, reducing the additional assessment for year 2. The Fessal case thus provides an example of double taxation producing a violation of human rights. Conceptually, the same type of double taxation occurred in a Finnish case that was brought before the ECtHR after exhaustion of Finnish domestic legal remedies, with one difference: the double taxation in this case was not caused by one single taxing jurisdiction, but by simultaneous taxation by both the location state and the residence state of a capital gain on real estate. The case concerned a Finnish resident owning a Spanish house in respect of which he made a capital gain. He was taxed for that gain by both Spain and Finland. Although a comprehensive tax treaty was in force, also providing for distributive rules as regards capital gains as well as a mutual agreement procedure in the case of persisting double taxation, double taxation was, in fact, not prevented, since despite negotiations, Finland and Spain could not mutually agree on the division of taxing rights between them. The Finnish taxpayer used the same arguments as the First Tier Tribunal in Fessal and as the ECtHR in Jokela,17 but to no avail. This case (Appl. No. 3596/17) was declared inadmissible by the ECtHR, apparently by a single judge, without reasoning.18 It is true that the right to property in Protocol 1 of the ECHR, like the ne bis in idem principle in Protocol 7 of the ECHR, does not protect a taxpayer against the combined effect of the parallel exercise of jurisdiction by two states, each of which separately does not cause excessive taxation. Apparently, this is so evident that the ECtHR considered it unnecessary to give reasons.

17. SF: ECtHR, 21 May 2002, Application no. 28856/95, Jokela v. Finland. This case concerned inheritance taxation in respect of a property for a much higher value than the compensation paid by the State for the expropriation of that same property, without any explanation for the marked difference in valuation. 18. The submission of this case in Strasbourg and the case number, as well as its inadmissibility, were brought to my notice by the Finnish legal counsel involved. I have not been able to find the case in the ECtHR’s HUDOC database under the case number mentioned.

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The rather disenchanting conclusion is that the exact same excessive taxation caused by a double charge to tax on the same income may be rectifiable if there is one culprit, but is not rectifiable if there are two culprits.

7.4. Internal consistency or the territoriality principle as a remedy for double taxation in the European Union? The type of double taxation occurring in the Finnish/Spanish case discussed in section 7.3. has partly been remedied by the US Supreme Court by using an internal consistency test19 as regards taxation of interstate income by the US states. The case Comptroller v. Wynne20 concerned the Wynne couple, who lived in Maryland but earned out-of-state income. Maryland taxed them for their total income. It credited the taxes already paid in the source states, but only against the Maryland state tax and not against its county taxes. In that respect, double taxation therefore persisted. The US Constitution contains an interstate commerce clause, prohibiting discrimination against interstate trade as compared to intrastate trade. It represents a legal principle comparable to the EU free movement rights. On the basis of this (dormant) “commerce clause”, a heavily divided US Supreme Court required the US states to apply the same system in their capacity as residence states as in their capacity as source states and vice versa (“internal consistency”). They may apply any system of taxation of interstate income as long as it is internally consistent. Accordingly, they may, as source states, apply the source principle and therefore tax the income of non-residents sourced within their territory, but if they do, they will have to acknowledge the source principle also in their capacity as residence states. This means that they will have to prevent double taxation in respect of out-of-state income of their residents by crediting the source state’s tax. Inversely, if they do not wish to credit the source tax on their residents’ out-of-state income because they consider the residence principle to trump the source principle, they are free to refrain from crediting the source state tax, but they will also have to refrain from taxing non-residents’ income sourced within their territory, as they will then need to recognize the precedence of the residence principle, which they claim themselves in their capacity as residence states.

19. Mason already in 2008 recommended the internal consistency test for the European Union; see R. Mason, Made in America for European Tax: the Internal Consistency Test, 5 Boston College Law Review XLIX, pp. 1277-1326 (2008). 20. US: Supreme Court, 18 May 2015, Docket No. 13-485, Comptroller (Maryland) v. Wynne.

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Theoretically, the US states have two more options: (i) tax residents as if they are non-residents, i.e. only for sourced income (territoriality principle); or (ii) tax non-residents as if they are residents, i.e. for total income, crediting out-of-state-tax. The Swiss federal court goes even further than the US Supreme Court, but has a firmer constitutional basis. It secures single taxation among the Swiss cantons on the basis of the territoriality principle. It exclusively divides taxing rights between the cantons on the basis of the question of which territory has the strongest links with the income to be taxed. In contrast to the ECJ and the US Supreme Court, the Swiss Federal Court can rely on an explicit prohibition of intercantonal double taxation in the Swiss Constitution, which, however, does not provide the necessary allocation criteria. This necessitated the federal court to develop its own criterion, i.e. territoriality.21 The ECJ has not yet ventured into any such daring approach, although it sometimes clearly prefers the source principle and regularly refers to “the fiscal principle of territoriality”, by which, however, it seems to mean a principle of international public law rather than a principle of international tax law.22 It allows Member States to apply worldwide taxation to residents and source taxation to non-residents, probably reasoning that source taxation is no less favourable than worldwide taxation, and it considers possibly ensuing international double taxation to be a result of a non-discriminatory “parallel exercise of taxing power” by two different Member States.23

21. See, for a comparison of the judicial policies of the US Supreme Court, the Swiss Federal Court and the ECJ as regards double taxation, A. van de Vijver, International Double Taxation in the European Union: Comparative Guidelines from Switzerland and the United States, EC Tax Review 1, pp. 10-22 (2017). 22. According to O. Marres, The Principle of Territoriality and Cross-Border Loss Compensation, 39 Intertax 2, pp. 112-125 (2011), the ECJEU uses the term “territoriality” as meaning full jurisdiction as regards residents and territorial jurisdiction as regards non-residents, which, in tax terms, leads to worldwide jurisdiction in respect of residents and source jurisdiction as regards non-residents. Obviously, that territoriality principle is not going to put an end to double taxation. 23. See especially BE: ECJ, 14 Nov. 2006, Case C-513/04, Mark Kerckhaert and Bernadette Morres v. Belgische Staat, ECJ Case Law IBFD; BE: ECJ, 16 July 2009, Case C-128/08, Jacques Damseaux v. Belgian State; and DE: ECJ, 12 Feb. 2009, Case C-67/08, Margarete Block v. Finanzamt Kaufbueren, ECJ Case Law IBFD. For an elaboration, see Terra & Wattel, European Tax Law, 7th edition 2018 (Wolters Kluwer 2018), secs. 14.2 and 16.1.2.

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7.5. Conclusion There are eye-catching similarities between (the prevention of) double taxation and (the prevention of) double jeopardy. However, where double jeopardy is prohibited as a violation of human rights, double taxation is not. The mere fact that income is taxed twice does not necessarily mean that the total tax burden on the taxpayer is unfair, discriminatory or excessive. That depends on the circumstances. Only in exceptional circumstances will double taxation lead to a violation of the non-discrimination principle or the right to property. It will especially not produce such violation if no one single jurisdiction can be blamed, as it is a consequence of the parallel exercise of taxing power by two separate sovereign states. The ECJ could use the EU free movement rights to reduce international double taxation within the European Union by interpreting them as requiring internal consistency of the international tax policies of the Member States (as the US Supreme Court does) or as requiring the territoriality principle of allocation to be applied (as the Swiss Federal Court does), but it has not done so, and probably will not do so in the near future, given the lack of clear support for either approach in the EU treaties and the political sensitivity of the Member States in respect of taxing power division issues.

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Appendix

Oxford-Style Debate The following chapters were written in the authors’ role as members of the team in an Oxford-style debate supporting/opposing the following motion: “This House believes that the notion of single taxation is a worthless chimera.”

Chapter 8 International Single Taxation: A Misguiding Notion Eric C.C.M. Kemmeren and Francesco De Lillo

8.1. Introduction 8.1.1. The motion of the House This chapter enshrines some reflections presented during the Oxford-style debate within the IBDF Duets in International Taxation: Single Taxation? (Amsterdam, 5 October 2017). The motion of the House was: “This House believes that the notion of single taxation is a worthless chimera”, and the authors were entrusted with the task of supporting the stance. The discussion concerned the guiding potential of the idea of single taxation in the process of rethinking the current international tax rules, and several interesting considerations emerged during the debate, despite its ludic nature.

8.1.2. Research question and methodology The aim of this chapter is to assess whether or not cross-border single taxation, as opposed to the allocation of tax jurisdiction to “ensure that profits are taxed where economic activities take place and value is created”1 in order to enhance “the exchange of goods and services and movements of capital, technology and persons”,2 should constitute a guiding notion as well as an internationally acceptable policy for the rebuilding of the current regimes of corporate income taxation. In other words, this chapter aims at questioning and challenging the position of those scholars – Avi-Yonah in primis – who affirm that single taxation should be regarded as the core

1. See, e.g. OECD, Base Erosion and Profit Shifting Project, Explanatory Statement, p. 4 (OECD 2015). 2. See, e.g. Model Tax Convention on Income and on Capital Introduction, para. 1 (21 Nov. 2017), Models IBFD.

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notion of a customary system that may be called international tax law or an international tax regime.3 In this context, questions arise. What would be the potential and the validity of the notion of single taxation? On the basis of what rationale should states take into consideration the outcome of the mutual interactions while designing and implementing their international tax policies? The authors intend here to demonstrate that the idea of single taxation is a misguiding notion and ultimately the product of a misunderstanding of the problems underlying the current international tax framework. Not only is its implementation incapable of solving these issues, but it is also questionable as to whether the notion of single taxation should be given priority, as the concept of single taxation ends up clashing with other fundamental – and less controversial – principles of the international tax law. For this purpose, the following sections deal firstly with the notion of single taxation itself, exploring the meaning and the positive implications as highlighted by its supporters (section 8.2.). Subsequently, the question will be raised as to whether the notion of single taxation is the Holy Grail (section 8.3). Next to this, the notion of single taxation will be tested against other principles, such as the principle of sovereignty, the direct benefits principle, internation equity, the principle of origin and tax neutrality (section 8.4.). Finally, the analysis will emphasize the fragility and inconsistency of the idea of single taxation (section 8.5.).

8.2.  The idea of single taxation 8.2.1. Theoretical framework According to its main supporter, the notion of single taxation means that “[i] ncome from cross-border transactions should be subject to tax once (that is,

3. R.S. Avi-Yonah & H. Xu, Evaluating BEPS: A Reconsideration of the Benefits Principle and Proposal for UN Oversight, 6 Harvard Business Law Review 2, pp. 208 and 234-235 (2016/17). See also, e.g. Y. Brauner, An International Tax Regime in Crystallization, 56 Tax Law Review 2, p. 291 (2003); J.M. de Melo Rigoni, The International Tax Regime in the Twenty-First Century: The Emergence of a Third Stage, 45 Intertax 3, pp. 205-218 (2017); D.M. Ring, One Nation Among Many: Policy Implications of Cross-Border Tax Arbitrage, 44 Boston College Law Review 2, pp. 79-175 (2002); R. Vann, International Aspects of Income Tax, in Tax Law Design and Drafting, vol. 2, ch. 18, pp. 720-721 (V. Thuronyi ed., International Monetary Fund 1998).

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neither more nor less than once)” (Emphasis added)4 at the rates established by the benefits principle, which traditionally attributes primary taxing rights upon active income to the source jurisdiction and ascribes to the residence state the primary tax claims over passive income. Combined together, the notion of single taxation and the benefits principle are meant to address the main issues underlying the taxation of cross-border income, namely the definition of the tax base and of the relative level of taxation, as well as the division of the tax base among the concurrent jurisdictions. In this context, the notion of single taxation and the benefits principle constitute core principles of customary international tax law.5 The allocation rule embodied by the benefits principle responds to both theoretical and factual justifications. On the one hand, it must be taken into account that investment income is mainly earned by individuals, and thus, traditional, residence-based taxation appears to be the most suitable solution. With regard to individuals, it is relatively easy to verify the residence status, and the distributive function of taxation can be fulfilled more effectively, as the resident individual fully exploits all the social benefits provided by the jurisdiction in which he is established. On the other hand, business income primarily concerns corporations, the residence of which is an extremely volatile concept, especially in the era of digitalization. Considering that multinational enterprises are spread across multiple jurisdictions, sourcebased taxation traditionally seems to be more consistent with the benefits perspective (after all, businesses benefit from the infrastructure, labour and other resources of the country in which they operate). Lastly, from a practical point of view, the source jurisdiction has, by definition, the first opportunity to tax income generated within its territory.6 However, it must be noted that it has also been suggested to reconsider the traditional allocation of tax jurisdiction of income based on the benefits

4. R.S. Avi-Yonah, International Taxation of Electronic Commerce, 52 Tax Law Review 3, p. 517 (1997). 5. Id. Such framework is examined and further developed in several papers written by the scholar; see R.S. Avi-Yonah, International Tax Law as International Law, 57 Tax Law Review 4, pp. 483-501 (2004); R.S. Avi-Yonah, Tax Competition, Tax Arbitrage and the International Tax Regime, 61 Bull. Intl. Taxn. 4, pp. 130-138 (2007), Journals IBFD; R.S. Avi-Yonah, Who Invented the Single Tax Principle? An Essay on the History of U.S. Treaty Policy, 59 New York Law School Law Review 2, pp. 305-315 (2014/15); and R.S. Avi-Yonah, Full circle? The Single Tax Principle, BEPS, and the New US Model, Global Taxation 1, pp. 12-13 (2016). 6. For all of these arguments, see, e.g. Avi-Yonah, International Taxation, id., at pp. 520-521.

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principle.7 It has been argued that the traditional allocation of tax jurisdiction should be reversed: passive income should primarily be taxed at source, and active income at residence. The main reason for this position seems to be that far fewer jurisdictions will need to cooperate. Furthermore, it has been demonstrated that in this manner, BEPS concerns will be more effectively addressed. Next to this, it has been held that such an allocation of tax jurisdiction will help build a win-win framework of international tax governance that will benefit both developed countries and developing countries. The notion of single taxation entails a sort of residual clause that demands the other jurisdiction to tax cross-border income if the state that has the primary taxing right under the benefits principle refrains from taxation.8 In other words, in order to avoid undertaxation, income should be taxed once, regardless of where the single levy is imposed. From this point of view, the notion of single taxation is shaped as an intrinsic feature of income and expresses an ideal of worldwide/supranational efficiency.9

8.2.2. Traces of the notion of single taxation in the international tax framework The origins of the idea that cross-border income should always be subject to a single layer of taxation may already be found in the early work of the League of Nations. According to the 1927 Report presented by the Committee of Technical Experts on Double Taxation and Tax Evasion, such a policy goal represents one of the “most elementary and undisputed principle[s] of fiscal justice”.10 Back then, international cooperation in the tax field was primary concerned with the elimination of juridical double taxation.11 The focus started to shift toward the (allegedly) opposite phenomenon of double non-taxation at the beginning of the 21st century, when the OECD Model Tax Convention 7. See, e.g. Avi-Yonah & Xu, supra n. 3, at pp. 188-189, 194-195, 210 and 234-238; and R.S. Avi-Yonah, The Triumph of BEPS: US Tax Reform and the Single Tax Principle, Law & Economics Working Papers, p. 142 (2017).  8. See, e.g. Avi-Yonah, International Taxation, supra n. 4, at p. 517. 9. See, e.g. F. De Lillo, ch. 1, sec. 1.2.2. of this book. 10. League of Nations Publications, Doc. G.216.M.85 II (April 1927), at p. 23: “experts should devise a scheme whereby all incomes would be taxed once and only once”. 11. As explained by, e.g. Ring, supra n. 1, double taxation may ultimately erase the profits of a transaction or even demand more than the income actually earned, and for this reason, both governments and taxpayers have a stronger interest in avoiding it. Conversely, double non-taxation is not able to hinder cross-border trade, but just distort its shape.

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(OECD Model)12 incorporated the outcome of the 1998 report on Harmful Tax Competition13 and the following 1999 report on the Application of the OECD Model Tax Convention to Partnerships.14 This new trend has culminated in the OECD/G20 BEPS Project with its 15 Action Points, which explicitly aim to put “an end to double non-taxation [and] facilitate a better alignment of taxation with economic activity and value creation”.15 As a result, a new preamble has been inserted into the 2017 update of the OECD Model,16 according to which the contracting parties intend to conclude a Convention “for the elimination of double taxation with respect to taxes on income and on capital without creating opportunities for non-taxation or reduced taxation through tax evasion or avoidance”.17 Such a statement would formally represent, according to Avi-Yonah, the OECD’s official commitment to the notion of single taxation.18

8.2.3. Single taxation: Can one really define it? Looking at the theoretical framework underlying the notion of single taxation, several doubts immediately arise regarding the exact scope and content of such an idea. If single taxation is perceived as the ideal condition between two opposite harmful occurrences19 (double taxation and double non-taxation) and the new preamble of the OECD Model doubtlessly incorporates the notion of single taxation, it should thus be concluded that tax treaties – at least when drafted on the basis of the latest OECD Model – are able to ensure the imposition of a single layer of taxation on cross-border income.

12. OECD Model Tax Convention on Income and on Capital (28 Jan. 2003), Models IBFD. 13. OECD, Harmful Tax Competition: An Emerging Global Issue (OECD 1998), International Organizations’’ Documentation IBFD. 14. OECD, The Application of the OECD Model Tax Convention to Partnerships (OECD 1999), International Organizations’ Documentation IBFD. 15. These are the words of OECD Secretary-General Angel Gurría, delivered during the presentation of the BEPS Project outputs to be discussed at the G20 Finance Ministers meeting in Lima on 8 October 2015. 16. OECD, Model Tax Convention on Income and on Capital (21 Nov. 2017), Models IBFD [hereinafter OECD Model 2017]. 17. See also, e.g. OECD, The Granting of Treaty Benefits in Inappropriate Circumstances – Action 6: 2015 Final Report, p. 91, para. 72 (OECD 2015), International Organizations’ Documentation IBFD. 18. Avi-Yonah, Full Circle?, supra n. 5, at p. 12. 19. See, e.g. De Lillo, ch. 1, sec. 1.2.4.1. of this book.

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Nonetheless, looking at the allocation rules provided by the OECD Model, it is difficult to agree with the above conclusion. On the one hand, most of the articles provide for a situation of shared taxing rights, in which both the contracting jurisdictions actually exercise their taxing rights generating double taxation, which is subsequently eliminated through the obligation of granting double tax relief. On the other hand, tax treaties are clearly incapable of solving double non-taxation issues, as they are meant to allocate/ distribute taxing powers but not to “create” them. Treaties cannot impose taxation on income when both the contracting parties refrain from doing so due to a conscious policy choice reflected in domestic tax laws.20 Thus, what are the implications of the incorporation of the notion of single taxation in the OECD Model? Underlying this doubt is a broader question: what exactly is single taxation?

8.2.3.1.  Taxing the same subject? Juridical double taxation is traditionally defined as the imposition of comparable taxes by two (or more) tax jurisdictions on the same taxpayer in respect of the same subject matter and for identical periods.21 Therefore, one would expect that the opposite phenomenon (namely double non-taxation) refers to the absence of any form of taxation on the same person and in respect of the same item of income, while single taxation actually entails the levy of a single layer of taxation upon the same taxpayer in respect of the same (cross-border) income. Yet, by further examining double non-taxation issues and the recommended solutions proposed by OECD in respect of the BEPS Project, the above expectations turn out to be deluded. This conclusion can be clearly illustrated by the approach in respect of hybrid mismatch arrangements and the recommendations included in the Final Report on BEPS Action 2.22 The report addresses several different arrangements (the use of hybrid financial 20. For a similar conclusion, see, e.g. M. Lang, Double Non-Taxation – General Report, in IFA Cahiers de droit fiscal international, vol. 89a, pp. 77-119 (IFA Cahiers 2004). 21. See Introduction, para. 1 OECD Model 2017. 22. See OECD, Neutralising the Effects of Hybrid Mismatch Arrangements – Action 2: 2015 Final Report, p. 11 (OECD 2015), International Organizations’ Documentation IBFD, where hybrid mismatch arrangements are defined as “arrangements exploit[ing] differences in the tax treatment of an entity or instrument under the laws of two or more tax jurisdictions to achieve double non-taxation, including long-term deferral. These types of arrangements are widespread and result in a substantial erosion of the taxable bases of the countries concerned”.

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instruments, payments made by or to hybrid entities and exploitation of dual resident entities). Regardless of the different configuration of the mismatches, the main solution proposed (the so-called “primary linking rule”) consists in the denial of the deduction of the payment in the hands of the payer so as to “fix” the non-taxation of the recipient on that specific payment. As pointed out by De Lillo, in all of the above scenarios, the focus is on a payment that flows from one taxpayer to another, provided that both are part of the same “control group”.23 Double non-taxation ultimately turns out to be a sort of economic concept rather than a juridical one, i.e. the ideal condition of single taxation that is met when the payment is taxed in the hands of the payer even if the recipient of the income is still left untaxed.24 Furthermore, the “control group” has been defined in such a manner that the payer or the recipient can be part of more than one group. Therefore, it may be concluded that the idea of imposing a single levy of taxation on cross-border income – surprisingly – does not actually mean that the same taxpayer should be taxed once and only once on the same item of income. According to the authors, this conclusion shows that the notion of single taxation is misguiding.

8.2.3.2.  Taxing the same object? Taking into account the observations included in section 8.2.3.1., the concept of single taxation seems to apply to items of income (payments) rather than to taxpayers. In this sense, and considering especially the residual clause described in section 8.2.1., the notion of single taxation embodies a sort of ideal of worldwide/global efficiency that demands that cross-border income should be taxed once and only once, regardless of where. Yet, such a supranational perspective may hardly be implemented and embraced by states in a concrete international framework made of sovereign jurisdictions for which there is no superior authority entrusted with the power of bindingly influencing their tax policies. As a consequence, the notion of taxable income will differ state by state. Each state will determine 23. For a definition of a “control group”, see id., at p. 114: “Parties will be treated as members of the same control group if: (a) they form part of the same consolidated group for accounting purposes or the provision between them can be regarded as a provision between associated enterprises under Article 9 of the OECD Model Tax Convention; (b) one person has a 50% investment or effective control of the other person (or a third person has a 50% or effective control of both).” 24. De Lillo, ch. 1, sec. 1.3.3.1. of this book.

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its own taxable object, its own taxable income i.e. its own taxable yields and its own tax-deductible expenses. As a result, the taxable cross-border income to be taken into account in two (or more) states will be almost never be the same object. Therefore, the notion of single taxation is misguiding also for this reason.

8.2.3.3.  Taxing at the fair rate? The idea of single taxation is conceived as the rightful solution to both double non-taxation and double taxation. As further illustrated in section 8.3., cross-border undertaxation as well as overtaxation are commonly regarded as harmful outcomes in terms of efficiency, neutrality and equity. After a careful examination of these arguments, it may be concluded that the real underlying concern in respect of the taxation of cross-border income is not related to the number of levies concretely imposed on that income, but is actually represented by the overall rate of taxation. This conclusion is supported by the wording of the new preamble to the 2017 OECD Model, according to which tax treaties aim at eliminating opportunities not only for non-taxation, but also for reduced taxation.25 Given the above, it must be observed that the notion of single taxation per se does not deal with rates of taxation and provides no guidance in this sense. Furthermore, the concept of a fair rate of taxation (albeit diffusely used in the (academic) debate) is a vague and undefined concept, which implies, once again, the adoption of a supranational perspective that is hardly feasible in the concrete international framework. After all, each sovereign jurisdiction is ultimately entitled to freely establish the domestic rate of taxation according to its specific revenue needs and policy choices. Conversely, which authority should be entrusted with the task of identifying a fair rate, and on the basis of what theoretical grounds?

8.3.  Is single taxation the Holy Grail? It is now time to question whether the idea of single taxation may actually be considered as the Holy Grail in respect of international tax issues. What problems should be solved by single taxation, and is the levy of a single layer of taxation actually capable of fixing them? 25.

See OECD Model 2017.

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8.3.1. Over-taxation of cross-border income Double or multiple taxation of cross-border income is commonly regarded as harmful because of efficiency and equity considerations. An excessive tax burden on income arising from cross-border transactions determines a distortive incentive to invest domestically, while at the same time penalizing international investments and trade.26 The result is that a tax system that it is not designed to prevent or eliminate international juridical double taxation lacks neutrality, both from a capital and labour-export perspective and from a capital and labour-import perspective.27 Given these negative implications, it is clear that what could actually hinder cross-border economic relations is the overall tax burden and not the number of levies imposed on income. For the purposes of explaining such reasoning, it has to be taken into account in the first place that, in a general tax system, taxation in accordance with the ability-to-pay principle might be imposed at four different moments:28: (1) the moment at which wealth is created/produced, which leads to taxes such as personal income taxes, corporate income taxes and wage taxes being levied; (2) the possession of wealth, thus subject to net wealth taxes; (3) the moment at which wealth is consumed, which entails the imposition of taxes such as consumption taxes, sales and use taxes and environmental taxes; and (4) the disposal of unconsumed wealth, in respect of which gift or inheritance taxes are levied. Typically, the tax mix of a jurisdiction may lead not just to one of the above moments of taxation, but to more than one or even all of them. Yet, due to the different purposes and tax bases, the imposition of both an income 26. See also, e.g. Avi-Yonah (1997), supra n. 4, at p. 518. 27. Capital and labour export neutrality (CLEN) is defined as such: An income recipient should pay the same total (domestic plus foreign) tax irrespective of whether he derives a given amount of labour or investment income from foreign or domestic sources. On the other hand, capital and labour import neutrality (CLIN) is defined as follows: Labour and capital funds originating in various states should compete on equal terms in the labour and capital markets of a state irrespective of the place of residence of the worker or investor. See, e.g. E.C.C.M. Kemmeren, A Global Framework for Capital Gains Taxes, 46 Intertax 4, p. 275 (2018). 28. See, e.g. E.C.C.M. Kemmeren, Legal and Economic Principles Support an Origin and Import Neutrality-Based over a Residence and Export Neutrality-Based Tax Treaty Policy, in Tax Treaties: Building Bridges between Law and Economics, sec. 3.3. (M. Lang et al. eds., IBFD 2010), Online Books IBFD; E.C.C.M. Kemmeren, Principle of Origin in Tax Conventions: A Rethinking of Models, sec. 2.3.2 (Pijnenburg 2001); G.W.J. Bruins et al., Report on Double Taxation, p. 18 (League of Nations 1923).

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tax and a consumption tax is not generally regarded as a form of harmful double taxation. Narrowing the focus to the field of income taxation, it is relevant to stress that double taxation is not wrong a priori, but only when it affects, in a discriminatory fashion, taxpayers that are in substantially equal positions.29 This is the reason why economic double taxation (i.e. the imposition of more than one levy of taxation over the same stream of income in the hands of the same or different persons), which occurs in the context of business taxation as an intrinsic implication of the inclusion in the tax mix of both a personal and corporate income tax, is usually left outside the scope of tax treaties. It is normally prevented only by virtue of a specific unilateral or bilateral policy choice. Economic double taxation arising equally in domestic or cross-border scenarios therefore cannot be regarded as unfair.

8.3.2. Undertaxation of cross-border income Moving to the opposite phenomenon, if cross-border income is taxed less than domestic income or not taxed at all, foreign investments are inefficiently incentivized to the detriment of domestic investments. In such a case, the tax system is once again not neutral, and multinational enterprises ultimately benefit from unfair tax advantages in comparison to small and medium businesses. At the same time, labour income is penalized to the advantage of business income.30 Therefore, non-taxation entails a tax morality issue, as well as an underlying concern of revenue losses. Yet, abandoning the aforementioned supranational perspective and looking at the phenomenon from the unilateral point of view of a single jurisdiction, is less than single taxation a problem as such? As further illustrated,31 tax sovereignty is, to a large extent, unlimited, and as such, it may be restricted primarily by virtue of a free policy choice. Thus, the concept of sovereignty means, on the one hand, that a jurisdiction is entitled to establish – by itself and initially without external interferences – who, what and when to tax. On the other hand, sovereignty also implies that a jurisdiction may opt for refraining from taxation under specific and predetermined circumstances. Following this reasoning, states are perfectly 29. See also, e.g., E.R.A. Seligman, Essays in Taxation, 10th ed., London (1925), at p. 99. 30. Id., p. 518-19. 31. See sec. 8.4.1.

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free to refrain completely from levying personal or corporate income taxes because they believe that such taxation does not match with its policy goals, or they can establish more specific exemptions, tax incentives or tax holidays. Similar choices may also be taken on a bilateral basis, for example, by granting tax sparing credits. All of this being considered, one may conclude that less than single taxation is not per se a problem, at least when it is the outcome of conscious public policy. It therefore seems hard to support the validity of a notion that demands that every item of income is taxed once and only once. As demonstrated in the section 8.4., such idea ultimately clashes with other essential principles of both national and international tax law; the notion of single taxation is misguiding.

8.4.  The idea of single taxation tested Sections 8.2.-8.3. of this chapter dealt with the notion of single taxation itself in an attempt to exactly understand its meaning and scope. The analysis has highlighted how the concept is actually vague and uncertain: it is, in fact, difficult to attach a sound rationale to the notion and to recognize its guiding potential for the purposes of rethinking/rebuilding the current systems of corporate income taxation. As already anticipated, the idea that cross-border income should be taxed once and only once ultimately has results inconsistent with other fundamental (and less controversial) principles of tax law. For these reasons, in sections 8.4.1.-8.4.5., these principles are used as benchmarks to assess the validity of single taxation as a policy goal. In particular, single taxation will be examined in relation to the principle of sovereignty, the direct benefits principle, internation equity, the principle of origin and tax neutrality.

8.4.1. The principle of (tax) sovereignty In the context of legal theory, the concept of sovereignty represents a cornerstone of public international law, developed in the political doctrine of the 18th and 19th centuries and conceived as an inherent unrestricted freedom (at least to a large extent) that typically characterizes political authorities. Thus, the idea of sovereignty is frequently identified or confused with

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concepts such as “nation”, “state” and “jurisdiction”,32 which are indissolubly interconnected with a specific territory and a community of individuals living in that territory. “Sovereignty” can be defined as “a self-referential claim to ultimate authority over a certain body politic”.33 Such a claim does not arise from external sources (in this sense, the claim is “original”, as it derives from the sovereign entity itself) and is unconditional, meaning that it is not subject to restrictions, at least initially. The only limit to its extent is represented by the existence of other similar claims that apply to different territories and political communities.34 Additionally, such a claim entails the faculty of sovereign states to partially give up ultimate authority in specific fields or for specific purposes (e.g. within the context of the European Union).35 Narrowing the analysis to the tax field, the principle of sovereignty implies that jurisdictions are ultimately free to design, without external interference (unless spontaneously accepted), the features and the content of their tax systems. It must be taken into account that taxation mainly serves the fulfilment of two different types of functions: on the one hand, a primary budgetary function, which consists of the essential task of raising and collecting revenues to meet public expenditures in order to ensure the correct functioning and development of a human society, and on the other hand, a regulatory function, meant to incentivize or penalize specific behaviours so as to promote relevant public policies. Within this functional framework, tax sovereignty grants states the possibility to autonomously determine what to tax and how much, depending on their specific revenue needs or policy priorities. Nonetheless, such ultimate freedom also entails the faculty of refraining from taxation in respect of specific circumstances. As stated in section 8.3.2., a general tax system may therefore refrain completely from levying personal or corporate income taxes because a sovereign state believes that such taxation does not match with its policy goals, or it may 32. For an extensive analysis of the concept of sovereignty and its historical developments, see, e.g. M. Isenbaert, EC Law and the Sovereignty of the Member States in Direct Taxation, especially ch. 2 (IBFD 2010), Online Books IBFD. 33. Id., at sec. 1. 34. See also, e.g. S.C.W. Douma, Optimization of tax sovereignty and free movement, sec. 5.1. (IBFD 2011), Online Books IBFD. 35. In the normative and institutional framework of the European Union, Member States keep on preserving their sovereign claims, but at the same time, those claims are restricted by the supranational authority of the European Union (see NL: ECJ, 5 Feb. 1963, Case C-26/62, NV Algemene Transport- en Expeditie Onderneming van Gend & Loos v. Netherlands Inland Revenue Administration). Thus, in such a context, sovereignty is not an absolute concept, but it takes the shape of “function sovereignty”, as the claim to ultimate authority is not defined solely by territorial borders, but also by functions performed and objectives pursued (see Isenbaert, supra n. 32, at sec. 2.2.).

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establish more specific exemptions, incentives and subsidies, as well as tax holidays. Given the above remarks, how can the notion of single taxation be reconciled with the concept of sovereignty? Why should a sovereign state be forced to exercise its taxing claims? It seems difficult to support the recognition, within the international tax framework, of an underlying principle that demands that every item of income should be taxed once and only once, regardless of the specific needs and public goals of different sovereign jurisdictions.

8.4.2. The direct benefits principle According to the direct benefits principle, a person who directly benefits from public goods and services provided by a state should also contribute to those expenses. In other words, the state that makes the production of wealth possible by means of its public goods and services should be entitled to tax that wealth. This principle, which ultimately constitutes the basis for both residence and source taxation, justifies not only taxation at the moment at which the wealth is produced, but also taxation of the possession of wealth, as well as its consumption and disposal inter vivos or mortis causa.36 Looking back once again at the notion of single taxation, and especially at its corollary, that requires counter-jurisdictions to activate their taxing powers when the jurisdiction entitled to primary taxing rights refrains from taxation, and no trace of a benefit perspective may be found. The idea of imposing one and one only layer of taxation on cross-border income, regardless of where, in fact turns out to be completely oblivious to the issue of allocating taxing claims among concurrent jurisdictions on the basis of a precise and solid theoretical justification. This idea is clearly misguiding in respect of the allocation of tax jurisdiction of income produced by a multinational enterprise if the aim is to allocate tax jurisdiction to the state that directly provides benefits (public goods and services) that enable the multinational enterprise to produce business profits in that state.

36.

See, e.g., Kemmeren 2010, supra n. 28, at sec. 3.3.

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8.4.3. Internation equity The concept of internation equity is strictly related to the direct benefits principle. Internation equity deals with the allocation of gains or losses between two or more nations, each of which has a connection to that particular gain. The national gain of the residence state increases because its residents have invested in another jurisdiction and earned a positive return. On the other hand, the state where that return has been earned should be able to recover from the investor some of the costs of public goods and services from which the investor benefits.37 Compared to the direct benefits principle, though, this concept is more concerned with the differences (in terms of economic strength and capital flows) between the investor’s jurisdiction and the jurisdictions in which the investment is made. It follows that the same observations expressed in respect of the clash between the idea of single taxation and the direct benefits principle also apply to the concept of internation equity. The theoretical configuration of international single taxation, in fact, completely neglects any jurisdictional/ allocation issue, as its main concern is the imposition of a single levy of taxation on cross-border income. Therefore, the authors do not believe that it can be held that the notion of single taxation will help build a win-win framework of international tax governance that will benefit both developed countries and developing countries.38 This is certainly true if the suggestion of Avi-Yonah would be adopted to tax passive income primarily at source and active income primarily at residence. He argues the following: [B]ecause most individuals are relatively risk averse, portfolio investment flows overwhelmingly to a small number of jurisdictions: the United States, European Union, and Japan. If these jurisdictions could impose a withholding tax on all outbound payments, most of the problem of taxing passive income could be resolved. […] For active income, about 90% of large multinationals are headquartered in G20 countries, and none of those countries have a corporate tax rate below 20%. If the G20 countries taxed their [multinational enterprises] based on where the headquarters are located on a current basis and restricted the ability to move the headquarters, the problem of taxing active income would be largely resolved.39 37. For an extensive analysis of the concept, see, e.g. K. Brooks, Inter-Nation Equity: The Development of an Important but Underappreciated International Tax Value, in Tax Reform in 21st Century, pp. 471-498 (R. Krever & J.G. Head eds., Kluwer Law International 2009). 38. See Avi-Yonah & Xu, supra n. 3, at p. 210. 39. Id., at pp. 237-238.

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The outcome is that most of the primary taxing jurisdiction on both passive and active income will be allocated to a small number of countries, which are not the developing countries. In substance, the developing countries will lose even more revenue for the benefit of a small number of developed countries than they may already be losing. Therefore, the authors strongly believe that the allocation of taxing jurisdiction as suggested is detrimental to the position of developing countries and inconsistent with the concept of internation equity.

8.4.4. The principle of origin The principle of origin justifies taxation of income by a state if the income is created within the territory of that state, i.e. the cause of the income is within the territory of that state, as that state made the acquisition/production of wealth possible.40 This principle should not be confused or identified with the principle of source; the latter, in fact, is not concerned with the causal relationship between production of income and the territory of a state. If the income is not generated in a state but nevertheless physically appears from that state, tax jurisdiction may be allocated to that state on the basis of the principle of source, but not the principle of origin. It follows that, in the light of this principle, the clash between residence and origin in respect of cross-border income should be solved in favour of the latter. This does not mean that the residence state should not exercise any claim on its residents when they exclusively earn foreign income, but rather that such state should not impose an income tax on that taxpayer (conversely, in a similar scenario, the principle of origin would allow the levying of a consumption tax). Using this benchmark for the purposes of testing the idea of single taxation, one may conclude that the latter concept is once again inconsistent with any specific allocation criteria. The notion of single taxation, in fact, applies regardless of any sort of consideration for the relationship between a territory and the production of wealth.

8.4.5. Tax neutrality Neutrality of taxes requires that taxation should not influence an efficient allocation of the production factors. The concept of efficiency is based on 40. See, e.g. Kemmeren 2010, supra n. 28, at sec. 3.3.1.5.1. See also Kemmeren 2001, supra n. 28.

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the assumption that productivity will be highest when the production factors are distributed by a market mechanism without, or at least with as little as possible, public interference. From an international tax policy perspective, ensuring neutrality implies first to establish whether the tax positions of the entrepreneur, the portfolio investor, the lessor, the professional and the employee with foreign income should be equal to the tax positions of residents with only domestic income or to the position of their competitors in the local foreign markets.41 Given the above policy dilemma, the content of single taxation seems to have no guiding relevance in ensuring that some form of neutrality is met within a tax system. Moreover, as pointed out, single taxation is grounded on a supranational perspective, which ignores the specific and individual point of view of a single jurisdiction.

8.4.6. The BEPS Project’s mission In the Foreword of the Final Report on each BEPS action, it is repeated that the OECD/G20 BEPS Project’s mandate is to implement an international framework in which multinational enterprises are taxed “where economic activities take place and value is created”.42 The idea of value creation seems to suggest an origin or at least a source basis, but still, the actual meaning of this slogan is the subject of a heated debate, and it remains outside the scope of this chapter. Yet, even if one is satisfied with such impressions, it is clear that the idea of single taxation does not entail any positive outcome for this purpose. As repeatedly stated throughout this chapter, a policy that demands that every item of cross-border income is taxed once and only once fully neglects allocation issues.

41. See, e.g. Kemmeren (2010), supra n. 28, at sec. 4.7. The choice by a state for CLEN or CLIN seems to depend largely on the size and structure of its own economy. 42. See OECD, supra n. 1, at p. 4.

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8.5. Conclusions This chapter intended to demonstrate how the idea of single taxation has no guiding potential within the process of rebuilding the current international tax framework. First, it was highlighted that the concept of single taxation itself, albeit intuitive prima facie, is actually vague and inconsistent. It does not entail per se any positive implication unless assessed from a supranational perspective. Moreover, the concept ultimately clashes with other less controversial principles of international taxation. After testing the notion of single taxation in the light of those benchmarks, the common result is that the idea that international income should be taxed just once is misguiding, as it is completely oblivious to the more pressing jurisdictional issues. Taking into account all of the arguments illustrated throughout this chapter, the authors are more than convinced that the idea of single taxation indeed turns out to be a “worthless chimera”.

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Chapter 9 International Single Taxation: The Holy Grail Dr Svetislav V. Kostić and Neha Mohan “This House would be most misguided if it were to believe that the notion of single taxation is a worthless chimera!”

9.1. Introduction: From Chalcedon to Byzantium, with Mahabharata at their side Entrusted with the task of defending the principle of single taxation, the authors, whose everyday lives are devoted to the technical aspects of taxation, embarked on an enlightening journey that took them from Chalcedon to Byzantium, as well as to other surprising sources of inspiration. The need for reliance on these unanticipated sources arose from the fact that we, as tax lawyers, tend to become obsessed with details, sometimes resembling the ancient clerics who, in the process of memorizing the scriptures, forgot the inherent concept of their creed. It is as though novel abstract notions scare us, and hence, we refuse to be drawn into contemplating them. On the other hand, we are prone to worshipping practical and specific solutions. As Graetz stated: “We have been blinded by adherence to inadequate principles and remain wedded to outdated concepts. As a result, we have no sound basis for pronouncing our international tax policy satisfactory or unsatisfactory.”1 The authors’ adventure in the defence of the concept of single taxation began by attempting to denote the fundamental premises of their analysis, for which they primarily relied on the work of Avi-Yonah: A coherent international tax regime exists, embodied in both the tax treaty network and in domestic law […] The practical implication is that countries

1. M.J. Graetz, The David Tillinghast Lecture: Taxing International Income - Inadequate Principles, Outdated Concepts, and Unsatisfactory Policy, 54 N.Y.U. Tax Law Review 3, p. 269 (2001).

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are not free to adopt any international tax rules they please, but rather operate in the context of the regime, which changes in the same ways international law changes over time.2

The basic norms that underline this international tax regime are the single taxation principle and the benefits principle.3 At first, the authors were averse to the very notion of an international tax regime. It seemed more rational to agree with Rosenbloom’s, arguments, as summarized by Avi-Yonah: International tax arbitrage is the natural response of taxpayers to the normal differences that occur between any two tax systems. As such, it does not represent a problem, or at least no adequate explanation for why it is a problem has yet been given, other than by invoking an “international tax system” that does not exist. Moreover, even if international tax arbitrage were a problem, in the current and any reasonably likely future state of the world, no solution is likely to be available. Therefore, tax policymakers should not bother to try to combat international tax arbitrage, and should repeal those provisions (such as the dual consolidated loss rules) that are inspired by the desire to prevent it.4

The OECD BEPS Project and the signing of the Multilateral Instrument in June of 20175 do not fundamentally change Rosenbloom’s conclusions. As Dagan noted: Were there an international tax regime or institution that facilitates and ensures cooperation between states in setting international tax rules, it might also seek to promote global welfare by minimizing distortions. But such a framework of international cooperation does not exist on the global level, and the quandary for neutrality proponents is how neutrality can be achieved in the current decentralized international tax regime, where states unilaterally set their international tax policies.6

The international tax policies of states are tailored to their own national interests and are not curtailed by an imaginary, independent international tax regime. Conversely, it is the international tax regime that is constituted by the unilateral actions of sovereign nations that are predominantly 2. R.S. Avi-Yonah, International Tax as International Law – An Analysis of the International Tax Regime p. 1 (Cambridge U. Press 2007). 3. Id. 4. R.S. Avi-Yonah, Commentary (Response to article by H. David Rosenbloom), 53 N.Y.U. Tax Law Review 2, p. 167 (2000). 5. Multilateral Instrument to Implement Tax Treaty Related Measures to Prevent Base Erosion and Profit Shifting (24 Nov. 2016), Treaties IBFD. 6. T. Dagan, International Tax Policy – Between Competition and Cooperation p. 53 (Cambridge U. Press 2018).

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constrained by the impact of the competition that rules the international tax market wherein states attempt to attract capital and taxpayers.7 Hence, at the beginning of the authors’ adventures, the principle of single taxation, under which “income from cross-border transactions should be subject to tax once (that is, neither more nor less than once)”,8 sounded like a logical continuation of a theoretical utopia. In order for two non-believers to successfully defend the position that single taxation is not a worthless chimera, it was necessary to search deeply for inspiration, which eventually came from somewhat unexpected sources. It is said that the city of Byzantium, later called Constantinople (presentday Istanbul), was established on the advice given by the oracle of Delphi to Megarian colonists to settle “opposite the blind.” The Megarian colonists settled at the place where the Golden Horn meets the Bosporus on the European side of the strait, opposite an earlier Greek settlement of Chalcedon (modern-day Kadıköy) on the Asian side. The Chalcedonians had been “blind” to the immeasurable geographical advantages of the site that lay right in front of them. This finding made the authors question if they had been too accepting of Graetz’s assessment of the global tax community, and thereby blind, like the Chalcedonians, to the arguments in favour of the notion of single taxation that lay right in front of them. However, in order to be able to “see the light”, the authors needed proper lenses, i.e. the right perspective. Hence, they dared to wonder if the devil was not in the details, or even in the principle itself, as it is defined by AviYonah, but in an even broader understanding. Widening their search, the authors found that while, in the BEPS-possessed world of today, we hotly debate the ideals of fair and sustainable taxation, these principles are quite ancient, as can be evidenced by the verses found in the millennia-old Mahabharata, wherein the venerable Bhishma councils King Yudhishthir: A king should milk his kingdom like a bee gathering honey from plants. He should act like the keeper of a cow who draws milk from her without boring her 7. Id., at P. 44. 8. R.S. Avi-Yonah, International Taxation of Electronic Commerce, 52 N.Y.U. Tax Law Review 3, p. 517 (1997).

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udders and without starving the calf. The king should (in the matter of taxes) act like the leech drawing blood mildly. He should conduct himself towards his subjects like a tigress in the matter of carrying her cubs, touching them with her teeth but never piercing them therewith. He should behave like a mouse which though possessed of sharp and pointed teeth still cuts the feet of sleeping animals in such a manner that they do not at all become conscious of it. A little by little should be taken from a growing subject and by this means should he be shorn. The demand should then be increased gradually till what is taken assumes a fair proportion. The king should enhance the burthens of his subjects gradually like a person gradually increasing the burthens of a young bullock … The king should never impose taxes unseasonably and on persons unable to bear them. He should impose them gradually and with conciliation, in proper season and according to due forms. These contrivances that I declare unto thee are legitimate means of king-craft.9

Evidently, the world in which King Yudhishthir reigned was much different from the one we live in today. However, this excerpt from the Mahabharata affirms that, if an idea has merit, the idea itself survives the many superficial changes through which our societies evolve. Therefore, the authors adopted the approach of defending the general soundness of the concept from which the principle of single taxation has emanated, and not the specifics thereof.

9.2.  The two chimeras In order to structure the argumentation for a debate entitled “This House believes that the notion of single taxation is a worthless chimera”, one first has to answer the question: What is a chimera? The Merriam-Webster dictionary provides a threefold definition of the word “chimera”: 1. a) capitalized: a fire-breathing she-monster in Greek mythology having a lion’s head, a goat’s body, and a serpent’s tail b) an imaginary monster compounded of incongruous parts 2. an illusion or fabrication of the mind; especially: an unrealizable dream 3. an individual, organ, or part consisting of tissues of diverse genetic constitution.

9. Mahabharata, Book 12: Santi Parva, Part I: Rajadharmanusasana Parva, sec. LXXXVIII, translation by K.M. Ganguli, available at http://sacred-texts.com/hin/m12/ m12a087.htm (28 Aug. 2018).

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Setting aside the third potential meaning of the word chimera, for reasons so obvious that they do not merit further elaboration, the logical conclusion is that the proper meaning to be used in the context of the debate is that of an unrealizable dream. In other words, the debate centres around the question: Is the notion of single taxation a utopia, fabricated by theoreticians? Therefore, the authors asked themselves whether the utopian nature of the single taxation principle was sufficient to deem it an unrealizable dream and, as one tends to do in all matters utopian, turned to religious sources of inspiration. In 1750, Jonathan Mayhew, a Minister of the West Congregational Church in Boston, who is often credited with coining the phrase “no taxation without representation” (or, for those more inclined to the Latin verse, “nullum tributum sine lege”), delivered a sermon on the centennial anniversary of the death of King Charles I,10 in which he stated: It is to be hoped that those who have any regard to the apostle’s character as an inspired writer, or even as a man of common understanding, will not represent him as reasoning in such a loose incoherent manner; and drawing conclusions which have not the least relation to his premises. For what can be more absurd than an argument thus framed, Rulers are, by their office, bound to consult the public welfare and the good of society, therefore you are bound to pay them tribute, to honor, and to submit to them, even when they destroy the public welfare, and are a common pest to society, by acting in direct contradiction to the nature and end of their office?11 […] For the apostle says nothing that is peculiar to kings; what he says, extends equally to all other persons whatever, vested with any civil office. They are all, in exactly the same sense, the ordinance of God; and the ministers of God; and obedience is equally enjoined to be paid to them all. For, as the apostle expresses it, there is NO POWER but of God: And we are required to render to

10. J. Mayhew & P. Royster, A Discourse concerning Unlimited Submission and NonResistance to the Higher Powers: With some Reflections on the Resistance made to King Charles I. And on the Anniversary of his Death: In which the Mysterious Doctrine of that Prince’s Saintship and Martyrdom is Unriddled (1750) (U. of Nebraska), available at http:// digitalcommons.unl.edu/cgi/viewcontent.cgi?article=1044&context=etas (28 Aug. 2018). Mayhew’s sermon become highly influential in Colonial revolutionary circles, while he was highly influential in stirring resistance to the 1765 Stamp Act. See C. Beneke, The Critical Turn – Jonathan Mayhew, the British Empire, and the Idea of Resistance in MidEighteenth-Century Boston, 10 Massachusetts Historical Review 10 (2008). 11. Id., at p. 28.

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ALL their DUES; and not MORE than their DUES. And what these dues are, and to whom they are to be rendered, the apostle sayeth not; but leaves to the reason and consciences of men to determine.12

Today, we tend to take Mayhew’s conclusions for granted and deem them part of the basic fabric of our societies. However, when they were uttered from the pulpit, they were considered revolutionary and dangerous, as in most of the world, the infallibility of the monarch ruled supreme, while even a hint of disobedience carried grave consequences. The problem that demanded resolution was that in the case of fair and equitable taxation and its Vedic origins, one could refer to the durability of the idea as the main argument for its merit, however utopian the idea itself may seem. In the case of the international tax regime and the notion of single taxation, no such shelter could be found. Thus, the authors were faced with two potential options: (1) a positive approach, under which they would attempt to prove the soundness of the notion of single taxation and of the existence of an international tax regime; or (2) to find a breach in what seemed to be quite strong walls of the opposing sides’ argumentation. At that point, it was intriguing for the authors to inquire into the question of whether our tendency to deem the principle of single taxation a utopia was caused by the fact that behind this illusion lurks a real chimera. Perhaps not the Chimera that the ancient Greeks feared, but a monster nevertheless: a monster that threatens the foundations of the world we have become accustomed to. Particularly, the arguments that can be raised against the notion of single taxation can be divided into two groups: (1) those that can be made in relation to any issue of international direct taxation (e.g. whether the definition of income is obsolete, whether one should re-examine who or what is and/or should be the taxpayer and the lack of clarity of the concept); and (2) those that essentially revolve around the problem of sovereignty. The horrid chimera stemming from the notion of single taxation is that when it is viewed in the context of the existence of an international tax regime (or

12.

Id., at p. 34.

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system), it threatens the principle of the all-powerful sovereign nation state, which is still the cornerstone of the world we live in. If one re-examines the problems of double juridical taxation or double nontaxation, both are essentially caused by the view that the world around us does not exist, or a conscious choice to ignore its existence. For instance, if we consider our current transfer pricing rules, we seem to be worshiping a false idol, i.e. the arm’s length standard, despite all of its faults, for the simple reason that we are afraid to venture outside the unilateral, or alternatively, bilateral concept to which we currently apply our respective rules. In other words, perhaps the greatest ally of the arm’s-length-principlebased transfer pricing rules is the contention that any alternative would require a multilateral consensus, which, by fiat, is deemed unachievable.13 Fundamentally, the current state of affairs in international taxation is governed by the need to appease the sovereign state, wherein we, relying on ancient wisdom (quite rightly so), deem multilateral consensus a fantasy, while we take the existence of the nation-state as an indisputable given. The chimera that Bellerophontes had to slay had two heads, both of which needed the authors’ attention: one symbolized the lack of clarity and coherence of the single taxation principle, while the other threatened with the nemesis of affronting the sanctity of the sovereign nation-state. As the authors were not so delusional as to believe that they could defend the existence of the international tax regime and the notion of single taxation better than those who coined these very concepts, they decided to lead the attack and storm the ramparts of their worthy opponents.

9.3. Picking the Apple at Runnymede It is difficult to imagine a more terrifying scenario for those fearful of globalization than the Apple case, i.e. the case against Ireland referred on 4 October 2017 to the Court of Justice of the European Union (ECJ) by the European Commission.14

13. Y. Brauner, Formula Based Transfer Pricing, 42 Intertax 10, pp. 621 and 642 (2014). 14. European Commission, Press release IP/17/3702, State aid: Commission refers Ireland to Court for failure to recover illegal tax benefits from Apple worth up to €13 billion (4 Oct. 2017). The Apple case is not unique, but the authors chose to address it in particular due to the amount of State aid for which recovery was warranted.

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The case concerned a supranational organization (with somewhat of a democratic deficit problem) forcing a sovereign democratic nation to tax a corporation, claiming that it understood the legislation of that country better than its magistrates. No other sovereign tax jurisdiction in the world had claimed taxation rights over the corporation or complained to have been directly offended by its tax arbitrage. Is this not clear evidence – evidence to the tone of EUR 13 billion in a single case – that an international tax regime actually exists? However, it serves little credit to the proponents of the existence of an international tax regime that the European Commission was not able to base its claim on a clear international tax rule, but was forced to reach out to the State aid provisions of article 107 of the Treaty on the Functioning of the European Union and claim that they independently installed an obligation for the Member States of the European Union to apply the (or a version of the) arm’s length principle in corporate taxation.15 In other words, the obligation of Ireland to abide by the arm’s length standard (although it is not clear which arm’s length standard we are actually dealing with)16 was not the consequence of the duty to respect a global set of tax rules (i.e. an international tax regime), but resulted from it being a member of a specific supranational organization with a potent institutional setting that is primarily focused on ensuring the functioning of a competitive common market among its Member States. From the perspective of single taxation, one comes face to face with the problem that it would seem that taxing somewhere, no matter where, is the goal that we are striving towards. Had the United States taxed the profits of Apple Operations Europe and Apple Sales International or had other countries followed the Italian example,17 the amount of the recovery demanded by the European Commission could have been far lower than the preposterous EUR 13 billion. As De Lillo pointed out,18 the same observation can be made with respect to Action 2 of the BEPS Action Plan, which is greatly influenced by the principle of single taxation, wherein one finds clear statements that it is taxation that we should strive towards, irrelevant of who is actually levying or paying the tax: 15. Commission Notice on the notion of State Aid as referred in Article 107(1) of the Treaty on the Functioning of the European Union, OJ C 262/1, para. 172 (19 July 2016). 16. Id., at para. 173. 17. Commission Decision (EU) 2017/1283 of 30 August 2016 on State aid Case SA.38373 (2014/C) (ex 2014/NN) (ex 2014/CP) implemented by Ireland to Apple, OJ L 187, paras. 99 and 451 (2017). 18. F. De Lillo, In Search of Single Taxation: The Twilight of an Idol? p. 49, LL.M Thesis, University of Amsterdam (2017), see ch. 1 of this book.

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If the payment is brought into account as ordinary income in at least one jurisdiction then there will be no mismatch for the rule to apply to.19 […] The Action Plan simply calls for the elimination of mismatches without requiring the jurisdiction applying the rule to establish that it has “lost” revenue under the arrangement. … Accordingly the hybrid mismatch rules apply automatically and without regard for whether the arrangement has eroded the tax base of the country applying the rule.20

Although the Apple case, as well as others that follow from the same 2013 European Commission inquiry in the provision of State aid through ambiguous tax rulings,21 seem to provide many arguments, but for the opposing side, there was one voice that attracted the authors’ attention. In these cases, there is one quite unusual participant, namely Oxfam: In its comments, Oxfam expresses support for the Commission’s investigation, encouraging the Commission to increase its investigation capacity also in view of the fact that it may be better placed than national bodies to structurally assess the ruling practice of the Member States. It calls on the Commission to ensure that adequate sanctions are adopted in cases where selective advantages are confirmed and that harmful tax practices are phased out quickly. It also indicates that grandfathering periods of six years in the case of the Irish tax residency rules that facilitate hybrid entity mismatches are much too long.22

The authors questioned what a confederation of 20 international organizations dedicated to fighting poverty23 had to do with the Apple case. This drew their attention to the Oxfam Strategic Plan 2013-2019, which states: 19. OECD, Neutralizing the Effects of Hybrid Mismatch Arrangements – Action 2: 2015 Final Report, para. 149 (OECD 2015). 20. Id., at para 278. 21. E.g. European Commission, Commission Decision (EU) 2017/502 of 21 October 2015 on State aid Case SA.38374 (2014/C ex 2014/NN) implemented by the Netherlands to Starbucks, OJ L 83 (29 Mar. 2017); European Commission, Commission Decision (EU) 2016/2326 of 21 October 2015 on State aid Case SA.38375 (2014/C ex 2014/NN) which Luxembourg granted to Fiat, OJ L 351 (22 Dec. 2016); and European Commission, Commission Decision (EU) 2018/859 of 7 October 2014 on State aid Case SA.38944 (2014/C), State aid granted to Amazon by Luxembourg. 22. Commission Notice on the notion of State Aid as referred in Article 107(1) of the Treaty on the Functioning of the European Union, para. 176. 23. Art. 3 of the Stichting Oxfam International Constitution states: “Whereas conflicts, injustice and the denial of people’s basic rights are major causes of poverty, it is necessary to achieve reform, particularly by empowerment of the poor. To this end, the objectives of the Foundation are: a. to relieve poverty, combat distress and alleviate suffering in any part of the world regardless of race, gender, creed or political convictions; b. to research the causes and effects of poverty, injustice and suffering;

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In a context of global financial austerity and declining aid flows, it is critical to mobilise additional national and international financial flows for poverty reduction and sustainable development. Fair taxation is at the heart of the social contract between the state and its citizens. It provides universal provision of essential services, health, education, access to clean water, sanitation, energy and disaster risk management (which are basic rights for all citizens), addresses inequality by providing resources indirectly to the poorest in communities and thereby increases their power.24

The 2016 Oxfam Briefing Paper No. 210 entitled “An Economy for the 1%: How privilege and power drive extreme inequality and how this can be stopped”, which is even more to the point, states: As tax returns from multinational companies and wealthy individuals fall short of their potential, governments are left with two options: either to cut back on the essential spending needed to reduce inequality and deprivation or to make up the shortfall by levying higher taxes on other, less wealthy sections of society and smaller businesses in the domestic economy. Both options see the poorest people lose out and the inequality gap grow. The offshore world and the opacity it offers also provide a safe haven for laundering the proceeds of political corruption, illicit arms dealing and the global drugs trade, contributing to the spread of globalized crime and facilitating the plunder of public funds by corrupt elites. Tax avoidance has rightly been described by the International Bar Association as an abuse of human rights and by the President of the World Bank as “a form of corruption that hurts the poor”. There will be no end to the inequality crisis until we end the era of tax havens once and for all. Achieving a global consensus on a more meaningful approach to tackling harmful tax practice is long overdue. Eighteen years ago the OECD’s Harmful Tax Competition report proposed that countries should consider terminating their tax conventions with listed tax havens. Unfortunately, OECD member countries that operate in practice as tax havens, together with other powerful members that are home to the world’s largest companies, succeeded in blocking further progress at that time. Sadly, we are still paying the price for this lack of political will. The more recent attempt of the G20/OECD Base Erosion and Profit Shifting (BEPS) project, endorsed by G20 leaders in November 2015, has again done little to curb harmful tax practices, and attempts to introduce tougher rules

c. to inform the general public and decision-makers about the causes and possible solutions; and d. to work as an international partnership of goodwill.” 24. Oxfam, The Power of People Against Poverty, Strategic Plan 2013-2019, p. 19, available at https://www.oxfam.org/sites/www.oxfam.org/files/file_attachments/story/ oxfam-strategic-plan-2013-2019_0.pdf (28 Aug. 2018).

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have been watered down. Under this process, there was an historic opportunity to reverse all the scandals and abusive practices that have been attracting headlines all over the world – but the chance was not taken.25

Further, in 2017, at the World Economic Forum in Davos, Winnie Byanyima, the Executive Director of Oxfam International, stated that, e.g. Kenya was losing USD 1.1 billion from tax incentives and exemptions, and drew from this data the following comparison: “That’s almost double its health budget; in a country where one in 40 children die at childbirth. This is really a human rights issue.”26 When the cost of certain behaviour begins to be counted in the number of infant corpses, it is safe to say that we have left the arena in which we are debating only legal technicalities and sound econometrics. We have entered the ideological battleground, and there is little we can do to withdraw from it. Morality, a value-based concept, comes into play in the works of not only idealistic human rights activists, but also battle-hardened tax academics. In the words of Avi-Yonah: I have argued that under any of the major views of corporations, corporations should not be permitted to engage in strategic behavior designed solely to minimize its taxes. From an artificial entity perspective, such behavior undermines the special bond between the state and the corporations it created. From the real entity perspective, it is as unacceptable as it would be if all individual citizens engaged in it. Further, from an aggregate perspective, strategic tax behavior does not leave the state with adequate revenues to fulfill the increased obligations imposed on it by forbidding corporations to engage in CSR. There are strong moral arguments against this strategic tax behavior that I have not covered in depth here. Passing the buck by shifting the tax burden to others, including taxpaying shareholders, hardly seems “responsible” in the moralistic sense. Even if competitors, especially foreign ones, practice reducing taxes as close to zero as possible, popularity does not justify immoral behavior.27

It is in the ideological domain that the notion of an international tax regime and the principle of single taxation triumphs. Our current international tax 25. Oxfam Briefing Paper No. 210, An Economy for the 1%: How privilege and power drive extreme inequality and how this can be stopped, pp. 20-21 (Oxfam 2016). 26. G. Wearden, Oxfam attacks failing global tax avoidance battle, Davos (2017), available at https://www.theguardian.com/business/2017/jan/19/davos-2017-oxfam-attacksfailing-global-tax-avoidance-battle (28 Aug. 2018). 27. R.S. Avi-Yonah, Corporate Taxation and Corporate Social Responsibility, p. 28–29, in 11 New York U. Journal of Law and Business 1, pp. 28-29 (2014). See also J.M. Fisher, Fairer Shores: Tax Havens, Tax Avoidance and Corporate Social Responsibility, 94 Boston University Law Review 1, pp. 337-365 (2014); and H. Gribnau, Corporate Social Responsibility and Tax Planning: Not by Rules Alone, 24 Social and Legal Studies 2, pp. 225-250 (2015).

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environment is craving strong foundational principles, which will allow us to comprehensively draft our tax policies and legal norms to implement them. The BEPS Project, the pinnacle of global efforts to achieve common solutions in international taxation, does not deal with the why, but rather with the what (to an extent) and the how.28 The G20 leaders managed to agree that “profits should be taxed where economic activities deriving the profits are performed and where value is created” and that “tax avoidance harmful practices and aggressive tax planning have to be tackled”.29 They put all of this in the context of “severe fiscal consolidation and social hardship”. Tax avoidance is an eternal problem, and measures to combat it cannot be the starting point of our tax systems. To understand which kind of tax avoidance concerns us and warrants concrete steps, we must have some reference point as to what our tax system ought to achieve. Social hardship is not a sufficient driver, as many countries, some of which are G20 members, could – provided that honesty is deemed an absolute virtue – argue that it was precisely their domestic law measures, in concert with the provisions of double taxation treaties, that allowed for double non-taxation, resulted in the growing prosperity of their populations and allowed for continuing economic development. Furthermore, one could also note that combating everyday indirect tax avoidance could perhaps have a more significant effect on the state of government coffers than BEPS-oriented measures. The idea of the existence of an international tax regime based on the single taxation and benefits principles may at least attempt to fill the void. With some alterations (as will be explained in section 9.4.), it aspires to answer the most relevant question as to why our tax systems should be drafted in a certain way. It is precisely because these concepts testify the dire need to determine the starting (value-based) point of any policy making process, that they should not be dismissed as worthless chimeras. Perhaps the international taxation regime does not exist. Perhaps the single taxation concept is plagued by many deficiencies and inconstancies. In time, as these concepts develop together with the world around us, we might face the same situation as those reading the Magna Carta Libertatum. Most of us have been taught that a little over 8 centuries ago, in 1215, on the meadow of Runnymede, King John signed the document laying down the foundations of civil liberties and the democratic system of government. However, if one were to actually read the text itself, one would be tested to find anything remotely related to these modern values, for the Magna Carta Libertatum 28. Y. Brauner, Treaties in the Aftermath of BEPS, Brooklyn Journal of International Law 3, pp. 995-996 (2016). 29. G20 Leaders’ Declaration (St. Petersburg, 6 Sept. 2013), para. 50.

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is a medieval document that takes for granted the inherent inequality of men (to even contemplate the equality of men and women would be sacrilege in those times, when wearing men’s clothes was sufficient to have a woman burned alive at the stake, e.g. Joan of Arc). The document deals with baronial privilege and does little – if anything – to alleviate the hardships endured by the vast majority of the population toiling under the yoke of serfdom. However, one can draw inspiration from the ideal at which the Magna Carta Libertatum story hints: curtailing despotic power or enumerating and protecting fundamental rights. Thus, we behead the first chimera of the lack of clarity and coherence of the single taxation principle by concluding that it is the inherent idea that guarantees durability, not the details (or actually all of the prima facie content, i.e. the Runnymede illusion).

9.4. The Ummah mindset and the Dutch migrant to Belgium who became the King of the Franks The second head of the chimera that symbolized the sovereignty argument loomed over the authors with terror. Ring’s words resonated menacingly; “No significant issue in international tax can be discussed without raising the question of sovereignty”.30 Our international tax order today is conditioned to the fact that the global community is compromised of sovereign nation-states that are free – provided that one does not adopt the theory that an international tax regime already exists – to tailor their tax systems as they see fit.31 However, even if one does not adhere to the notion that countries are not free to adopt any international tax rules they please, but rather operate in the context of the regime, one still has to acknowledge that globalization has affected the omnipotence of the sovereign nation-state: In the international tax market, where states compete for residents, investments, and tax revenues, their sovereignty becomes fragmented. Many residents can now unbundle states’ sovereignty and pick and choose from among the public goods other states offer. Under this unbundled sovereignty, states can no longer unilaterally ensure the cooperation of their citizens without either imposing illiberal restrictions on those citizens or else cooperating with other countries.

30. D.M. Ring, What’s at Stake in the Sovereign Debate?: International Tax and the Nation-State, 49 Virginia Journal of International Law 1, p. 156 (2008). 31. S.A. Stevens, The Duty of Countries and Enterprises to Pay Their Fair Share, 42 Intertax 11, p. 702 (2014).

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Thus, as far as tax and redistribution are concerned, under globalization, the state can no longer be considered a sovereign endowed with monopolistic coercive power.32

Vanistendael is resolute as to the finiteness of the process of globalization: “The idea of regaining control of our national economic borders and returning to the situation prior to economic globalization is a Fata Morgana.”33 Here, we find ourselves in a sort of a limbo. On the one hand, the sovereignty of nation-states has been affected by globalization and the technological revolution that is taking place as we speak. On the other hand, the nation-state is still the key player on the world stage, and, with perhaps the ever more relative exception of the European Union, countries are driven to cooperation by pure self-interest. What is more important is that the perspective by which this self-interest is determined is still fully emerged in the rather selfish understanding of the sovereignty of individual nationstates and the need to protect their ability to collect revenue, regardless of how that revenue is to be spent.34 Alternatively, voices can be heard (and these seem to be getting louder by the day) promoting the tailoring of an international tax regime with the goal of fighting poverty and achieving a more just allocation of wealth in the world. However, these lamentations also take for granted the existence of nation-states and are directed against a mindset in which hurting others in order to promote one’s own welfare is not acceptable behaviour. It is doubtful that either the selfish sovereign nation-state perspective (cooperative or competitive) or the one focused on fighting economic inequality will aid the creation of an international tax regime. History has very few examples wherein nation-states were immune to selfish interests. Furthermore, poverty and the misery of others has never been a key driver of the policy of those who are well off (again, the selfish interest element). Thus, if we adopt a rather grim but nevertheless realistic view that selfishness can be taken as a given, we can find a self-interest argument to support the view that the statist approach is obsolete.

32. T. Dagan, International Tax and Global Justice, 18 Theoretical Inquiries into Law 1, p. 4 (2017). 33. F. Vanistendael, Democracy, Revolution and Taxation, 71 Bull. Intl. Taxn. 8, p. 446 (2017), Journals IBFD. 34. G20 Leaders’ Declaration, supra n. 28, at para. 50.

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Sangiovanni stated: Equality as a demand of justice is a requirement of reciprocity in the mutual provision of a central class of collective goods, namely those goods necessary for developing and acting on a plan of life. Because states … provide these goods rather than the global order, we have special obligations of egalitarian justice to fellow citizens and residents, who together sustain the state, that we do not have with respect to noncitizens and non-residents. This does not imply that we have no obligations of distributive justice at the global level, only that these are different in both form and content from those we have at the domestic.35 […] Consider the basic extractive, regulative, and distributive capacities central to any modern state. When well-functioning, these basic state capacities, backed by a system of courts, administration, police, and military, free us from the need to protect ourselves continuously from physical attack, guarantee access to a legally regulated market, and establish and stabilize a system of property rights and entitlements. Consider further that state capacity in each of these areas is not manna from heaven. It requires a financial and sociological basis to function effectively, indeed even to exist. Yet, the global order, in all cases but those of failed and occupied states, does not provide this basis. Although the global order secures the recognition of the state as a legal person in international law and in some cases also provides an external source of finance (e.g. through [International Monetary Fund] loans), citizens and residents, in all but the most extreme cases, provide the financial and sociological support required to sustain the state. It is they who constitute and maintain the state through taxation, through participation in various forms of political activity, and through simple compliance, which includes the full range of our everyday, legally regulated activity. Without their contributions to the de facto authority of the state – contributions paid in the coin of compliance, trust, resources, and participation – we would lack the individual capabilities to function as citizens, producers, and biological beings.36

While it would be relatively easy to agree with Sangiovanni, we must pause here and note that the modern nation-state essentially developed in the Western world (i.e. Europe and North America) in the last 3 centuries. Kissinger names Cardinal Richelieu in the 17th century as the father of the modern nation-state37 and notes that it took other European states another century to adopt this French novelty. The period in which the nation-state triumphed is also a period in which we take for granted circumstances that 35. A. Sangiovanni, Global Justice, Reciprocity, and the State, 35 Philosophy & Public Affairs 1, p. 4 (2007). 36. Id., at pp. 20-21. 37. H. Kissinger, Diplomacy pp. 58-59 (Simon and Schuster 1994).

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never before existed in history: continuous progress and the triumph of mankind over nature. More particularly, in the last 100 years, i.e. in the period that coincides with the development of international tax law, in many parts of the world, we forgot how to fear hunger and pestilence. It is as if our selfishness has been born out of our opulence (in comparison to the environment of our ancestors). Unfortunately, it would seem that the good days are over. Climate change is affecting millions, and we are just now starting to feel the first pinches of developments that are bound to bring excruciating pain. On an overpopulated planet where food and drinking water are becoming ever scarcer, rising water levels are endangering our cities and rising temperatures are already causing mass migrations, it is difficult to see how unilateral action can have a meaningful impact. Perhaps some of us may trust in walls to defend our national, sovereign state borders from migrants that today come from places plagued by heat waves and merciless droughts, but may very soon come from submerged plains near the oceans. Alas, walls will not stop or bring the sun, the wind or the rain. For the first time in history, the human race is faced with challenges that demand global action and where consequences, good or bad, cannot be avoided by anyone. There is no room to hide. Individual innocence or guilt will not play a role. Only communal action will, and such action will carry a great cost. Thus, while in the past, it would be quite idealistic to dream of an international tax regime, the harsh reality that the future brings and the battles that are already set for us will demand that we find a way to pay for the trespassings of our kind against nature and for our own survival. True, the trials that lie before us seem quite unique, but the idea of large, heterogeneous groups of people with strong sectarian instincts and traditions being drawn together into a single communal polity by virtue of selfpreservation interests is not that novel. If one were to go back in time some 1.5 millennia and visit the area of the planet that would suffer most from draught and temperature increases in the future, namely the Middle East, we would see precisely this social change taking place. Indeed, it was under the auspices of Islam that the Prophet Mohammed was able to forge a single Ummah (society) out of the warring tribes of Arabia, who would be later on joined by quite different peoples on (initially) three continents. It was the creation of the Ummah that allowed the peoples who, until that time, were scratching a bare sustenance living and were dwelling on the fringes of history, to, within a few decades, create one the largest empires ever seen and lay the foundations of a religious, ethical and legal concept that is adhered to today by almost a quarter of humanity. It is not so surprising to find that 252

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in order to fund this Ummah, a specific form of taxation, “Zakat”, was envisioned, and one should now attempt to see that we can draw inspiration from the dangers threatening our own eco-Ummah, a society molded by the threat of a looming environmental and climate catastrophe, in order to tailor the international tax regime of tomorrow. Would it be sacrilege to suggest that the future international tax regime and single taxation could potentially be achieved through environment-based taxation, i.e. a global system where the polluter, whether individual or corporate, pays locally for the consumption of natural resources and for polluting the environment? Such a system would do away with the need to define “single taxation” in terms of a single payer or single instance or effective tax rate. There would also be no distinction between individual and corporate taxpayers, nor between debt and equity. The polluter would simply pay a standard rate of tax (defined in terms of kilograms mined or cubic centimeters released, for instance) in the jurisdiction where the consumption or pollution takes place. Hence, environment-based taxation is in line with the Ummah mindset, as it focuses on protecting the environment, which should presently be a prime concern for all jurisdictions. The main argument against environment-based taxation is that it would decrease tax revenues worldwide. However, research and forecasts by economists as well as tax experts show that shifting away from the current income-based taxation system towards an environment-based taxation system could potentially raise the same revenues globally. Admittedly, the distribution of tax revenues between the various jurisdictions could change drastically, but such a system of taxation would logically have to be complemented by a mechanism that allows for channeling resources globally.38 Given that the population is increasing rapidly while resources are rapidly declining, shifting away from taxes on labour towards taxes on scarce resources would be for the benefit of all. However, turning the age-old income-based taxation system completely on its head (even though it no longer reflects the way the world works today) might be unlikely, given that some jurisdictions stand to gain more than others. Yet, for argument’s sake, 38. For instance, the great island of plastic waste floating in the Pacific is located in international waters and, as such, is the responsibility of no individual nation. However, it is contributing to the depletion of fish supply, which serves to feed all of mankind. As all of mankind contributed to the creation of the great island of plastic waste, all of mankind should help pay for the cleanup.

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a global system of locally payable taxes would preserve the “sovereignty” of the various jurisdictions to the extent that they would be able to tax the consumption and pollution within their jurisdictions in accordance with globally decided rates. Hence, it would seem that the only hindrance to achieving “single taxation” – the illusive Holy Grail of taxation – is the political disharmony that would arise out of the discussion regarding the shift away from the current system. Environment-based taxation might merit more thought and discussion than we currently attribute to it, especially if one envisions a global tax system that doesn’t need to be constantly updated with anti-avoidance measures. As we have seen, the edifice of sovereignty may be crumbling before our very eyes, and it is not strange that the words by which St. Remigius baptized Clovis, the first Merovingian King of the Franks, resonate loudly:39 “Mitis depone colla Sicamber, adora quod incendisti, incendi quod adorasti!”40

9.5.  The Echnaton conclusion More than 33 centuries ago, Pharaoh Amenhotep IV ruled in ancient Egypt. In the 5th year of his reign, he changed his name to Echnaton (or Akhenaten) and decided to replace the polytheistic religion of his kingdom with something resembling a quasi-monotheistic creed centred around the deity of Aten. Echnaton’s policies were short-lived, but as centuries passed, the concept he introduced transformed and gained strength and is today adhered to by the majority of mankind (i.e. the great monotheistic religions, the origins of which are influenced by ancient Egypt). The statues of Echnaton found in Amarna, at the site of the city he founded and devoted to Aten, portray a strange-looking individual, one with almost an alien disposition. Based on the story of Echnaton, the authors drew their final conclusions in defence of the notion of an international tax regime and the principle of single taxation as follows:

39. The Franks migrated south from the southern part of the Netherlands and the northern part of Belgium and finally gave their country the name of France. 40. “Bow down your head Sicamber, worship that which you have burned and burn that which you have adored!”

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– most of the critical arguments against the authors’ stance are made either in defence of the status quo or go after the details of a system that is still in the phase of theoretical conception and thus entitled to some leeway; and – perhaps the ones who are promoting the idea of single taxation seem odd (like Echnaton); perhaps the idea seems novel, and perhaps it requires a dose of courage, but the idea itself has one strong ally: the reality of the world around us and the grave need to think and act globally, because the ultimate threats to our future are global. Single taxation is not a worthless chimera. In fact, it is the holy grail of international taxation that should be eagerly pursued in an attempt to provide a much-needed theoretical starting point from which to tailor our international tax rules. Instead of dismissing the idea of an international tax regime as a delusion, we should be invested in research and reconciliation in order to achieve a fair and efficient international tax system (whether it be based on environmental taxation or something else) that might one day help solve the ecological and political problems that plague the planet. The authors sincerely believe that this is achievable, despite our diverse heritages, cultures, traditions and interests, because we have more in common than we think, and this makes the journey before us a little bit easier, or at least enjoyable.

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List of Contributors Daniel M. Berman, A.B. & J.D. (Harvard University), was National Tax Principal at RSM (retired 2018) and is Adjunct Professor of Law at Boston University. He was previously Director of the Graduate Tax (LL.M) Program and Professor of the Practice of Tax Law at BU Law. He practiced international tax law for 25 years in Washington, D.C. in major law firms and in the federal government, serving as Legislation Counsel to the Congressional Joint Committee on Taxation and as Deputy International Tax Counsel to the US Treasury Department. He is the author of Making Tax Law (Carolina Academic Press 2014), as well as many articles. Francesco De Lillo, Master of Law (Milan) and advanced LL.M in international tax law (Amsterdam), is currently Associate within the European Team of the IBFD Knowledge Centre. He has several years of experience in the academic-legal publishing sector and he opened the floor for the 2017 edition of IBFD’s Duets in International Taxation. His scientific interests include international tax law principles, anti-avoidance policies and hybrid mismatches. Guilherme Galdino received his LL.B from the University of São Paulo. He is currently a lawyer at Lacaz Martins, Pereira Neto, Gurevich & Schoueri Advogados in São Paulo. Eric C.C.M. Kemmeren is Professor of International Tax Law and International Taxation at the Fiscal Institute of Tilburg at Tilburg University, the Netherlands. He is also a member of the board of the European Tax College, Deputy Justice of the Arnhem Court of Appeals (Tax Division), and of Counsel to Ernst & Young Belastingadviseurs LLP in Rotterdam, the Netherlands. Svetislav V. Kostić is a Docent at the University of Belgrade Faculty of Law, where he teaches general tax law, international tax law and EU tax law to both undergraduate and graduate students. He is a graduate of the University of Belgrade Faculty of Law and holds a Doctorate degree from the same university (2014) and an LL.M degree from the New York University School of Law (ITP 2007/2008). Neha Mohan is a recent graduate of the UvA-IBFD Master’s Programme for International Tax Law and currently works at IBFD as a Research

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Associate in the European Knowledge Group. She has previously worked at PwC in India in the Direct Tax Group, mainly focusing on international advisory and litigation assignments. Her research interests lie in the interdisciplinary aspects of tax, economics and sociological impact, specifically tax fairness and ecological taxation. Luís Flávio Neto is a postdoctoral research fellow at IBFD in the Netherlands, as well as a tax law professor at the Brazilian Institute of Tax Law and Universidade São Judas Tadeu (USJT) in Brazil. Dr Neto is also a judge at the highest administrative tax court of Brazil (CARF) and a member of the International Association of Tax Judges (IATJ). He holds an LL.M and a PhD from the Universidade de São Paulo (USP) in Brazil. Luís Eduardo Schoueri is a full Professor of Tax Law at the University of São Paulo Law School, the Vice President of the Brazilian Institute of Tax Law (IBDT) and a founding partner at Lacaz Martins, Pereira Neto, Gurevich & Schoueri Advogados. He obtained a Master’s degree in Law from the University of Munich and completed Doctor and free professor degrees at the University of São Paulo. Frans Vanistendael is Professor Emeritus of the Catholic University Leuven, Belgium, where he was Dean of the faculty (1999-2005). He was a founding member of the European Association of Tax Law Professors, Academic Chairman of IBFD (2007-2013) and Director of the European Tax College (2000-2013). Prof. Vanistendael served as cabinet advisor to several ministers of finance in Belgium and as Royal Commissioner of Tax Reform (1987). He has written more than 400 books and articles on various tax subjects. Peter J. Wattel is Professor of EU Tax Law at the Amsterdam Center for Tax Law at the University of Amsterdam, Advocate-General of the Supreme Court of the Netherlands and State Councillor Extraordinary of the Netherlands Council of State. Joanna Wheeler is a senior member of the IBFD academic group and is seconded to the University of Amsterdam (UvA) as the Director of the Advanced LL.M programme “International Tax Law: Principles, Policy and Practice”. She has been the editor of many different IBFD publications, is the founding editor of IBFD’s database on the taxation of trusts and the pioneer of IBFD’s programme of online courses. In 2012, she was awarded her PhD by the University of Amsterdam.

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Xu Yan is Associate Professor at the China University of Political Science and Law, Director of the Institute of Hong Kong, Macau and Taiwan Law College of Comparative Law at China University of Political Science and Law. She was a visiting scholar at Boston University in the United States, as well as Freiburg University and Tuebingen University in Germany. Yan’s research fields are tax law, economic law and society law, especially focusing on the coordination of regional taxation. She is now a special researcher at the institute of taxation science at SAT in China and the member of Standing Council of the Beijing Finance and Tax Law Research Society.

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