Is Article 29(9) a game-changer? What would be the outcome of
existing jurisprudence in light of Article 29(9)?
Adv LLM thesis
submitted by
Umair Bashir
in fulfilment of the requirements of the
'Advanced Master of Laws in International Tax Law'
degree at the University of Amsterdam
supervised by
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name: Umair Bashir
date: 12.07.2020
Table of Contents
Table of Contents……… III
List of abbreviations used………..………. V
Executive summary……… VI
Main Findings………. VII
1.
Evolution of PPT……… 1
1.1. 1977 Model Tax Convention………... 1
1.2. The 2003 Model Convention………... 1
1.3. BEPS Action 6 Report laying foundation of PPT In The 2017 Model………. 2
1.4 (Co)Existence Of 2003 Guiding Principles and Article 29(9)……… 3
2.
Evaluation of the Principal Purpose Test………... 5
2.1. Understanding PPT………. 5
2.2. Burden of Proof………. 5
2.3. The Subjectivity Test……… 7
2.4. Exploring ‘One of the Principal Purposes’ in the Reasonability Test……… 8
2.5. Analysis of the ‘object and purpose’ in Article 29(9)……… 10
2.6. Whether the PPT brings legal certainty?... 11
2.7. Exploring the Principle of Good Faith in Context of Article 31(1) of VCLT………. 12
3.
Analysing Cases in Light of The Principal Purpose Test Rule………... 14
3.1. LSF-KEB Holding SCA & Ors. v Republic of Korea………... 14
3.1.1. Facts & Judgment………... 14
3.1.2. Analysis……… 14
3.1.3. Examining the case in light of the PPT rule………... 15
3.2. Royal Dutch Shell Case……… 16
3.2.1. Facts and Judgment……….. 16
3.2.2. Analysis……… 16
3.2.3. Examining the Case in Light of the PPT Rule……… 17
3.3. Alta Energy Luxembourg Case [2020]……….. 17
3.3.1. Facts and Judgment………... 17
3.3.2. Analysis……… 18
3.3.3. Examining the case in light of the PPT rule………... 18
3.4 X Holding ApS………. 19
3.4.1 Facts and Judgment……….. 19
3.4.2. Analysis……… 20
3.4.3. Examining the case in light of the PPT rule……… 21
3.5. Northern Indiana Public Service Corporation v. Commissioner……… 22
3.5.1. Facts and Judgment……….. 22
3.5.2. Analysis……… 22
3.6. Azadi Bachao Andolan………. 23
3.6.1. Facts and Judgment……….. 23
3.6.2. Analysis……… 24
3.7. Vodafone International Holdings BV v. Union of India……….. 25
3.7.1. Facts and Judgment……….. 25
3.7.2. Analysis……… 25
3.7.3. Examining the case in light of the PPT Rule………. 25
4.
Conclusion - Is Art 29(9) a game changer?... 26
Bibliography………
28List of abbreviations used
Art. Article
BEPS Base Erosion and Profit Shifting BIT Bilateral Investment Treaty
CJEU Court of Justice of the European Union DTC Double Tax Convention
FCA Federal Court of Appeals FDI Foreign Direct Investment FII Foreign Institutional Investment GAAR General Anti Avoidance Rules
HMRC Her Majesty’s Revenue and Customs HTIL Hutchinson Telecom India Limited
IBFD International Bureau of Fiscal Documentation ISBN International Standard Book Number
KEB Korea Exchange Bank
LSF Lone Star Fund MLI Multilateral Instrument
MTT Model Tax Treaty
NAPS Northern Indiana Public Service Company
NL Netherlands
OECD Organization for Economic Cooperation and Development PPT Principal Purpose Test
SAAR Specific Anti Avoidance Rules
SC Supreme Court
SSRN Social Science Research Network TCC Tax Court of Canada
UK United Kingdom
US / USA United States of America
Executive summary
The OECD in its BEPS Action 6 Report proposed certain solutions for avoiding improper use of tax treaties. One of the main keystones of the recommendations has been the introduction of the ‘Principal Purpose Test’ – which later culminated to Article 29(9) of the OECD 2017 Model. Further legitimacy for this anti-abuse provision has been given by having the PPT as a minimum standard under the MLI for all countries involved in the inclusive framework. This thesis examines the history, philosophy and mechanics of the PPT. It further prophesizes if some of the major cases on denial of treaty benefits on account of (alleged) abuse of treaty - delivered by domestic courts in India, Canada, USA, UK, Switzerland and South Korea – would survive the (arguably) stricter test of the PPT. All of this is, of course, not to say that before 2017, there was no frowning upon of improper use of treaty benefits. The commentaries to Article 1 in the 2003 model made it very clear that that treaty benefits ought to be denied if one of the main purposes of the underlying transaction is found to have been entered into for obtaining a favourable tax benefit. Other more rudimentary statements for denying improper use of treaty benefits were present even in the 1977 model.
The traditional understanding is that the upgrade in the 2017 model from the 2003 model is (i) the 2017 model mandates prevention of treaty abuse in the text itself, rather than just the commentary as present in the 2003 model (ii) the burden of proof is shifted (at least to some extent, depending on various authors’ views) from the tax authority to the taxpayer to prove that the transaction was not entered into for tax reasons (iii) clear intention of preventing abuse being found in the preamble – further bolstering the object and purpose of the (provisions of the) treaty.
To our knowledge there is no judgment that has been delivered by any major court on the
interpretation of the PPT. Hence this thesis is all the more interesting for the reader (and maybe even a judge or a tax authority) to examine and understand from a judgment point of view, the exact scope of PPT while demonstrating the effect (if any) of the difference with the old (soft) law. Other experts have also written about PPT, but this thesis is different in as much as a judgment-based approach has been followed. This can also help businesses and their tax advisors to examine a holistic view of the provision and be more informed of the tax implications before entering into a given transaction. There are a lot of grey areas. For example, even before 2017, treaty ought to be read in light of its object and purpose (under the VCLT). One school of thought exists that the object and purpose of certain provisions were always spelt out (for example, having a beneficial owner requirement, time threshold requirement etc.) and so the novelty of the PPT raises an existential question. Literature also exists pondering on how exactly the burden is shifted (or even, if I may, shared) from (between) the tax authority to the taxpayer? To what extent ought the subjective element be analysed, and how strong is its marriage with the objective element?
For the specific cases analysed, if the taxpayer eventually got exonerated from the court and was allowed the treaty benefits before 2017, I believe that the taxpayer has a good enough case to survive PPT after 2017 as well because these tests have been indirectly addressed by the court one way or the other. This does not mean that PPT is not a game changer across the board – obviously the intention for prevention of improper use of tax treaty benefits has been set down in stone – and it is possible that some courts that perhaps were more hesitant to apply the commentary as binding law (or even hesitant in according a higher burden on the taxpayer) – would indeed need to rethink their position in light of the PPT. One may also believe that more than the provision itself, it is the preamble (which reflects more than anything the policy of the states, especially after entering the MLI regime) that might change direction of courts to believe that the scope of the PPT is indeed larger than the previous (soft) law.
Main Findings
Lonestar –The court indeed held that the transaction was of an abusive character on account of the presence of the conduit company to obtain improper tax benefits. Hence the court followed the
look-through approach. The benefits were sought to be accrued based on the Bilateral Investment Treaty
which was silent on abuse. No reference was made to the Korea – Belgium tax treaty. Surprisingly instead, the South Korea – US Tax Treaty was activated and the treaty benefits were denied. My analysis is that where without an anti-abuse provision in the treaty itself the benefits were structurally denied, clearly by imputation, with the PPT, there is no doubt that the benefits would also be denied. X Holdings – This is a case before 2017 wherein the court used the good faith doctrine to deny treaty benefits, even though there was no express anti-abuse treaty provision present. The court could have easily held in favour of the taxpayer and criticisms exist that the court referred the
commentary to import the good faith principle but still did not consider the overall ‘guiding principles’ – but criticisms aside, the court had indeed held in favour of the tax authorities. Hence, in presence of the PPT and ceteris paribus, I conclude that where there is an anti-abuse doctrine present, the result would surely remain the same.
Vodafone (and its relied on judgment, Azadi Bachao Andolan) –The Supreme Court had
understood the importance of condoning treaty shopping incidences for a developing economy and held that merely because almost all the investment in India from Mauritius is effectively from resident of third states, that alone does not warrant denial of treaty benefits. This said, applying the PPT rule, it is clear that the object and purpose of the Government of India entering into such
negotiations with the Government of Mauritius is to ensure that India gets investments and boosts its economy. Hence, even with PPT, the taxpayer can establish that granting the benefit is within the object and purpose of the provisions of the India-Mauritius treaty.
Royal Dutch Shell – This is a case where taxpayer had exercised his option of receiving the
dividends after the declaration of the dividend but before the release of the funds. The court held that the beneficial ownership requirement ought to be seen that the time of the payment, and not at the time of the declaration. Here, issuer of the coupon was unrelated to the taxpayer and the taxpayer indeed had agency on how to use the dividends once distributed. Granting of benefits under the distributive rules stresses the importance on such agency. I see no difficulty in the survival of PPT - such granting was indeed the object & purpose of the provisions of the convention.
Northern Indiana – Even with the PPT rule, I believe that the tax authority would find it very difficult to make a case regarding the subjective element because it was normal at that time for American companies interested in accessing the European financial market to route through the Netherlands Antilles. Even the objective element cannot be passed by the tax authority because the Antilles entity indeed made a substantial profit over a spread of 1% and they had full agency / authority on usage of such funds to make more profits. Hence, PPT would not change the fate of this judgment. Alta – In Alta, the treaty clauses were negotiated in such a way that there was exemption in the source state (Canada) in the given transaction while knowing very well that there is exemption in the resident state as well (Luxembourg). This clearly was the object and purpose of the parties, because (i) granting of the benefits was not part of the OECD model – it was separately negotiated between the parties and (ii) if the intention was indeed to ensure that the tax was taxed at least once (somewhere), then the parties would have appropriately negotiated a subject to tax clause. Fact that they did not, shows that granting of the benefits was very well within the object and purpose of the provisions of the convention and I believe that PPT would not stand in the way of granting treaty benefits.
1. Evolution of PPT
1.1. 1977 Model Tax ConventionThe Model 1977 for the first time, introduced the world to the issue of Treaty Abuse. The Paragraphs 8 and 9 of Commentary to Article 1 of 1977 Model laid down the conceptual foundation of treaty abuse, also known as treaty shopping- describing it as an event where taxpayers, who are
non-resident of the Contracting State tries to take tax advantages by “creation of usually artificial legal constructions”1 or through a “legal entity”2 available under the concerned domestic rules of that
Contracting State. The model incorporated a limitation upon these practices wherein the source country was capable of granting reduction as well exemption in taxes on dividends, interest and royalties where the beneficial owner of the recipient income was a resident of the other Contracting State. The major takeaway from Para 12.1 of the Commentary to Article 10 is that a mere conduit company cannot be a beneficial owner, and accordingly treaty benefits ought not to be made
available to such conduit; that 1977 had a very rigid definition of beneficial ownership and the basis of exclusion of nominees, agents and conduits.
On a conjoint reading of Paragraph 7 and Paragraph 10 to Article 1, the 1977 Model points out the (i) rampant exploitation by taxpayers resident in contracting states without entering into tax treaties (through, for example, conduits) and stresses on preservation of the domestic anti-avoidance rules, and (ii) as well granting protection from Domestic Anti-avoidance rules to residents of those states which have entered into tax treaty(ies) with the other states, in absence of any preservation clause.3 The 1977 Model4 failed to provide for methods that could provide a balance between preserving the object and purpose of tax treaties and domestic GAAR, and curb the growing treaty abuse practices. 1.2. The 2003 Model Convention
In the 2003 Model, the OECD Committee recognised the growing trend of countries using world-wide network of tax treaties facilitated by use of artificial legal constructions5 to indulge in treaty shopping and avail tax benefits under domestic laws and exemptions under treaty arrangements. In this context addition of Paragraph 7 and 9.5 in the Commentary is relevant in van Weeghel’s view, who states that inclusion of these paragraphs made it clear that it is also the purpose of the model convention (tax conventions) to prevent tax avoidance and evasion.
The 2003 OECD Commentary in Paragraph 9.5 to Article 1 lays down the guiding principle (for the prevention of treaty abuse). The guiding principles laid down the foundation for the reasonability test, wherein the first part of the sentence dealt with the tax benefit being availed being the main purpose, and the latter part dealt with the benefit considered valid and legal if it is within the object and purpose of the provisions, and simultaneously, the convention would not preclude application of Domestic
1 Paragraph 8 to Commentary to Article 1, OECD Model Tax Convention on Income & Capital (11 Apr. 1977), Model IBFD.
2 Paragraph 9 to Commentary on Article 1, OECD Model Tax Convention on Income & Capital (11 Apr. 1977), Model IBFD.
3 Stef van Weeghel, ‘A Deconstruction of the Principal Purposes Test’ (2019) 11 World Tax Journal 3-45, p.6.
4 Ibid.
avoidance Rules. As per Arnold6 and Jimenez7, this position is contradictory and conflicts with the purpose of 2003 tax (read: the prevention of tax evasion). This is self-contradicting stand, as it causes a conflict between preservation of Domestic GAAR and at the same time, effective implementation of tax treaties. The Paragraphs 13 to 19 to Article 1 were a summary of the concepts laid down in the earlier OECD Conduit Companies Report.8
However, to the contrary, the reason behind the member states not incorporating the guiding principles in their treaties was, as van Weeghel observes: a fear that it would erode the earlier practice of countries using their domestic anti-abuse principles in absence of treaty SAAR. Further, incorporating this change in their treaties would require re-negotiation, which would impact treaties not subject to re-negotiation. Lang believes that older treaties ought not to be read in light of the later commentary – as the older treaties are drafted to suit their own “economic interests and peculiarities of their law and social systems”9. The first instance of the Commentary’s application and reference was in the Case of A. Holding ApS10 which brought about a landmark change: for the first time ever in determining the issue of treaty abuse, the Courts looked at the prohibition of abuse of rights, then dwelled on the intention of tax avoidance or beneficial ownership.11 The Court referred to various Paragraphs to Commentary attached to Article 1 of the 2003 Model to determine treaty abuse yet, did not rely on the guiding principles in determining the abuse, and instead referred to the unwritten treaty principle of prohibition of abuse derived from Article 31(1) VCLT.
Article 31 of VCLT doesn’t recognise Commentary for the purpose of interpretation of treaties-since guiding principles were never retained in the model convention-hence, its reach was limited to applying as only a soft law12, which can only provide guidance but not implement a stricter regime.
1.3. BEPS Action 6 Report laying foundation of PPT In The 2017 Model
The OECD Final Report of 2015 included 15 action items containing recommendations, inter alia, Action 6 which highlighted the mechanisms of treaty abuse. This Report (para 19) provided solutions to deal with the issue of treaty shopping, covered on the following subsequent levels:
(i) Spelling out clearly that contracting states wish to prevent tax avoidance, esp. avoid creating opportunities for treaty shopping.
(ii) Having an anti-abuse rule based on the limitation-on-benefits provisions.
For situations not covered in (ii), having an anti-abuse rule based on the principal purposes of transactions or arrangements, incorporating principles reflected in paragraphs 9.5, 22, 22.1 and 22.2 of the Commentary of Article 1.
6 Brian J Arnold, ‘Tax Treaties and Tax Avoidance: The 2003 Revisions to the Commentary to the OECD Model’ 58 Bulletin for International Fiscal Documentation (2004) pp. 244-260, at p.249.
7 Adolfo Martin Jimenez, ‘The 2003 Revision of the OECD Commentaries on the Improper Use of Tax Treaties: A Case for the Declining Effect of the OECD Commentaries?’ 58 Bulletin for International Fiscal
Documentation 6 (2004) pp. 17-30 , at p.19.
8 OECD, Report on Double Taxation Conventions and the Use of Conduit Companies (OECD 1987). 9 Michael Lang, Introduction to the Law of Double Taxation Conventions (Amsterdam, Linde Verlag GmbH, IBFD 2014) ch II. State Practice in the Conclusions of DTCs 4. Bilateral Pecularities, at p.29.
10 X Holding ApS- Federal Tax Appeals Commissions, SRK 2003-159, 3 March 2005. 11 Article 4(1) of the 2003 OECD Model.
12 Sunghak Baik and Matthias Petutschnig, ‘Objective or Subjective - Anti-Treaty Shopping Policy in Selected Asian Jurisdictions in the Post-BEPS World’ [2018], Singapore Management University School of
Accountancy Research Paper No. 2018-S-73 (Special Issue: Tax) <http://dx.doi.org/10.2139/ssrn.3104976>
Action 6 improved upon the 2003 revisions and was able to achieve the OECD recommendations in the entirety of its effect. This is reflected in Article X of 2015 Report which is inclusive of both the objective anti-treaty LOB13 rule as well as the subjective PPT.14
The Action 6 item could go into effect without bilateral treaty negotiations principally due to MLI. This led to issuing the Multilateral Convention to implement the treaty related measures to prevent Base Erosion and Profit Shopping15 MLI applies, in context, along with the Treaty to modify its Application in accordance with the best recommendations. The Principal Purpose Test has been incorporated into article 29(9) of the OECD Model.16
Earlier, the anti-abuse paragraphs under the 2003 Commentary were perhaps not as effective, because they were not covered under Article 31(2) of the Vienna Convention on the Law of Treaties (‘VCLT’), since, by nature, it is only a commentary. However, upon the incorporation of important amendments to into the 2017 treaty, the anti-abuse provisions ought to be read in light of Articles 31(2) and 32 of VCLT. Under Article 29(9), there exists (i) a subjective element (i.e., determination of the intention of the taxpayer) and (ii) an objective element (i.e., the determination of the facts and circumstances). As regards the burden of proof, one can conclude that (i) from the point of view of the tax authorities – they need to reasonably conclude, (with regard to all relevant facts and
circumstances) that the obtaining of a (tax) benefit was one of the principal purposes of any
arrangement or transaction (ii) From the point of view of the taxpayer – they need to establish that the granting of that benefit is in accordance with the object and purpose.
1.4 (Co)Existence Of 2003 Guiding Principles and Article 29(9)
According to the Guiding Principles, where the ‘main purpose’ for entering into certain transactions or arrangements is to secure a more favourable tax position; the pursuance of which is in contravention to the object and purpose of the relevant provisions, the parties should not be granted any benefits from that convention.
Thus, the guiding principles incorporate a subjective (main purpose) and objective requirement (more favourable tax position). This gives the 2003 Convention a form of treaty GAAR wherein general standards are laid down obligating the parties to adhere to these standards on the basis of which benefits may be granted.
Accordingly, in a case17 where the ‘main purpose’ for entering into certain transactions or
arrangements is to secure a more favourable tax position; the pursuance of which is in contravention to the object and purpose of the relevant provisions, the parties should not be granted any benefits from that convention.
13 Article X (1) – (5) Entitlement to Benefits, OECD, Action 6, Preventing the Granting of Treaty Benefits in Inappropriate Circumstances (2014).
14 Article X (7) - Ibid.
15 Multilateral Convention to Implement Tax Treaty Related Measures to prevent base Erosion & Profit Shopping. (7/6/17) Treaties IBFD.
16 “Notwithstanding the other provisions of this Convention, a benefit under this Convention shall not be
granted in respect of an item of income or capital if it is reasonable to conclude, having regard to all relevant facts and circumstances, that obtaining that benefit was one of the principal purposes of any arrangement or
transaction that resulted directly or indirectly in that benefit, unless it is established that granting that benefit in
these circumstances would be in accordance with the object and purpose of the relevant provisions of this
Convention.”
Under the Guiding Principles, the burden of proof was heavily placed on the tax authorities, where they have to prove that the taxpayer’s transaction is in satisfaction of both the tests. With the advent of the 2017 Model, the aspect of burden of proof is split between both tax authorities and taxpayer. Where, even though the Tax authorities have to undertake an objective analysis of the transaction, they can ‘reasonably conclude’ whether availing benefits was one of the principal purposes. De Broe and Luts18 are of the opinion that the division of balance of proof is ‘manifestly unbalanced’ and asymmetrical as opposed to the guiding principles, where both the tests have to be established on an ‘equal footing’.
Regarding the Objectivity Test, Moreno19 is of the view that 2017 Model is comparatively more restrictive than the guiding principles, as determination of object and purpose is limited to the relevant provision only. Even van Weeghel20 is of the view that the objective requirement by extending its scope of application to the ‘object & purpose’ of the entire treaty, is rather vague due to its broad implications. Further along, the Guiding Principles in its text provided for inclusion of implicit tax treaty anti-abuse provisions.
As opposed to the 2003 Guiding Principles, the OECD has decided to opt for ‘one of the principal purposes’ rather than ‘main purpose’. Chand is of the view that this has lowered the threshold for determination of abuse, as “This implies that, even if an arrangement has many main/principal purposes and to obtain a tax benefit was one of the main/principal purposes, the arrangement
undertaken by the taxpayer will satisfy this test. Thus, by providing for “a main purpose” or “one of the principal purposes” test the OECD provides for a low threshold to uphold the abuse of a tax treaty.”21 The PPT Rule in the 2017 Model is built on the framework of the guiding principles, yet it seeks to apply in isolation and independent from other provisions of the convention. What is striking over here is the insertion of Paragraph 61 of the Commentary on Article 1, which states that the guiding principle will operate independent of Article 29(9). Further Para 76 states that incorporation of legislative GAAR which is intended to prevent abusive arrangement, reflects the principle of Para 61, and in this scenario, this will satisfy the requirements of Article 29(9)22, thereby concluding no conflict between the domestic GAAR and Article 29(9).
Regarding ensuring compatibility of the tax treaties with the PPT rule, Article 1 of 2017 Model has taken cue from Article 1 of 2003 model and has stated that domestic anti-abuse rules will be required to comply with the treaties to the extent that the benefits would have also been denied under the guiding principles. Danon23 is of the view, that this position is more inclined towards the interpretative value than establishment of facts.
18 Luc De Broe and Joris Luts, ‘BEPS Action 6: Tax Treaty Abuse’ 43 Intertax (2015), pp.122–146, at p.131 19 Andrés Báez Moreno, ‘GAARs and Treaties. From the Guiding Principle to the Principal Purpose Test. What Have We Gained from BEPS Action 6?’ 45 Intertax (2016), pp.432-446, at p.437.
20 van Weeghel (n 3), at p.14.
21 Vikram Chand, ‘The Guiding Principle and the Principal Purpose Test’, 12 International Taxation 34 (2015), pp.484-490, at p.487.
22 Para 77 of Commentary to Article 1, 2017 OECD Model.
23 Robert J Danon, ‘The PPT in Post-BEPS Tax Treaty Law: It Is a GAAR but Just a GAAR!’ 74 Bulletin for International Taxation (2020), pp.1-60 at p.11.
2. Evaluation of the Principal Purpose Test
2.1. Understanding PPT:The bare text of the Article 29(9) is divided into two parts for creating a better distinction of
requirements to be met by concerned authorities. This is to recognize the paradigm shift in burden of proof of the two main bodies involved-The tax-payers and the tax-authorities- a change from the earlier position in the Guiding Principles of 2003
Firstly, it is important to understand what the OECD MTT considers as benefit as inclusive of “all limitations (e.g. a tax reduction, exemption, deferral or refund) on taxation imposed on the State of source under Articles 6 through 22 of the Convention, the relief from double taxation provided by Article 23, and the protection afforded to residents and nationals of a Contracting State under Article 24 or any other similar limitations.”24 This portion of the text is ideally known as the Reasonableness test, or more commonly the Subjective part of the text. Here, the initial burden is placed on the Tax Authorities to make an objective assessment of the facts and circumstances surrounding the benefits to be granted resulting of the transaction; and further determine whether availing this benefit was one of the principal purposes of the transaction.
The portion of the text of Article 29(9) is essentially known as the Objective Test, as reproduced below:
“… unless it is established that granting that benefit in these circumstances would be in accordance with….”
In this test, the burden of proof is shifted to the Tax-Payers once the Tax Authorities are able to pass the Reasonableness test with respect to motive of the Tax-payers;25 The taxpayers have to establish that benefits sought to be granted are not operating in contravention to the relevant provisions of the Convention. Before delving further into the Subjective-Objective Tests of PPT, it is important to explore the angle of Burden of Proof in PPT and how the latest 2017 Model has changed the scenario - to better understand what the two tests entail.
2.2. Burden of Proof
As stated above, the (apparent) shift of ‘Burden of Proof’ is the most noteworthy change that the 2017 MTT seeks to bring about. In the earlier 2003 MTT, the entire onus of establishing the abusive nature of the transaction was to be borne by the tax Authorities. While the 2017 MTT, the OECD attempted to create a separation of elements to be individually satisfied by either of the payers or the tax-authorities, the lack of a cohesive structure in this distinction may create a lot of confusion.
It appears that Article 29(9) has shifted the burden of proof on the taxpayer which was not the case as in guiding principle as discussed earlier in Part 1.4.26 In guiding principle, onus to prove Subjective and objective elements is on the tax authorities. This topic is not as simple as it seems to conclude that onus is entirely shifted to the taxpayer. Different scholars believe that burden of proof in the PPT is biased in the favour of the tax authorities as they have a lower threshold to fulfil as compared to the 2003 model.
24 Para 175, Commentary to Article 29(9) of OECD 2017 MTT. 25 van Weeghel (n 3). at p.14.
Lang has defined the burden of proof as “the requirements are not too demanding - it must be merely “reasonable”: but not, for instance, compelling. Therefore, the tax authority does not need to produce full evidence thereof”.27 In a very recent28 piece, Lang has said that the burden on the taxpayer in establishing that the benefits granted is within the object and purpose of the convention is not an exception to the main rule (first level exception), rather it is an exception to the exception to the main rule (second level exception). To put it simply, he says that (i) Granting of treaty benefits (generally) – is the rule; and requires a broad interpretation, albeit within the scope of the VCLT (ii) The denial of treaty benefits granted in (i) – is the (first level) exception to the main rule, and therefore ought to be read narrowly. In (iii) the requirement of the taxpayer to establish that the benefits granted in (i) is indeed within the object and purpose of the provisions of the convention (as is anyway required to be ensured under the VCLT) is consequently, a (second level) exception to the exception to the main rule. This ought to be again read broadly. Therefore, he views that there has really not been any major shift in terms of a policy change or in terms of the onus distribution between tax authority and the taxpayer. He himself admits that (ii) and (iii) effectively emphasizes the need to ensure that the benefits are within the object and purpose (which was always a requirement under the VCLT
anyway). In other words, the tax payer’s onus in establishing his object and purpose in (iii) ought to be read ejusdem generis to the granting of the treaty benefits in (i). Consequently, he views that no benefit can ever be denied under Article 29(9) – because any benefit that is granted under (i) in light of its object and purpose, even if sought to be denied in (ii), will always be rekindled in (iii).
Chand depicts, “even though the tax authorities will be required to undertake an objective analysis of the facts of the transaction they only have to ‘reasonably’ (and not convincingly) conclude that the subjective element is satisfied.”29
Per Weber 30, ‘’reasonable to conclude does not mean the weight of the burden of proof on the tax authorities, but it means that the assessment of the tax authority must be obtained through an
objective analysis based on facts and circumstances (and it has to weigh all facts and circumstances; may thus not be based on an assumption; or only refer to the tax advantage as such).”
Para 178 to Article 29(9) clarifies that tax authorities don’t have onus to furnish conclusive proof in order to discharge its burden of proof. Yet, in my view, any irrelevant or low standard evidence submitted by tax authorities will lead to many questions raised by courts on discharging their burden. As mentioned above, if a benefit is denied, tax authority still ought to be firm on the strength of the evidences available with them (so as to reasonably conclude), and in absence of proving facts and circumstances, their case is unlikely to stand.
In my view nothing has changed much, as while finalizing a tax assessment, tax authority has to come up with documentary evidence i.e. tax authority has to analyse (as if what a reasonable person would do) based on facts and circumstances that one of the principal purposes of the arrangement is to obtain a tax advantage. If an assessment is based on mere intention and subjectivity (without any reasonableness to conclude, after analysing all relevant facts and circumstances any objective benefit accrued to the taxpayer), any reassessment sought by the tax authority would not prevail in the court of law.
27 Michael Lang, ‘BEPS Action 6: Introducing an Antiabuse Rule in Tax Treaties’ 74 Tax Notes International (2014) 7. pp.655-664, at p.658.
28 Michael Lang, ‘The Signalling Function of Article 29 (9) of the OECD Model – The “ Principal Purpose Test' 74 Bulletin for International Taxation (2020) 4, pp.1-11, at p.2.
29 Supra n.21.
30 Dennis Weber, ‘The Reasonableness Test of the Principal Purpose Test Rule in OECD BEPS Action 6 (Tax Treaty Abuse) versus the EU Principle of Legal Certainty and the EU Abuse of Law Case Law’ 10 Erasmus
I think that courts will not rely on subjective or superficial arguments from tax authorities, tax authorities have to conclude reasonably by evaluating facts and circumstances. Accordingly, the burden of proof still lies with both tax authority and taxpayer. However, once the tax authority has reasonably concluded that obtaining the tax benefit was one of the principal purposes, then a (much higher) burden is saddled on the taxpayer to establish that obtaining the benefit was within the object and purpose of provisions of the convention.
2.3. The Subjectivity Test:
On perusal of the Subjectivity Test under the PPT, it is found that the OECD MTT has placed huge reliance on the element of discretion in the hands of the tax authority in determining the intention of the taxpayer. Under the Subjectivity Test, the threshold is fairly lower (as compared to the Guiding Principles of 2003) where the responsibility is limited to ‘reasonable to conclude’ that the benefit availed was one of the principal purposes.
Weber31 suggests that the tax authorities should ideally undertake an objective analysis of the facts and circumstances of the case under the reasonability requirement and Danon32 limits the subjectivity to only ‘main purpose’ (going by his logic that the PPT is a mere codification of the guiding principle), yet even so, the dilemma of evaluating intention on an objective basis is quite difficult. Chand33 states that the 2017 version of PPT34 rule still has a lower threshold for the primary fact that they have to only ‘reasonably conclude’ to satisfy the subjectivity test compared to when the taxpayer are required to ‘establish’ that grant of treaty benefits is in the light and within the scope of object & purpose of relevant provisions of the treaty.
The Tax Authorities are not required to submit a conclusive proof.35 This criterion, once satisfied, will create a presumption against the taxpayer’s intention to bring about the transaction to avail such benefits that are contrary to the Object and Purpose of the relevant provision. However, Lang36 doesn't agree with this proposition and has written in this context that: “In practice, furnishing
evidence of the motives will therefore not be relevant, but the tax authorities will be tempted to
presume intention simply because of the presence of a benefit.” I am of the view that this temptation (pointed out by authors) on behalf of the tax authorities to go for the easier route of presuming is problematic for taxpayers, because it goes against the Commentary guidelines which have called for an objective analysis of all the facts and circumstances to determine treaty abuse.
To quote the HMRC’s view on the primacy of the objective test over the subjective test (never-mind that the UK GAAR refers to the ‘main purpose’ – the principle is important here)37:
“The expression ‘reasonable to conclude’ shows that this is an objective test, which is to be applied by taking into account all the relevant circumstances and asking whether, in the light of those circumstances, a reasonable conclusion would be that obtaining a tax advantage was
31 ibid. at p.56.
32 Robert J Danon, ‘Treaty Abuse in the Post-BEPS World: Analysis of the Policy Shift and Impact of the Principal Purpose Test for MNE Groups’ 72 Bulletin for International Taxation (2017) 1, pp.31-55, at p.44
33 Vikram Chand, ‘The Principal Purpose Test in the Multilateral Convention: An in-Depth Analysis’ 46 Intertax (2018) 1, pp.18-44, at p.21.
34 Para 170: The provisions of paragraph 9 have the effect of denying a benefit under a tax convention where
one of the principal purposes of an arrangement or transaction that has been entered into is to obtain a benefit under the convention. Where this is the case, however, the last part of the paragraph allows the person to whom the benefit would otherwise be denied the possibility of establishing that obtaining the benefit in these circumstances would be in accordance with the object and purpose of the relevant provisions of this Convention.
35 Para 178 to Commentary to Article 29, 2017 Model. 36 Supra n.27.
37 HM Revenue and Customs (HMRC) General Anti Abuse Rule (GAAR) guidance (Approved by the
the main purpose, or one of the main purposes, of the arrangements. It is neither necessary nor appropriate to inquire whether any particular person (for example the taxpayer himself, or a promoter of the arrangements, if there was one) actually had that intention. In practice, though, it would be very rare to find a situation where objectively the obtaining of a tax advantage appeared to be one of the main purposes of an arrangement although, subjectively, the participators did not in fact have any such aim.”
(emphasis added)
The requirement to not produce conclusive evidence by the tax Authorities, is worrisome as it creates an atmosphere of abuse of administrative power by investing unfettered discretionary powers. The satisfaction of the ‘Reasonableness test’ is comparatively easier and the threshold is lowered for the tax authorities. As cases of treaty abuse often end up in Courts for Judicial Decisions, it is imperative that the Authorities be mandated to produce such evidence which point out toward the Tax-Payer’s culpability. On a deeper scrutiny of the language of the Article 29(9) along with the
Commentary attached thereto, it seems that OECD Committee wanted to tilt the power in favour of Tax Authorities, which is further evidenced by inclusion of Para 10838:
“108. The paragraph grants broad discretion to the competent authority and, as long as the
competent authority has exercised that discretion in accordance with the requirements of the paragraph, it cannot be considered that the decision of the competent authority is an action that results in taxation not in accordance with the provisions of the Convention (see paragraph 1 of Article 25).”
(emphasis supplied) Such a stand may pose conflict with such posterior treaties which have dualistic approach and provide for application of Domestic GAAR. Weber finds this approach problematic especially in scenarios, where the tax authorities have only applied the PPT rule in isolation with other treaty clauses granting the benefit. 39
It is to be seen how the courts would address the subjectivity test. I am of the view that the discretion offered to the tax authorities goes against the legal certainty principle (discussed later below) and it is doubtful if the courts would accord unblemished powers to the tax authority on while evaluating the subjectivity criteria.
2.4. Exploring ‘One of the Principal Purposes’ in the Reasonability Test
For further understanding, we may want to refer to Point 10 of Commentary on the PPT rule in BEPS Final Report of 2015 which says that in order to determine whether the principal purpose was to obtain benefits, an objective analysis has to be made of the aims and objects of the parties of transactions, and circumstances surrounding this arrangement thereby forming the purpose. The intention of the Parties has to be imported from the objective analysis of the above said elements. However, there is no requirement to produce a conclusive proof to establish the intention. At the same, the manner of arrangements in the underlying transaction and the effects resulting therefrom, would have no conclusive bearing on proving the purpose of the transaction. Broadening the scope of this analysis, Point 11 states that mere assertion by the Parties that the concerned transaction is not aimed at obtaining benefits is not sufficient to avoid application of PPT. Determination of such an event has to be done in consonance with examining all the evidence present. Lastly, the possibility of different interpretations of these events have to be objectively considered.
38 Commentary to Article 29(9).
On a conjoint reading of both the articles, it is clear that ‘one of the principal purposes’ requirement under PPT has to be subjected to narrow interpretation so that the focus is shifted from stressing only on tax benefits to understanding the actual objective of the transaction. Para 178 of the Commentary emphasizes on the phrase “requires an objective analysis of all relevant facts and circumstances” and “where an arrangement can be reasonably explained by the existence of treaty benefits, it is likely a principal purpose.” This view is reflected in the clarification of paragraph 181 on Article 29 the OECD 2017 model:
“181. A purpose will not be a principal purpose when it is reasonable to conclude, having regard to all relevant facts and circumstances, that obtaining the benefit was not a principal consideration and would not have justified entering into any arrangement or transaction that has, alone or together with other transactions, resulted in the benefit. In particular, where an arrangement is inextricably interlinked to a core commercial activity, and its form has not been driven by considerations of obtaining a benefit, it is unlikely that its principal purpose will be considered to be to obtain that benefit. Where, however, an arrangement
is entered into for the purpose of obtaining similar benefits under a number of treaties, it should not be considered that obtaining benefits under one benefit under one treaty from being considered a principal purpose for that arrangement.”
(emphasis supplied) Para 10640 states,
“106. The reference to “one of its principal purposes” in the paragraph means that obtaining benefits under a tax treaty needs not be the sole or dominant purpose for the establishment, acquisition or maintenance of the person and the conduct of its operations. It is sufficient that at least one of the principal purposes was to obtain treaty benefits.”
Further delving into this, the Commentary states that:
“169. Paragraph 9 mirrors the guidance in paragraphs 61 and 76 to 80 of the Commentary on Article 1. According to that guidance, the benefits of a tax convention should not be available where one of the principal purposes of certain transactions or arrangements is to secure a benefit under a tax treaty and obtaining that benefit in these circumstances would be contrary to the object and purpose of the relevant provisions of the tax convention. Paragraph 9 incorporates the principles underlying these paragraphs into the Convention itself in order to allow States to address cases of improper use of the Convention even if their domestic law does not allow them to do so in accordance with paragraphs 76 to 80 of the Commentary on Article 1; it also confirms the application of these principles for States whose domestic law already allows them to address such cases.”
In furtherance of this principle, the Commentary further states that the Contracting State may deny the benefits, if one of the principal purposes of an arrangement or transaction was to avail that benefit. This runs in conflict with the Para 171, which states that:
“171. Paragraph 9 supplements and does not restrict in any way the scope or application of the provisions of paragraphs 1 to 7 (the limitation-on-benefits rule) and of paragraph 8 (the rule applicable to a permanent establishment situated in a third jurisdiction): a benefit that is denied in accordance with these paragraphs is not a “benefit under the Convention” that paragraph 9 would also deny. Moreover, the guidance provided in the Commentary on paragraph 9 should not be used to interpret paragraphs 1 to 8 and vice-versa.”
At one juncture, the OECD holds the view that one of the principal purpose should not be to avail benefits, and its investigation by the tax authorities would operate in isolation with the rest of the provisions under the MTT; and at another juncture, it projects the view that such an operative agenda surrounding Article 29(9) can somehow still further in supplementing LOB benefits.
It is important to understand that in order to align the text of Article 29(9) in harmonization with that of MLI and VCLT for a harmonious interpretation that the “one of the principal purposes” be inclined on the same plane with the general principles of abuse. As Robert F. van Brederode41 pointed out, that the most suitable form of GAAR that can be applied to tax treaties would be one which “provides as its first element the main (not sole) purpose for entering into transactions to obtain a more favourable tax position(generally with no business purpose), and as its second element an objective and
purposive interpretation of double tax conventions.” He further says that at time of evaluation of the relevant business purposes of such transactions, non-tax purposes should prevail over tax purposes. As evidenced by the latest examples of abusive transactions laid down in the OECD Commentary, the focal point of determination of abuse is derived from various other principles as well which encompass examining whether the intent of tax treaties is to provide benefits to encourage cross-border
investment42 and whether it has a commercial purpose.
This stance is problematic because in essence, determination of intent should not be an element for determination of Tax legislations.43 The Text of the treaty fails to provide for any such ‘Commercial Test’ on which the transaction may be evaluated to determine if there is any improper use of treaty. At best, any source of reference is confined to the examples added to the Commentary, which could be used by Courts to limit the scope of Article 29(9), but even then, it will be the discretion of the Court to reject it completely.
2.5. Analysis of the ‘object and purpose’ in Article 29(9):
The second prong of the PPT Rule is the Objectivity Test, where once the tax authorities have ‘reasonably concluded’ that availing treaty benefit was one of the principal purposes of the taxpayer’s transaction, the taxpayer is burdened with the onus of establishing that availing the said benefits are within the ‘object and provision’ of the relevant provision. In pursuance of this, the 2017 Model44 suggests importing other elements in aiding its interpretation such as Treaty Text and its Preamble, to be read along with Article 31(1) of VCLT.
Additionally, other aids include MLI Treaty and Preamble, updated 2017 Model and explanatory statement attached to MLI. The preamble of the 2017 Model, when read with Article 29(9) of the 2017 Model, exclusively deals with the extent to which “one of the principal purposes” be inclusive of “object and purpose” built on the guiding principles of 2003. In furtherance of which, it is important to recognise that in order to accord validity to its transaction, the tax payers may resort to interpreting the Preamble of the concerned treaty so as to evaluate a transaction’s legality in consideration with all its elements. Elliffe45 imports the principle of Article 31(2) and states that the context of the treaty should also be inclusive of its Preamble.
41 Brederode, RF Van, Ethics and Taxation (USA, Springer Nature Singapore Pte Ltd, 2020) at p.316. Also see: Supra n.33.
42 Example L of Para 182, Commentary to Article 29(9) of 2017 OECD Model. 43 Moreno n.19.
44 Para 16.2 to the Commentary on Article 1 on 2017 Model.
45 Craig Elliffe, 'The Meaning of the Principal Purpose Test: One Ring to Bind Them All?' 11 World Tax Journal (2019) 1, pp.1-43, at p.7.
It is to be possible to view here that the wordings of Article 29(9) goes against the letter and spirit of both the MLI Preamble as well as Article 31(1) of VCLT- Where the text of both the said provisions provide for considering the object and purpose of the convention, Article 29(9) operates in isolation of the rest of the treaty and has the effect of nullifying those benefits rightly granted to the taxpayers. The Objectivity Test necessitates a one-sided purposive interpretation which requires satisfaction of ‘object and purpose’ of relevant provisions only on the tax-payer. Kuźniacki 46 raises a valid point at this juncture: One may be inclined to believe that that the Tax-Authorities are not required to assess the object and purpose’ of provision, but if that were the case, Article 29(9) would have overridden Article 31(1) of VCLT. The tax authorities are required to objectively evaluate the transaction under the Subjectivity Requirement. His solution to this issue is to apply the objectivity test, “as a dividing line between arrangements or transactions whose principal purpose is to obtain a treaty benefit and convey the envisaged treaty benefit, and those that do not”.47
The Article has failed to incorporate even the business test or the economic purpose test, even though the Commentary is suggestive of including the principles. Due to the lack of certainty in determining what can be the purpose for a provision, as Chand states, “unlike domestic legislation, are drafted in general terms without highlighting the legislature’s intention to incorporate a particular rule into the tax treaty.” And secondly, the level of influence and discretion exercised by the Tax Authorities in deciding the actual purpose of the relevant provision, many authors are of the opinion that the Reasonability and Objectivity Test are inextricably linked.48 On evaluation of the examples provided in the 29(9) Commentary, van Weeghel has noticed that even when these examples “serve to clarify the application of article 29(9) either address the principal purpose prong of the PPT or the object-and-purpose prong, or both. The distinction is not always clear. Some address the nexus, while some address abusive transactions.”49
2.6. Whether the PPT brings legal certainty?
Tax avoidance is recognised as a legitimate point of concern under Public International Law - it is important to maintain a balance between tax equity and legal certainty. The Judicial Precedent surrounding treaty abuse has largely been inspired and derived from the international legal principles throughout the world. In tax legislations around the world, the legal principle which is of pertinent importance is that of Legal Certainty. The principle of Legal Certainty under International Taxation operates to ensure that the taxpayer is aware of its taxing obligations and there is no confusion regarding the same.
The OECD Model can be surmised to have infested uncertainty to the taxpayers. The grant of vast discretionary powers to the tax authorities, as intended by the OECD, broadens the scope of applicability of Article 29(9).
Dennis Weber views legal certainty as enshrined under the Subjectivity Test. This is derived from importing principles established under CJEU that Subjectivity Test is intertwined with objectivity and that determination of subjective intention has been based on an objective analysis.
He further writes:
46 Błażej Kuźniacki, ‘The Principal Purpose Test (PPT) in BEPS Action 6 and the MLI: Exploring Challenges Arising from Its Legal Implementation and Practical Application’, 10 World Tax Journal (2018) 2, pp.1-93, at p.19. Also see: Supra n. 27.
47 ibid, p.20.
48 van Weeghel n.3, at p.11 49 ibid at p.11.
“To me, this would not seem to be contrary to the principle of legal certainty; The reasonableness test in fact underlines the principle of legal certainty: when a tax treaty is applicable, a taxpayer may invoke the benefits of this treaty, unless, but this must be based on an objective analysis of the facts and circumstances, that obtaining a tax benefit is one of the principal reasons of an arrangement.”50
Thus, taking his view into consideration, the most plausible solution that can be offered to the present issue is for the OECD to evolve such “… precise and internationally recognised criteria by which to determine its legal consequence.” 51 Additionally, on a perusal of the Commentary attached to the 2017 MTT along with the 13 examples adduced to the Commentary, it can be safely said that even though the examples cover a wide array of factual scenarios, they are not exhaustive and are very much limited in their application, thereby making little to no contribution toward legal certainty (and probably creating even less legal certainty instead). However, they do show an inclination towards understanding the “economic substance and/or business purpose of arrangements which are to be considered to benefit from treaty provisions.”52
As discussed earlier, Lang believes that the PPT would not bring about any new changes in the scope of countering abuse in the treaty – and therefore by imputation, there may not be any change in the applicability of the legal certainty principle.
To summarise above, in my view (i) one of the principal purposes – covers a lot of tax and non-tax aspects and too subjective to the whims of the tax authorities (and maybe the court as well) (ii) reasonability to conclude – again means that there exists a fear that the tax authorities may read too much into this and thereby activate Article 29(9) without sufficient legal basis (iii) unless established - softens the blow which is feared in (ii), as explained by Lang (iv) Object and purpose- The tax authorities will surely be tempted to claim denial of treaty benefits on the grounds of the object and purpose of the treaty provision not being fulfilled under the PPT and this point of view is expected to be litigated before the courts until the dust settles.
When the dust settles, the principle will come out that PPT does not create any new legal basis for denial off treaty benefits if they are granted under the distributive rules. One can also prophesize that there is also a possibility that the view is eventually taken by the courts that the PPT does indeed deny treaty benefits which were provided under the distributive rules possibly due to harnessing of public opinion.
2.7. Exploring the Principle of Good Faith in Context of Article 31(1) of VCLT Article 31, paragraph 1 of the VCLT reads as follows:
“A treaty shall be interpreted in good faith in accordance with the ordinary meaning given to the terms of the treaty in their context and in the light of its object and purpose”.
VCLT mainly deals with the ‘object and purpose’ of the treaty and it reflects the intention/ policy of the states. Preamble of the tax treaty is the statement which reflects the ‘object and purpose' of the treaty.
Good faith has also been addressed in page 81 of BEPS action 6 report and clarifies that an interpretation of tax conventions that allows states to disregard abusive transactions, when entered into with the view of obtaining unintended benefits.
50 Weber n.30, at p.58.
51 Błażej Kuźniacki n.46. at p.29 52 ibid, at p.23.
Article 31 VCLT also clarifies that terms should be given an “ordinary meaning” in their “context”. Accordingly, the denial of treaty benefits must be supported by the terms of the treaty and which should be read in their context. Article 31 VCLT does not permit such interpretation and text of the treaty would be given more weight on the intention of the negotiating parties while entering into the treaty. If we refer to OECD commentary Paragraphs 9.2 and 22.1 to Article 1, which state that there is no conflict between anti-abuse rules and tax treaties, treaty benefit can be denied on the basis of domestic anti abuse laws as well.
Good faith principle is covered under Para 13 of the OECD Commentaries to article 3(2) establishes that where “. a state should not be allowed to make a convention inoperative by amending afterwards in its domestic law the scope of terms not defined in the Convention.”
While commentary to Article 1 sees no conflict and domestic GAAR can be applied independently whereas commentary 3(2) states that domestic law should not change the scope of convention. Therefore, there is a possibility that (at least before the 2017 model) one might argue that Article 1 and Article 3(2) have a disconnect – for example, if subsequent domestic GAAR is introduced, the question arises on whether that subsequent GAAR would make any of the treaty benefits inoperative? The X Holdings ApS case (analysed further later), which dealt with the pre-2017 scenario, is a useful discussion for this. It holds that the good faith principle includes protection against abuse.53 Same principle is enunciated in the Yanko Weiss Holdings (1996) Ltd. case.54 Though this is not the exact scope of this thesis, in my opinion, there is no conflict, surely not after the 2017 model – because the preamble itself lays down the need to avoid tax evasion and avoidance. Since this thesis is on the impact of certain judgments post PPT, I would not discuss this any further.
Some authors55 raise some additional issues: (i) Whether analysis is performed in the framework of article 31 of VCLT or based on PPT. There has been a debate in academic world whether VCLT needs to analysed in light of “the object and purpose of the relevant provisions” or “object and purpose of the treaty”? This is another open issue that I will not answer in my thesis (ii) Relation of Guiding principle and the PPT - As mentioned in this thesis, para 61 of Article 29(9) explains that the guiding principle is part of treaty text in shape of PPT and both (guiding principle and PPT) may also apply independently. The question is whether it is possible to grant treaty benefits based on the guiding principle pursuant to article 31 of the VCLT, but on the other hand, have them denied under article 29(9) of the OECD Model? These issues are still not addressed in Article 1.56 I would not answer this question in the thesis either.
I would also like to add that the foundation of good faith established in VCLT Article 31 and 32 will have greater impact in future, considering the recent signing of MLI. By the way of MLI (of which the PPT forms the minimum standard), the object and purpose of the treaty has been changed and through the PPT, the subjective elements and objective element are added to ensure prevention against treaty abuse. These subjective elements effect too much discretionary powers to the tax authorities.
The rule of interpretation of treaties laid down in articles 31-32 VCLT, especially good faith principle will become more relevant to limit that discretionary element to tax authorities of states by introducing highly subjective, and vague tests. To my view, the court will put a limit to these powers and will lay down a criterion which OECD has unable to achieve.
53 Switzerland - Case 2A.239/2005, 28 November 2005 (Decision), para 3.4.3. 54 Case No. 5663/07, 30 December 2007.
55 Danon n.23.
We can conclude that that principle of good faith is relevant for analysing the object and purpose of the treaty, in light of its ordinary meaning. The 2003 model, as discussed before, had a lacuna that it did not have the status of the treaty text, and therefore, the object and purpose would be interpreted at the treaty level (as per Art. 31 of the VCLT), and not at the provision level (for example, if the SAAR test is passed, but the GAAR test is only in the commentary form). In this sense, Article 29(9) of the 2017 model (along with the preamble) is thought to be paradigm shift57 in elevating the status of the anti-abuse intention at the text level itself. Hence, after 2017, the object and purpose of both the treaty as well as the provisions of the convention ought to be read cumulatively. Therefore, irrespective of whether the object and purpose are analysed at the treaty level, or at the provision level, there would be consistency, in light of Art. 31 of the VCLT.
3. Analysing Cases in Light of The Principal Purpose Test Rule
3.1. LSF-KEB Holding SCA & Ors. v Republic of Korea3.1.1. Facts and Judgment
Lone Star Funds is a US private equity firm and had other funds including Lone Star Fund III (LSF). LSF has other group entities and incorporated an entity in Belgium, Star Holdings (SH). In 2003, SH acquired 51% shares in Korean Exchange Bank (KEB) who has invested in real estate property in Korea. Due to certain disputes with the Government, sale of Belgium LSF was delayed, Belgium LSF was sold to a Korean entity and the local tax authorities withheld 10% of the sale proceeds as tax on capital gains realised by LSF.
Tax authorities viewed LSF Belgium as a conduit company, hence capital gain resulting from the sale of the shares should be treated as derived by LSF in the US. Capital gains are exempt under Bilateral Investment Treaty (BIT)58 between Belgium and South Korea. LSF Belgium relied on the BIT and alleged that the Korean Govt failed to comply with its obligations under the treaty by refusing to approve the sale of KEB in a timely manner, and imposing capital gains tax on the sales of its investments.59
The Supreme Court resorted to the domestic tax law and the contention of the tax authorities was accepted that the Belgian subsidiary is a conduit company and could not benefit from the BIT; and considered US Limited partnership is the beneficial owner, hence tax can be levied on capital gains on real property in Korea as per US-Korean tax treaty.60 Although, on grounds of an assessment error by the tax authorities, the decision was in favour of LSF.
3.1.2. Analysis
The Court took a ‘look through’ approach whereby an ultimate beneficial owner is considered i.e. US entity instead of Belgian entity. The court refuted the existence of Belgian subsidiary as it didn’t have any business activities in Belgium and is established for the sole purpose of affording treaty benefits under the BIT and surprisingly didn’t take into account Belgium-Korean tax treaty.
57 ibid.
58 There was no Income Tax DTT between Belgium and South Korea.
59 The BIT allows exemption on tax for investment activities. As per Article 6 of the said Investment Treaty, such Capital Gains could only be taxed in Belgium and not in Korea.
60 It is interesting to note that However, the ‘individual tax assessment’ was held inapplicable, due to the legal status of LSF III (legal status is corporate equivalent).
The objective and purpose of the treaty provision is to exempt tax on capital gains, hence any restrictive elements should be specified and needs to be contain within itself, such as including such entities which may not be allowed to enter in such transactions, along with the nature of beneficial ownership of the holding company.
Korean tax authorities used their domestic law/principles to deny treaty benefits, but Lang61says, “domestic anti-abuse legislations do not apply to deny treaty benefits”: Both the Domestic legislations as well as DTC are separate legal systems to which uniform rules of interpretation do not apply. This is so because, if the tax authorities of both the Contracting States begin to interpret each provision of the said tax treaty to suit the requirements of the respective domestic provisions, then there will be two different interpretations regarding each such provision.
Tax treaties, in their very nature, depart from the fold of Domestic tax laws; In that, the treaty clauses have already laid out such situations wherein domestic right to tax “is reduced, eliminated or
maintained”.62 Therefore, even Domestic legislations are allowed to take precedence over Tax treaties, then the very purpose and function of such a treaty is lost.
The court interpretation is in line with the Report on the use of Conduit Companies 1987, wherein it was recommended that the treaty benefits be denied under Art. 10-12 to such conduit companies who own certain assets, but could not be regarded as a beneficial owner due to its narrow powers
rendering it to a mere fiduciary.
3.1.3. Examining the case in light of the PPT rule
Korea has signed the MLI in 201763 and has implemented the minimum standard through the inclusion of preamble and the PPT. Belgian entity was a conduit and didn’t engage in any business activities while analysing subjective and objective test under the PPT.
In context of Alta case (to be discussed later), Lonestar would have met the PPT threshold as gain was exempt under the tax treaty and would have met the object and purpose of the treaty provisions. Though in context of Lonestar judgment itself, court took a narrow view without looking into the object and purpose of treaty provisions and object and purpose of the convention and disregarded the Belgian entity.
If court would have looked into the holistic object and purpose of the tax treaty, the decision may be different in first place. Now with the advent of PPT, I don’t see any change in the decision already accorded, as PPT offer an additional ammunition for the states. However, I would like to highlight that PPT test is not the key factor here which could change the decision as also stated by Moreno64 ‘‘that we have not earned or lost with the new formulation.’’
In Vodafone case (also to be discussed later), court ruled Domestic GAAR cannot be applied to tax capital gains which are exempt under of tax treaty provisions. In Alta case, exemption of Capital gains is within the object and purpose of the treaty provision even though Luxemburg company was
considered conduit. Treaty shopping was not held abusive.
61 Lang, n.9, at p.59. 62 ibid, at p.59–60.
63 Para 35, OECD (2020), Prevention of Treaty Abuse-Second Peer Review Report on Treaty Shopping, OECD, Paris. Available at: http://www.oecd.org/tax/beps/prevention-of-treaty-abuse-second-peer-review-report-on-treaty-shopping.pdf. Visited on 11.07.2020.
