The OECD’s new Principal Purpose Test and Limitation on Benefits rules as they apply to the Netherlands’ dividend withholding tax
Andrew Faughnan
Mastertrack: Internationaal en Europees Belastingrecht Begeleider: Michel Van Dun
The OECD’s new Principal Purpose Test and Limitation on Benefits rules as they apply to the Netherlands’ dividend withholding tax
Andrew Faughnan, University of Amsterdam/Universiteit van Amsterdam
Abstract
The OECD’s BEPS project is nearing implementation. One of its goals is to offer a solid general anti-abuse rule1 specifically aimed at treaty shopping to be included in bilateral agreements for the avoidance of double taxation and the prevention of fiscal evasion. A multilateral instrument (MLI) has been drafted which will allow that rule, known as the Principal Purpose Test (PPT) to apply automatically to existing
conventions. The PPT assesses whether it is appropriate, given the facts and
circumstances, to grant treaty benefits. States can however opt to include a limitation on benefits rule (LOB) in their tax agreements which, by contrast, restricts application of the agreement to taxpayers that have objectively demonstrable, substantial ties to their state of residence. Two radically different approaches, both aimed at treaty shopping: are they up to the job, and could their application yield conflicting results if applied to identical scenarios?
Before applying this hypothesis to cases involving dividend withholding tax, an overview will be presented touching on the topics of tax evasion and avoidance, the function of dividends in the relationship between a corporation and its shareholders, the OECD’s previously ambivalent stance on the topic of treaty shopping, Dutch experiences dealing with treaty shopping and dividend stripping, an overview of the OECD’s current proposals, and a survey of potential legal certainty, effectivity, and EU compatibility issues.
The signing ceremony of the MLI was held in June 2017. An appendix summarizes the choices made by the current 68 signatories.
Table of Contents 1. Introduction
1.1 Tax planning or tax evasion?
1.2 The OECD Model Convention on Income and Capital (MC) 1.3 The dividend article (10 MC)
1.4 (Treaty) shopping for a better rate 2. The entrepreneur and the enterprise
2.1 The corporate shell
2.2 Reaping the benefits of ownership
2.3 The consequences of the distribution of corporate profits 2.3.1 Domestic
2.3.2 International
2.4 Quid pro quo in the interest of attracting trade and investment from abroad 2.5 Gracefully renouncing one’s right to tax
2.6 Enjoying treaty benefits
2.7 Seeking treaty benefits that do not apply to a given situation 2.7.1 Strategy #1: sell the dividend coupons
2.7.2 Strategy #2: sell the shares and buy them back later
3. BEPS treaty shopping measures: The Principle Purpose Test as a standalone measure, in combination with Limitation on Benefits rules, or supplanted and replaced by an LOB rule in conjunction with anti-conduit rules
3.1 The Multilateral Instrument
3.2 Pre-history: the era preceding the BEPS project
3.2.1 The OECD takes notice of treaty abuse (1977) … 3.2.2 … and comes close to acting on it (2003) 4. Aspects of the current Dutch approach to treaty abuse:
4.1 The tools currently available 4.2 Dutch Treaty concepts
4.2.1 Ultimate beneficial ownership in Dutch bilateral tax treaties 4.2.2 Limitation on Benefits clauses
4.3 Domestic law concepts:
4.3.1 Ultimate beneficial ownership in Dutch tax law 4.3.2 Unwritten tenets in Dutch tax law
4.3.2.2 Fraus conventionis (or fraus tractatus) 5. Achieving the OECD’s minimum standard
5.1 Alterations to the preamble
5.2 Updating the terms used in existing agreements 5.3 Article 7 MLI: Defining the minimum standard 5.3.1 PPT is the primus inter pares
5.3.2 Supplementing the PPT with the basic LOB 5.3.3 The extensive LOB article
5.3.4 Not the preferred method: LOB supplemented by conduit rules 5.4 Legal certainty
5.4.1 PPT 5.4.2 LOB
5.5 Suitability as an anti-abuse measure 5.5.1 LOB
5.5.2 PPT
5.6 Compatibility with EU law 5.6.1 LOB
5.6.2 PPT 6. Treaty abuse
6.1 The “quintessential” method, and other forms of dividend stripping 6.1.1 “Marketmaker”
6.1.2 Hold on, wasn’t the sale of the coupons a taxable event? 6.2 Corrective legislation
6.2.1 Beneficial ownership
6.2.2 Consequences for the application of fraus legis/tractatus 7. What if the BEPS project had already been a done deal decades ago?
7.1 PPT
7.1.1 Strategy #1: the Marketmaker gambit 7.1.2 Strategy #2: the cum/ex dividend swap 7.2 Simplified LOB
7.3 Extensive LOB in conjunction with conduit rules 8. Conclusion
1. Introduction
1.1 Tax planning or tax evasion?
Tax avoidance and tax evasion, still coyly defended in some circles as prudent “tax planning” even when it clearly goes overboard, has probably been with us since taxes were first levied. While in times past it may have been considered savvy, perhaps even elegant, to have money stashed away in a numbered Swiss bank account, the vox populi seems, certainly since the credit crunch of 2008, to reflect growing impatience with individuals and corporations not thought to pay their fair share. New laws and international agreements have struck fear into the hearts of Swiss (Panamanian? Delaware?) account holders - think of Fatca and its more universally applicable coeval the “Common Reporting Standard” that both demand the automatic exchange of account holder information between tax jurisdictions. Multinationals ranging from Starbucks to Apple, Amazon to McDonalds, seem barely able to keep up with the waves of negative publicity whenever their tax rulings, double Irish/Dutch sandwiches and ocean money revolve back into the news cycle. One of the most notable reactions to this is the ambitious BEPS project, launched by the OECD at the behest of the G20, and which is now nearing implementation.
1.2 The OECD Model Convention on Income and Capital (MC)
The OECD has long been the arbiter2 of the contents of many of the thousands of bilateral conventions on double taxation in existence today. It maintains an extensive commentary on every last clause of the MC it has drafted as a guide for nations contemplating entering into such an agreement with any of their trading partners.
The OECD has come to the conclusion that the cunning exploitation of tariff disparities between bilateral treaties based on its MC is a grave problem that behooves immediate attention. This is quite a bold position to take, considering that the OECD commentary first made mention of treaty abuse as long ago as 1977.
1.3 The dividend article (10 MC)
2 Not the sole arbiter. The UN also maintains its own Model Double Taxation Convention between Developed
Dividend withholding tax is, for better or worse, levied by many nations. One of the plum rewards granted to dividend recipients covered by an OECD-based treaty is a lower
withholding rate at source, and a commitment by the state of residence to compensate it with a tax credit or an exemption. The OECD suggests that treaty partners limit withholding to 5% on participation dividends and to 15% on portfolio dividends. Considering that some states have statutory withholding rates north of 30%, this can be a very significant perk. A state of residence that itself plans to tax the dividend at, for instance, 15% will generally be willing to compensate withholding up to 15%, but not for more than that.
1.4 (Treaty) shopping for a better rate
Corporations or natural persons whose dividend bearing investments or participations are not covered by a favorable tax treaty may wonder if they can get around the system: they go treaty shopping.
In the Netherlands, whenever the tax authorities have tried to prevent treaty benefits from being applied in situations that prima facie signal treaty shopping, they have been
unsuccessful at trial. This is not for lack of trying: strategies involving the interpretation of treaty terms, or that invoke domestic general anti-abuse principles, have been attempted to deny treaty benefits under circumstances where, by all reasonable accounts, they should probably not be granted.
This lack of success may or may not be a quirk of the Netherlands’ legal system and extensive network of bilateral tax conventions, but the measures contained in the BEPS project might just be what is needed to successfully counter tax avoidance and evasion, treaty shopping, dividend stripping and, ultimately, tax base erosion.
Before I examine those measures, I think it would be useful to consider how a business evolves into a commercial corporation, and to reflect on the role dividends play for the latter.
For some people, once the realization dawns that others may be willing to part with their money in exchange for the fruits of one’s labor or ingenuity, the logical first step for the entrepreneurially inclined among us is to put thought into action and set up a business. Perhaps no more than a mundane observation, this nevertheless implies a conceptual leap into the legal realm. In the Netherlands, for instance, once one antes up one’s labor and capital in a concerted and sustained manner, while managing - whether or not successfully - to set foot onto the marketplace with at least a reasonable expectation of turning a profit, while
simultaneously bearing the risk of failure and the right to enjoy any financial rewards, an enterprise has been summoned into existence and the individual running it has attained the status of entrepreneur. In the case of an independent contractor, it might be difficult to actually perceive any difference between the enterprise and the entrepreneur, intertwined as they are.
If the business turns a profit most jurisdictions, including the Netherlands, consider this a taxable event. The taxable profits can be directly attributed to the person or persons running the business. The tax collector, while not ignoring the business per se, peers straight through it to identify the individual or individuals the law deems should be taxed.
2.1 The corporate shell
A higher level of entrepreneurial sophistication can be achieved when and if the business itself is subsumed by a legal entity endowed with legal personality, corporate capacity. This obviously presupposes the willful calling into existence of such an entity, but once a business has been enveloped by a body corporate, it is no longer run at the entrepreneur’s personal risk and expense, but rather, at the corporation’s. If the enterprise turns a profit, this is now a taxable event for the corporation. In many jurisdictions, once again including the
Netherlands, corporate tax will be due.The tax collector, thus satisfied, looks no further than the corporation in search of anybody to tax. The corporation is thus not transparent.
A body corporate enjoys a peculiar legal status: it is a “legal” invention that bears certain characteristics of personhood, even though it cannot logically be regarded as the equal of a “natural” person of flesh and blood. Unlike us, its days are not necessarily numbered – legal
intervention is necessary to end the “life” of a legal person – and very much unlike those of us fortunate enough to live our lives in freedom, it has an owner or owners.
The owner or owners can demonstrate ownership in many cases by virtue of being the bearers, virtually or tangibly, of share or stock certificates in the corporation.
2.2 Reaping the benefits of ownership
There are essentially two ways for a shareholder to see a return on investment:
1. A shareholder can dispose of stock for more than was paid for it resulting in a net gain, or for less resulting in a net loss. In some jurisdictions, this may result in a capital gain. The MC then assigns sole taxing rights to the state of residence.3
2. The corporation can, upon instruction from its shareholders, its owners, pay them all or a portion of its after-tax profits in the form of dividend. This creates yet another taxable event.
2.3 The consequences of the distribution of corporate profits
2.3.1 Domestic
From the perspective of the corporation, under Dutch tax law there is an obligation to withhold, with certain exceptions, a percentage of the dividend and to remit that amount to the tax authorities4. When a corporation established in the Netherlands withholds dividend tax, currently 15%, from dividend payable to a natural or legal person also living in or
3 Article 13(5) MC. If at least 50% of the value of the shares represents real estate holdings, the state in which that real property is held then has the sole right to tax.
4 Article 1 Wet op de dividendbelasting 1965, or DB1965, establishes the withholding obligation, and article 4 enumerates the instances in which withholding is not obligatory, such as when the recipient of the dividend qualifies for the “participation exemption” (which applies if the recipient owns 5% or more of the entity paying the dividend) or if both are part of a so-called group tax rules unit (fiscale eenheid) as specified in article 15 Vpb1969.
established in the Netherlands, the amount withheld is directly creditable to any subsequent income or corporate tax liability borne by the shareholder.
For resident taxpayers, dividend withholding in the Netherlands is therefore something of a non-event since it is generally creditable or refundable anyway. The Wet op de
dividendbelasting 1965 (Dividend Withholding Tax Act 1965, or DB1965) defines dividend tax as a direct tax, to be levied upon natural and legal persons entitled to the proceeds arising from shares in corporations.5 The Act itself makes no mention of dividend tax being applied as a tax credit for either income tax or corporate tax. That mechanism is described in the Wet op de inkomstenbelasting 2001 (Income Tax Act, or IB2001) and the Wet op de
vennootschapsbelasting 1969 (Corporate Tax Act, or Vpb1969), respectively.
2.3.2 International
Ownership of shares in a commercial corporation is, of course, not generally restricted to residents of any particular jurisdiction to the exclusion of residents of other jurisdictions. Unless a non-resident shareholder is liable for Dutch income or corporate tax, there is no corresponding tax liability that can be used to offset the dividend withholding tax. It is then a final levy.
Unless further measures are taken, a non-resident shareholder is potentially subject to both dividend withholding tax at source and, more likely than not, either income or corporate tax in the shareholder/taxpayer’s state of residence. This results in juridical double taxation – one and the same taxpayer is taxed by two (or more) jurisdictions on the same item of income.
2.4 Quid pro quo in the interest of attracting trade and investment from abroad
While no shareholder wants to be taxed twice on the same item of income, double taxation is no less of a concern for the jurisdictions imposing tax. A jurisdiction that chooses to withhold dividend tax might very well feel little compunction about contributing to a situation in which a non-resident shareholder undergoes double taxation, but the reverse also applies. Its own residents who are the beneficiaries of cross-border dividend subject to withholding at source could also end up being taxed twice on the same item of income.
From the perspective of an investor, it would then be both reasonable and financially
expedient to restrict investments to shares and participations in domestic corporations rather than risk undergoing taxation both at home and at source. Even though a nation with a large internal market might conceivably be able to sustain its economy at a reasonable level of prosperity by relying only on domestic investment, many nations have chosen to forgo, either partially or entirely, levying withholding tax on dividend payments headed abroad in the interest of encouraging trade and investment.
Most jurisdictions seem loath to abolish dividend withholding tax unilaterally. Instead, if they engage in any degree of cross-border economic activity, nations have traditionally sought to conclude bilateral tax treaties that aim to eliminate or mitigate the effects of double taxation - including the risk of double taxation caused by the levy of withholding tax on cross border dividend payments.
2.5 Gracefully renouncing one’s right to tax
The divvying up of the right to tax dividends is one of the key issues dealt with in bilateral agreements based on the MC. Parties to an OECD-inspired bilateral convention will agree that the recipient’s state of residence may tax dividends, but that the state in which the
corporation making the payment resides is at rights to do so as well – within limits. The MC’s current suggested withholding percentage of 15% is lowered to 5% if the beneficial owner of the dividend is a company which itself directly holds a substantial participation (of at least 25%) in the company paying the dividend.6
Once a withholding percentage is agreed to bilaterally, it will then in many cases apply equally to dividend payments going in either direction – dividend payments sourced in Country A and paid to a beneficial owner in Country B, and vice versa. Reciprocity is key.
In some cases, though, parties to a treaty agree to asymmetrical withholding rates on dividend payments. This can be explained in light of the fact that a bilateral tax treaty deals with a wide range of tax topics. The treaty is the final result of an extensive negotiation process. One party could conceivably agree to a lower dividend withholding rate than its treaty partner is willing to apply, in exchange for something else it wishes to achieve during negotiations.
The Netherlands’ statutory default withholding rate7 on portfolio dividend payments is identical to the
suggested MC rate, i.e. 15%, and it frequently sticks to that rate in its bilateral conventions. The MC 5% rate for “participation” dividend tax withholding is also frequently adopted, although in some treaty situations the withholding rate is 0%. It should also be noted that dividend paid by a Dutch corporation to a corporation resident in another EU member state may fall under the purview of the
Parent-subsidiary Directive and, accordingly, those payments may be exempt from dividend tax withholding entirely, no matter what may have been agreed to in a bilateral tax treaty.
The MC furthermore proposes that withholding on interest payments made to residents of the other contracting state be limited to 10% across the board. Royalty payments made to
residents of the other contracting state should, in the view embodied in the MC, only be taxed by the state in which the recipient resides for purposes of the treaty - there should be no withholding at sourceat all.
Considering that many states that adhere to the MC have higher statutory withholdingrates than it suggests they adopt in their bilateral conventions8, one could surmise that those higher statutory rates are set pro forma with the intention of dangling the prospect of treaty relief as a negotiation strategy.
The Nederlands Standaardverdrag, Netherlands Model Tax Treaty, or NSv, follows the MC in that the recipient’s state of residence is awarded primary rights to tax passive income, with secondary rights awarded to the source state.9 A specific withholding rate is, however, not specified, and therefore can presumably be used as a negotiating point when the Netherlands is involved in talks aimed at concluding a bilateral tax convention. Interest payments are to be taxed only by the state in which the recipient resides, as are royalty payments. In reality, the 7 Article 5, DB1965.
8 All observations on statutory or treaty-induced withholding rates on dividend, interest and royalties are gleaned from tables published in Teksten Internationaal belastingrecht 2016/2017, C. Van Raad, Wolters Kluwer, Deventer.
Netherlands would seem to be a particularly strong proponent of the notion that passive income should be taxed where the recipient lives.
2.6 Enjoying treaty benefits
Treaty benefits are available exclusively to the residents (as defined by the treaty) of the contracting states. The most favored nation principle10 extolled by the World Trade
Organization does not enter into the equation. This is most emphatically the case with regard to dividend tax withholding rates that deviate favorably from the statutory laws of nations that have entered into a bilateral tax treaty. If, for instance, the Netherlands, in accordance with its laws, normally withholds 15% on dividend payments at source, but agrees to forgo withholding entirely on payments made to corporations that reside in Country X on the strength of the bilateral tax treaty concluded between the Netherlands and Country X, residents of Country Y, which has concluded no such treaty with the Netherlands, have no claim to those benefits. Treaty-induced withholding rates are negotiated on a case by case basis, and some nations do end up being “more favored” than others.
2.7 Seeking treaty benefits that do not apply to a given situation
It is, however, not unknown for an individual or a corporation to game the system in an attempt to qualify for benefits – such as a lower withholding on dividend payments - for which no right exists based on the existence of terms agreed to in a tax treaty.
2.7.1 Strategy #1: sell the dividend coupons
Knowing that dividend coupons are negotiable instruments that may be traded freely, in effect divorcing them from the underlying stock shares, a shareholder who does not qualify for a reduced withholding rate on the strength of any tax treaty can sell them
to an individual who does. If black letter law does not specify that the owner of the stocks or shares is subject to a levy of withholding tax on dividend payments, it can be argued that the beneficial owner of the dividend, the taxable subject, is the bearer of the dividend coupons. The bearer of the coupons collects the dividend - subject to a favorable treaty withholding rate - and splits the difference with the seller of the coupons who has incidentally never relinquished ownership of the shares. Everybody turns a profit, except of course for the tax collector.
2.7.2 Strategy #2: sell the shares and buy them back later
Another favored strategy is to divest oneself of (publicly traded) shares cum-dividend - after the dividend is declared but before it is made payable - and to buy back an equal number of shares ex-dividend immediately after dividend has been paid. This obviously involves some risk. The share price could explode during that short interval and, depending on the jurisdiction, sale of the shares cum-dividend could incur a taxable capital gain. The entire operation is based on the assumption that the share price ex-dividend will closely mirror the price cum-dividend minus the dividend itself. Sell shares at 100 just after a dividend of 20 has been declared - but before it has been made payable - and buy them back for 80 after the dividend of 20 has been paid. The original shareholder, who might not qualify for any type of treaty relief on dividend withholding, de facto cashes in on the dividend before it is payable, sits out the tax withholding, and still ends up maintaining (or reinstating) his original stock position.
Although Dutch case law demonstrates that local tax authorities are aware of such practices, attempts to tackle them have largely been in vain. Practices like these were enough of a thorn in the side of the collective members of the G20 that they were moved to request11 the OECD to rethink its MC and to include provisions that would make it easier to deny treaty benefits under inappropriate, or even merely suspicious, circumstances. Part of the BEPS project is therefore devoted to addressing treaty abuse in its many guises, one of which is shopping around for the treaty that offers the most favorable withholding rate.
11 G20 Leaders' Declaration, September 6, 2013, St Petersburg, para. 50 – 52, consulted at http://www.g20.utoronto.ca/2013/2013-0906-declaration.html on June 10, 2017.
3. BEPS treaty shopping measures: The Principle Purpose Test as a standalone measure, in combination with Limitation on Benefits rules, or supplanted and replaced by an LOB rule in conjunction with anti-conduit rules
The OECD has to that end proposed that future bilateral tax agreements covered by the MLI adopt a general anti-abuse rule bolstered by a frank statement expressing that one of the main goals of the agreement is to avoid its benefits being granted in inappropriate circumstances.
To achieve this, the OECD urges jurisdictions that sign onto the MLI to agree to adopt the PPT: tax administrations, subject to a relatively low burden of proof, may deny treaty benefits if the facts at hand make it reasonable to conclude that granting benefits in the given case would be tantamount to treaty abuse. It is then up to the taxpayer to establish that granting the benefits would not be at odds with the goal and purpose of the agreement. Alternatively, signatories may choose to supplement the PPT with either a standard-issue or a tailor-made LOB, or, if the idea of the PPT is at too far a remove from the legal and fiscal traditions of either or both of the parties to the agreement, to draft an extensive LOB supplemented by anti-conduit rules.
LOB rules amount to a heightened set of objective criteria that need to be met by a taxpayer seeking relief under the tax agreement, i.e. a lower withholding rate of dividend withholding tax. The fact that the affairs of a corporate taxpayer have been arranged in such a manner as to meet LOB requirements does not necessarily mean that no whiff of treaty abuse might still linger about any of its transactions.
Without the PPT at its disposal, a nation that is party to an agreement containing only an LOB rule would ultimately be unable to effectively deter treaty abuse. The OECD therefore dictates that if the PTT does not apply to the covered agreement, an extensive LOB must be drafted, and it must be supplemented by rules that deny benefits if a company, for the sole purpose of gaining those benefits, establishes any sort of a beachhead, or conduit, in a tax jurisdiction that is governed by a more favorable tax agreement.
To underscore the urgency felt with regard to the proposed changes to the MC, the OECD has drafted a legal instrument that allows the proposed changes to apply to existing bilateral tax agreements as well. The Multilateral Instrument (MLI) is worked out in Action 15 of the greater BEPS project, and its signing ceremony was held on June 7, 2017. In the run-up to the big event, signatories were allowed to indicate which combination of PPT and LOB they wished to have apply to their existing tax agreements.
3.2 Pre-history: the era preceding the BEPS project
3.2.1 The OECD takes notice of treaty abuse (1977) …
The OECD first acknowledged the phenomenon of the improper use of bilateral tax treaties in its 1977 commentary on article 1 of the MC. Tax treaties, anno 1977:
“The purpose of double tax conventions is to promote, by eliminating international double taxation, exchanges of goods and services, and the movement of capital and persons; they should not, however, help tax avoidance or evasion.”12
A legitimate right to engage in tax planning – making full use of treaty provisions – was recognized. It was clearly up to contracting states to ensure that their own legislation contained provisions that would frustrate treaty abuse above and beyond what might be considered acceptable tax planning.
While national anti-abuse legislation could conceivably come into conflict with the provisions of bilateral tax treaties, the doctrine of pacta sunt servanda enshrined in the Vienna Convention on the Law of Treaties13 would compel treaty partners to honor its provisions. National legislation may not be used as an excuse to deviate from the text of a treaty.14
The less than compelling wording of the OECD commentary (“should not…help tax avoidance or evasion”) seemingly left little room to deviate from application of benefit-granting provisions of a treaty, even in cases that the OECD commentary was now starting to recognize. “Extensive” treaty interpretation was not something the OECD was ready to
12 MC commentary on article 1, s.7.
13 Article 26 Vienna Convention on the Law of Treaties, Vienna, May 23, 1969. 14 Ibid, article 27.
encourage: the 1977 commentary stated, quite optimistically, that the states concerned would no doubt only agree to treaty provisions that did not conflict with their own laws and
regulations.15
3.2.2 … and comes close to acting on it (2003)
More than a quarter of a century later, the commentary on article 1 of the MC received a major update. As of 2003, tax avoidance and evasion were deemed worthy of considerably more attention than had been given in 1977: the topic was now considered a “purpose” of the MC and therefore of any bilateral tax treaty taking it as its model. The passage exhorting jurisdictions to pass their own tax avoidance legislation was dropped.
The 2003 commentary adopts a more pragmatic tone when it notes that, since national measures could be effective in thwarting the maneuvers of taxpayers hoping to exploit treaty mismatches, contracting states would be “unlikely to agree to provisions of bilateral double tax conventions that would have the effect of allowing abusive transactions that would otherwise be prevented by the provisions and rules of this kind contained in its domestic law.”16
On the whole, the 2003 commentary still seems to subscribe to the idea that treaty abuse regulations should be instituted in statutory law rather than in the treaties themselves. It ponders whether benefits should be granted for abusive transactions, but then frets on what to do about national anti-abuse provisions and jurisprudence that threaten to come into conflict with the provisions of a tax convention.17 If states would just regard the abuse of treaty provisions as equivalent to abuse of their own tax laws, the 2003 commentary opines, there should be no conflict between the two. It is, after all, domestic legislation that establishes the authority to tax. An alternative approach instructs contracting states to simply disregard or reclassify “abusive transactions”.18
The commentary warns, however, against jumping the gun with assertions of treaty abuse. It offers a “guiding principle”, that can be broken down into subjective and objective
15 MC commentary on article 1, s. 7.1. 16 Ibid.
17 Ibid. 9.1. 18 Ibid. 9.2.
components, to determine whether treaty benefits should be granted or withheld: if obtaining favorable tax treatment is a taxpayer’s main purpose for entering into a transaction, and obtaining that favorable treatment runs contrary to the object and purpose of the relevant treaty provisions, treaty benefits should not be granted.19
The great potential inherent to such a general rule or blanket approach does not, however, make the inclusion of specific anti-abuse rules obsolete.20 The commentary points out that the MC itself already contains specific anti-abuse provisions, notably the concept of beneficial ownership which debuted in the interest, dividend and royalty articles a quarter of a century earlier.
4. Aspects of the current Dutch approach to treaty abuse:
4.1 The tools currently available
Over time, various methods have been attempted to combat the improper use of bilateral tax conventions. The bilateral conventions themselves set hurdles for taxpayers seeking treaty benefits by including OECD terms, i.e. “beneficial ownership”21, that provide a legal basis for denying benefits, or by posing additional, highly detailed requirements that limit the pool of taxpayers that qualify for benefits. The term “beneficial owner” has also found its way into various articles of Dutch tax law.22
A nation’s sovereignty over its own legislative process – and therefore its right to implement tax abuse measures of its own design - is not necessarily curtailed by virtue of being party to a bilateral tax convention. Universal legal dogmas or specific national legal tenets can, at least in theory, be invoked as grounds for denying treaty benefits in inappropriate
circumstances.
4.2 Dutch Treaty concepts
4.2.1 Ultimate beneficial ownership in Dutch bilateral tax treaties
19 Ibid. 9.5. 20 Ibid. 9.6.
21 MC articles 10(2), 11(2) and 12(1).
Dutch bilateral conventions are structured in a manner similar to the OECD’s MC. The OECD term “beneficial owner” is adopted in the articles that deal with the so-called passive income streams – dividend, interest and royalties. The more favorable withholding
percentages granted by the many bilateral treaties concluded by the Netherlands are only available to the ultimate beneficial owner of the passive income, yet the notion of ultimate beneficial ownership has never successfully been invoked as a means of demonstrating treaty abuse in cases that have been heard by the Hoge Raad, the Supreme Court of the Netherlands, or HR.
4.2.2 Limitation on Benefits clauses
Few bilateral conventions concluded by the Netherlands contain an LOB clause, although a willingness to include them has been expressed as a matter of public policy:
“The Netherlands is committed to the prevention of [tax] treaty abuse and is therefore prepared to include limitations on the granting of treaty benefits in the event the Netherlands or one of its treaty partners perceives, in light of the interplay between their respective systems of taxation, any risk of treaty abuse.”23
Certain nations, notably the United States, consistently negotiate clauses in their bilateral tax conventions that give the means to deny treaty benefits to persons or entities that do not fulfill certain heightened, but wholly objective criteria. The consensus is that while LOB clauses provide taxpayers with a high level of legal certainty, they are also notoriously complicated and difficult to apply.24
The Netherlands’ bilateral conventions concluded with Japan and the United States both contain an LOB rule, in articles 21 and 26 of the respective treaties.
4.3 Domestic law concepts:
23 Ministerie van Financiën, Notitie fiscaal Verdragsbeleid 2011, para. 2.20.2, my translation.
24 Qunfang Jiang, “Treaty Shopping and Limitation on Benefits Articles in the Context of the OECD Base Erosion and Profit Shifting Project”, Bulletin for International Taxation, March 2015.
4.3.1 Ultimate beneficial ownership in Dutch tax law
The term “uiteindelijk gerechtigde”, beneficial owner, is always given a “negative” definition in Dutch tax legislation. A natural or legal person who receives a dividend payment under favorable treaty terms after entering into a series of quid pro quo transactions with a party ineligible (or less eligible) for treaty benefits is, in any event, not the beneficial owner of the dividend. Such provisions are aimed at dividend stripping in general, and at preventing dividend withholding tax paid in this manner from being used as a tax creditin particular.
4.3.2 Unwritten tenets in Dutch tax law
4.3.2.1 Fraus legis
Notwithstanding the Netherlands constitutional imperative dictating that the imposition of tax by the national government must have a legal basis in an Act of Parliament25, courts have recognized that, in some cases, tax may be levied in contravention of the text of a tax act.
The concept of fraus legis, or evasion of the law, first appears in the annals of the HR in a case dealing with the interpretation of a contractual stipulation which, strictly speaking, effectively frustrated the levy of inheritance tax.26 The parties involved obviously thought they had successfully gamed the system, but the HR concluded that they had overplayed their hand, and took into consideration that:
“it has been established that when crafting … the contractual stipulation … no other interest was served, and with no other intent than to frustrate the legal effect of the statutory provision…”
Here the HR notes the subjective component that led it to conclude that fraus legis had occurred. The intent to evade taxes is the first of two constituent elements of fraus legis.
The HR then goes on to establish the second, objective constituent element:
25 Dutch Constitution Grondwet, article 104. 26 HR May 26, 1926, NJ 1926 p. 723.
“… the parties entered into a transaction … which so closely resembles the taxable event described in the [Inheritance Tax Act] that the aim and purpose of the Act would be forsaken if the transaction entered into by parties in fraudem legis were not taxed in the same way as the transaction described in the law…”27
If a taxpayer enters into a transaction with the sole intent of gaining a tax advantage, and that tax advantage can only be granted by doing harm to both the aim and purpose of the law, the offending transaction can be juridically reconfigured - “converted” - into one that constitutes a taxable event.
In the case just cited, the court notes that the parties involved in the disputed transaction did so with the sole intent of evading the application of a tax law. Over the course of time, a finding of fraus legis has come to require only that tax evasion be of overriding importance for the disputed transaction. The terms “aim” and “purpose” of a tax provision are by nature intangible quantities, and the Dutch tax administration can anyway only apply fraus legis after all other methods codified by law for combatting tax evasion have been exhausted. It is the ultimum remedium.
4.3.2.2 Fraus conventionis (or fraus tractatus)
As we have seen, Fraus legis can be remedied by the fiscal requalification of a transaction, and in HR December 15, 1993, BNB 1994/259, the proceeds from a sale of stock shares had been partially reclassified as dividend by applying the tenet of fraus legis. The HR noted that: “Neither the text nor the explanatory notes provided by the parties to the treaty provide evidence of their mutual intent to… “28 allow the Netherlands to unilaterally treat a capital gain as dividend. This would have had the effect of allowing the Netherlands (as the “source state”) to impose dividend withholding tax, whereas it couldn’t have taxed a capital gain at all. The consensus reached by parties upon conclusion of the treaty remains the benchmark for its interpretation.
In a statement to the lower house of Parliament29, the Dutch State Secretary for Finance pointed out that neither fraus legis, nor the similar tenet of fraus tractatus – which sets its
27 Ibid., my translation.
28 HR December 15, 1993, BNB 1994/259, paragraph 3.4. 29 Kamerstukken II, 2002/03 28 259, nr. 10.
sights on abuse of the terms agreed to in bilateral tax conventions – was codified in the tax laws of either party to the bilateral convention concluded with Belgium. While the HR’s case law does not, according to the State Secretary, allow any definitive conclusions to be drawn on its willingness to apply fraus tractatus to deny treaty benefits, he remained steadfast in his conviction that it could be applied if both parties to the convention were in agreement that it should be.
It has been argued that if the text of a bilateral convention follows the MC closely, there is no reason not to use the published OECD commentary as a tool for interpreting the intent of parties at the time they reached agreement on its terms.30 The HR has subsequently signaled that it holds the MC commentary in great esteem, and considers it to be a legitimate source of law.31 Finally, the OECD itself promotes the use of the commentary as an interpretative tool for the judiciary.32
Despite all this, the HR has, to date, never accepted application of either fraus legis or fraus tractatus to deny treaty benefits.
5. Achieving the OECD’s minimum standard
In light of its current proposals aimed at providing more robust tools for combatting treaty abuse, and a means of airlifting those tools into existing agreements, we may safely conclude that the OECD has distanced itself from the idea that treaty abuse is best dealt with by
statutory law, and not by provisions of bilateral agreements.
Action 6 of the BEPS project provides several alternative routes that lead to a viable level of defense against treaty shopping in bilateral tax agreements. Action 15 provides an instrument for updating current agreements at the stroke of a pen. Signatories to the MLI may elect to implement the PPT either exclusively or in conjunction with the simplified LOB. As a last
30 HR July 14, 2006, BNB 2007/42, commentary Van Weeghel.
31 HR March 1, 2013, NTFR 2013/522, section 3.3.2; HR February 20, 2009, BNB 2009/262, sections 3.8 and 3.9; HR February 21, 2003, BNB 2003/177, section 3.5 and HR November 1, 2000, 35 398, BNB 2001/19, section 3.4.
resort, treaty partners are offered the option of drafting their own detailed LOB which must be supplemented by rules which circumvent the use of conduits as a means of gaining treaty benefits. The OECD nonetheless recognizes that some existing bilateral tax agreements may already provide sufficient safeguards against treaty shopping – there may already be a general provision in the spirit of the PPTin place, or a highly-detailed LOB.
Signatories to the MLI therefore agree to implement these tools in their future bilateral tax agreements and to have the MLI do the same for existing covered agreements. This achieves what Action 6 dubs the “minimum standard”33 safeguarding against treaty shopping.
5.1 Alterations to the preamble
Section 3 of the multilateral instrument addresses treaty abuse, including the phenomenon of treaty-shopping. Its Article 6 sets out the language to be superimposed onto, or to replace, the existing preamble of any covered tax agreement.34 Circumvention of treaty-shopping must be specifically cited as a main purpose of covered agreements.35
5.2 Updating the terms used in existing agreements
The term “convention” as it is used in the MC becomes “covered tax agreement” under BEPS, and “contracting state” becomes “contracting jurisdiction”.36 In recognition of the ex-post application of the MLI to previously concluded agreements, parties using the OECD preamble will no longer “intend to conclude” a bilateral convention aimed at preventing double taxation, but rather simply “intend to eliminate double taxation”37 – more temporally
33 Article 7(15) MLI. 34 Article 6(2) MLI. 35 Article 6(1) MLI.
36 Explanatory statement MLI, paragraph 15. 37 Section 78.
neutral wording.38 Quite logically, parties whose covered agreement already contains such language are released from the obligation of altering the preamble.39
5.3 Article 7 MLI: Defining the minimum standard
5.3.1 PPT is the primus inter pares
Article 7 of the MLI sets the parameters that covered agreements must meet to adequately prevent treaty-shopping. The PPT described in the article’s first paragraph is its core provision. Benefits claimed under an agreement covered by the MLI must be denied if the taxing authorities can reasonably conclude, all things considered, that a taxpayer has entered into an arrangement or a transaction with the aim of gaining a benefit to which he, she, or it would otherwise not be entitled.
Gaining the benefit need not be the sole purpose of the arrangement or transaction – the benefit already becomes uncertain if gaining it was “one of” its principal purposes. Whereas a tax authority that intends to deny a benefit is merely required to demonstrate that it could reasonably draw the conclusion impugning the arrangement or transaction, the taxpayer is required to establish that granting the benefit would not frustrate the object and purpose of the pertinent article of the covered tax agreement. This division of the burden of proof – reasonable to conclude versus establish - clearly works to the advantage of the taxing authority that wishes to deny benefits, and to the disadvantage of the taxpayer who hopes to reclaim them.
5.3.2 Supplementing the PPT with the basic LOB
The PPT is not only given pride of place: the explanatory statement to the MLI describes the PPT as the only strategy capable of subverting treaty abuse on its own. Parties are however
38 Incidentally, there seems to be no sunset clause in the MLI. This leads me to speculate that covered conventions will remain subject to its provisions in perpetuity, even after subsequent negotiations that result in textual changes to a covered agreement. If they deem it necessary or appropriate, parties will then presumably notify the Depositor that they have mutually agreed to revoke the decision to have a specific bilateral
convention be covered by the MLI. 39 Article 6(4) MLI.
allowed to supplement the PPT with the OECD’s “simplified” LOB, or to opt out of the PPT altogether as long as a detailed LOB is drafted for their specific situation, and as long as the final result meets the minimum standard.
A choice for the simplified LOB is only binding if both parties have chosen to implement it for (all) their bilateral tax agreements. Article 7 also addresses the possibility that one party expresses a preference for the PPT and the other for the limited LOB. The MLI then grants the PPT right of way – the simplified LOB provision is deactivated by default.40 The party that is thus forced to concede use of the simplified LOB in favor of the PPT may however then opt out of article 7 in its entirety.
An escape is also provided from this outcome: parties that have chosen to apply the PPT exclusively can agree to acquiesce to those of their treaty partners that favor use of the simplified LOB: they can commit to symmetrical application41 of the simplified LOB or, alternatively, agree to allow their “LOB treaty partners” to apply the simplified LOB asymmetrically.42
If a jurisdiction has not positively affirmed its tolerance for allowing any of its treaty partners to use the simplified LOB, the default position is reinstated and only the PPT applies.43
The MLI’s simplified LOB, if set in place, poses an additional hurdle for taxpayers wishing to enjoy the benefits of a covered tax agreement. Taxpayers - excluding natural persons, or the other jurisdiction itself - must meet certain minimal requirements that demonstrate a substantial connection to their state of residence. If they do, they are deemed “qualified persons”, and are therefore eligible for treaty benefits. Publicly traded companies, non-profits, and pension funds generally qualify, as well as companies owned at least 50%
locally. Companies engaged in the active conduct of a business qualify for benefits regardless of whether they are technically “qualified persons”. Conversely, holding companies, group financing entities and the like do not qualify. Banks, insurance companies, and securities dealers do. Taxpayers may appeal to their competent authority if benefits are denied, at which point they are subject to a burden of proof similar, and most likely identical, to the burden placed on taxpayers whose benefits have been denied under the PPT.
40 Article 7(6) MLI, explanatory statement, paragraph 101. 41 Article 7(7)a MLI, explanatory statement, paragraph 102. 42 Article 7(7)b MLI, explanatory statement, paragraph 102. 43 MLI explanatory statement, paragraph 103.
5.3.3 The extensive LOB article
The MLI offers no template for drafting a detailed LOB rule.44 If a jurisdiction feels the need to craft such an elaborate article45, the detailed LOB will undoubtedly reflect the concerns of that individual state, and it will probably need to be customized for each bilateral tax
agreement it concludes, reflecting the peculiarities of each bilateral relationship.
While the provisions of the simplified LOB are adopted from the proposals made in the Action 6 report for “Article X” - the “Entitlement to Benefits” article, Action 6 also contains the expansive text of, and commentary on, a “detailed” LOB, which did not make it into the final version of the MLI.
Bilateral tax conventions concluded by the United States invariably contain a detailed LOB article. Conventions concluded by the Netherlands rarely include one.46
5.3.4 Not the preferred method: LOB supplemented by conduit rules
The MLI minimum standard may also be met by drafting a detailed LOB supplemented by rules that specifically restrict the use of conduit companies, permanent establishments, representatives, or nominees to gain benefits.
Conduit rules perhaps fulfill the same functionconceptually as the PPT: if it is reasonable to conclude that a natural or legal person not eligible for tax treaty benefits has set up or
acquired a conduit in a jurisdiction where tax agreement benefits apply - merely to enjoy the benefits by collecting the dividend payments there – application of the agreement may be denied unless it can be established that granting benefits under the circumstances would in no way frustrate the goal and purpose of the tax agreement whose benefits are being claimed.
44 The option of including a detailed LOB at all was at the request of the United States, and a timing conflict involving the publication of a new US model treaty made it impractical to update the MLI’s version to reflect that.
45 As a very rough point of comparison: while the “simplified” LOB provisions in the MLI already total a daunting 1,400 words, the LOB article 22 in the US Model Tax Treaty clocks in at just under 4,000.
46 Examples include article 26 of the convention concluded with the United States, and article 21 of the treaty with Japan.
This is closely related to the concept of ultimate beneficial ownership: while a conduit company may take payment of dividend, common sense tells us that the corporation that set up the conduit in the first place is the real ultimate beneficial owner.47
5.4 Legal certainty
5.4.1 PPT
The PPT is couched in open-ended terms similar to the requirements for fraus legis in Dutch tax law, if not identical in means of application. Fraus legis places the burden of proof for both the subjective intent of the taxpayer and the irreconcilability with object and purpose of the tax provision squarely upon the shoulders of the tax inspector. An invocation of fraus tractatus, if it were ever to be granted, would no doubt assign a similar burden to the tax authorities.
The PPT quashes all hope of receiving a treaty benefit if it is reasonable to conclude that one of the taxpayer’s subjective intentions is to receive it – hardly a difficult task. It is then up to the taxpayer to offer negative proof – granting the benefit in no way conflicts with object or purpose of the bilateral tax convention. This will make the PPT an effective tool for tax authorities, but one that leaves the taxpayer with little legal certainty. The appeals procedure48 and compulsory consultation with the competent authority of the other jurisdiction is, in this light, not a luxury.
5.4.2 LOB
An LOB, no matter how it is configured, – whether the “simplified” OECD version, or the bracingly complex United States’ versions – ultimately deals with treaty shopping by limiting
47 Van Weeghel, S., Improper Use of Tax Treaties, section 6.4.3, Kluwer Law International.
48 Article 7(4) MLI. Paragraph 9 of the explanatory statement to the MLI refers to the mutually binding arbitration procedure outlined in BEPS Action 14.
the pool of taxpayers able to make use of the benefits afforded by the tax agreement. Once a taxpayer fulfills the objective characteristics that grant the status of “qualified person”, all debate on the propriety of granting treaty benefits should theoretically cease.
Under the MLI, this is however not necessarily the case. It is not inconceivable that a “qualified person” could be denied treaty benefits if it is nonetheless “…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…” at which point the tables are turned and the qualified person must establish “…that granting that benefit in these circumstances would be in accordance with the object and purpose of the relevant…”49 provision in the covered agreement.
Unless all parties to a covered agreement agree that the PPT may be ignored50, a qualified person’s treaty benefits can still be put in jeopardy by the PPT, and I believe that conduit rules will bring similar uncertainty to qualified persons in jurisdictions that choose to draft their own extensive LOB, as will become clear in the next section. The same concerns that apply to the standalone PPT apply here as well, and the appeals procedure51 remains, equally, a necessity.
5.5 Suitability as an anti-abuse measure
5.5.1 LOB
Mechanical application of the simplified LOB may make it somewhat unsuitable for actually achieving what it sets out to do, i.e. preventing the granting of benefits under dubious
circumstances. Once one of the qualifying criteria is satisfied, the LOB rule itself offers no mechanism that takes into consideration whether a taxpayer has entered into a transaction largely - orsolely, for that matter - to gain benefits. That function is left to the PPT which in most cases will still apply to transactions entered into by qualified persons.
49Article 7(1) MLI.
50 Articles 7(7) and 7(16) MLI. 51 Article 7(4-5) MLI.
Bender and Engelen note that this conundrum is also solved by the anti-conduit rules
necessary to achieve the minimum standard in conjunction with a detailed LOB, but point out that a two-step criterion is not conducive to a sense of legal certainty.52
I agree with this observation. The facts and circumstances surrounding any suspicious arrangement or transaction entered into by a qualified person under the simplified LOB will be taken into consideration, in most cases, by the PPT, and by conduit rules if an extensive LOB has been drafted. Although a jurisdiction that has drafted, or plans to draft, an extensive LOB and accompanying conduit rules may also elect to ignore the PPT entirely under the MLI, the MLI minimum standard remains the benchmark.53 The most logical way of
achieving this would be to take a general anti-abuse approach when assessing conduits: if it is reasonable to conclude that a natural or legal person not eligible for tax treaty benefits has set up or acquired a conduit in a jurisdiction where tax treaty relief applies - merely to enjoy treaty benefits by collecting the dividend payments there – application of the agreement may be denied unless it can be established that granting benefits under the circumstances would in no way frustrate the object and purpose of the tax agreement whose benefits are being claimed. As with the PPT, the appeals procedure remains a necessity.
5.5.2 PPT
The PPT allows the specifics of a case to be taken into consideration, and is also subject to an appeals procedure. Considering that its universally applicable norm will make it a powerful and flexible tool for combatting treaty abuse, treaty shopping and the granting of benefits where they probably shouldn’t be granted, the appeals procedure and compulsory
consultation with the authority of the other contrasting state are necessary safeguards against overkill. Any transaction involving treaty benefits could potentially be tested by the
“reasonable to conclude” norm,54 making the granting of the benefit unpredictable.
52 Bender and Engelen, “De maatregelen tegen treaty shopping bedreiging en kans”, Weekblad voor Fiscaal
Recht, 2016/51.
53 Article 7(15)a MLI. 54 Bender and Engelen, p. 5.
5.6 Compatibility with EU law
5.6.1 LOB
As the Netherlands is a member state of the European Union, it is worth mentioning that the European Commission recently requested the Netherlands, in a “reasoned opinion”, to amend the LOB-article in its bilateral tax convention with Japan.
As in the OECD BEPS version, a taxpayer is a “qualified person”, and therefore qualifies for benefits, if the bulk of its shares are held by treaty residents of either of the contracting jurisdictions, i.e. the Netherlands or Japan. The Commission is of the opinion that a member state is not entitled to conclude a tax agreement with a non-EU state that affords companies held by residents of the Netherlands better treatment than comparable companies held by residents of other EU-member states or the European Economic Area.55 It is forbidden by EU law to discriminate in such a manner, and the Commission would be at rights to sue over the alleged infringement at the EU Court of Justice in Luxembourg.56
As of June, 2017, only two member states – Bulgaria and Slovakia – have elected to have the simplified LOB apply to their covered agreements. The Commission will presumably remain alert to any discriminatory effect the simplified LOB might have.
5.6.2 PPT
It is debatable whether the Commission is more alarmed at the prospect of EU member states agreeing to an LOB-rule in their covered tax agreements, or whether it simply prefers they implement the standalone PPT.57 Member states are however urged to assure themselves that even the PPTis “EU-proof” – they need to be reasonably certain that its wording and
55 European Commission - Fact Sheet, November infringements package: key decisions, Brussels, 19 November 2015, available at http://europa.eu/rapid/press-release_MEMO-15-6006_en.htm last consulted on May 25, 2017.
56 This may be a moot point: Japan has signed on to the MLI and agreed to use only the PPT.
57 Commission Recommendation of 28.1.2016 on the implementation of measures against tax treaty abuse, Brussels, 28.1.2016, C(2016) 271 final, available at
https://ec.europa.eu/transparency/regdoc/rep/3/2016/EN/3-2016-271-EN-F1-1.PDF last consulted on May 25, 2017.
application are compatible with Luxembourg case law. The Commission recommends that if a taxpayer needs to rebut the assertion that one of the principal purposes of an arrangement or transaction was gaining a benefit, it should suffice to demonstrate that a “genuine economic activity” was at its heart. To achieve this the text of article 7(1) MLI is altered as follows: “Notwithstanding the other provisions of this Convention, a benefit under this Convention shall not be granted in respect of an item of income or capital if it is reasonable to conclude, having regard to all relevant facts and circumstances, that obtaining that benefit was one of the principal purposes of any arrangement or transaction that resulted directly or indirectly in that benefit, unless it is established that it reflects a genuine economic activity or that granting that benefit in these circumstances would be in accordance with the object and purpose of the relevant provisions of this Convention.”
The addition suggested by the Commission harkens back to the Court of Justice’s Cadbury Schweppes jurisprudence: the taxpayer should not lose a treaty benefit if the arrangement or transaction was not “wholly artificial”58. It is also reminiscent of the criterion preventing the granting of benefits attached to the EU-Council’s Parent-Subsidiary Directive: “Member States shall not grant the benefits of this Directive to an arrangement or a series of
arrangements which…are not genuine having regard to all relevant facts and circumstances” or “to the extent that they are not put into place for valid commercial reasons which reflect economic reality.”59
The ramifications of this could be that, if member states adopt the Commission’s wording for their covered tax agreements, it would apply to agreements with “third countries”60 as well. The question then arises whether the EU’s protection of the free movement of capital applies. A holding in a company which gives the shareholder definite influence over the company's decisions and the ability to determine its activities falls under the EU right of establishment.61 The free movement of capital applies to “third” countries and the freedom of establishment exclusively within the EU. Small shareholders would enjoy the protection of the Treaty on the Functioning of the EU, while major shareholders would not.
58 Court of Justice of the EU, C-196/04, Cadbury Schweppes.
59 Council directive EU 2015/121 of 27 January 2015 amending Directive 2011/96/EU on the common system
of taxation applicable in the case of parent companies and subsidiaries of different Member States, which alters
article 1 of the 2011 Directive. 60 Non-EU jurisdictions.
6. Treaty abuse
The various approaches prescribed by the MLI – PPT, PPT tolerant of the simplified LOB (or de facto forbidding its use), PPT supplemented by a simplified LOB, detailed LOB with conduit company regulations – could easily conflict, may in fact yield different outcomes in decisions granting or denying benefits when applied to the facts of a given case. I will test this hypothesis in the following section by considering the facts of the Marketmaker case.
6.1 The “quintessential”62 method, and other forms of dividend stripping
Various strategies that all boil down to permutations of dividend stripping have been contested before Dutch courts, but one case heard in 1994 has repeatedly been cited as an example of the difficulties the tax collector faces when attempting to deny the benefit associated with article 10 MC from being applied to dividend payments that have been preceded by careful planning involving one or several transactions that achieve the
shareholder’s desired result of enjoying a lower rate of dividend tax withholding than would normally apply.
6.1.1 “Marketmaker”
The facts of the Marketmaker case63 involved the sale by a Luxembourg entity64to a London “market maker”65 of the dividend coupons associated with a block of shares in Royal Dutch
62 Van Weeghel, section 8.2.3.3.
63 HR April 6, 1994, ECLI:NL:1994:ZC5639.
64 Van Weeghel conjectures that the Luxembourg entity was a société holding and therefore ineligible for facilities granted by the tax treaty concluded between the Netherlands and Luxembourg (op. cit. Van Weeghel section 8.2.3.3). Marres and Wattel adds that it is also probable that the entity was itself not subject to corporate tax in Luxembourg and could, for that reason, not claim treaty benefits (Marres and Wattel, section 2.4.2).
65 A market maker is a stock brokerage that earns its keep by assuming the risk involved in maintaining an inventory of shares which can then be bought and sold more or less instantaneously. This keeps the markets trading smoothly.
Shell. At the time the coupons changed hands, a dividend had been declared but the coupons were not yet payable to bearer. The market maker cashed them in days later when they became payable at which point dividend tax was withheld, at the Netherlands’ statutory rate of 25%. The market maker, established and resident in the United Kingdom for purposes of the 1980 treaty concluded between the UK and the Netherlands, requested application of its article 10(2)b, which reduced withholding to 15%. Dutch tax authorities balked at this, claiming that the market maker was not the beneficial owner and therefore had no claim to the lower withholding rate. The HR concluded that the bearer of the dividend coupons when they became payable to bearer was the beneficial owner. The relevant provision did not literally require that the bearer of the coupons own the underlying shares. The treaty rate of 15% needed to be applied in lieu of the statutory rate of 25%.
6.1.2 Hold on, wasn’t the sale of the coupons a taxable event?
At no point did the Luxembourg entity divest itself of its shares. Dividend was declared, establishing a claim on the soon to be disbursed dividend. The claim - or at least the coupons that served as proof of the claim - could be traded freely. I feel it would not be unreasonable to argue that once dividend was declared, beneficial ownership of the claim to the (future) dividend had attached itself to the owner of the underlying shares. By transferring the claim in exchange for an amount of money, the Luxembourg entity had enjoyed proceeds arising from the underlying stock shares in Royal Dutch. And, as we have seen, under the law of the Netherlands, dividend withholding tax is due from whomever enjoys proceeds arising from stock shares. Did a taxable event not occur when the dividend coupons were transferred to the market maker?
No, according to the HR. The only relevant factor in determining beneficial ownership is who is standing in line holding the dividend coupon when the cashier’s window opens on payday.
6.2 Corrective legislation
This state of affairs was subsequently dealt with by the Dutch legislator. Dividend
withholding tax cannot be credited to an income tax or corporate tax liability if the taxpayer on whose account the tax was withheld is not also the ultimate beneficial owner of the proceeds arising from the shares. The stipulations66 do not go on to actually define the term ultimate beneficial owner, but do specify that a natural or legal person not normally eligible for treaty benefits cannot enter into a series of quid pro quo transactions with an eligible party and still reasonably expect the lower treaty-induced withholding rates to apply (Strategy #1 from section 2.7.1 above).
The variation on the dividend stripping theme (Strategy #2 from section 2.7.2 above)
involving a shareholder, ineligible for treaty benefits, selling shares cum-dividend and buying them back ex-dividend falls under the exclusions imposed by the post-Marketmaker
legislation. However, it is not hard to imagine that such a series of transactions could be carried out discretely, out of the line of sight of the tax collector - especially if the sale and buy back involved publicly traded shares. Just the same, if this activity does come to light, it would not sit well if an unsuspecting buyer67 of the shares cum-dividend were to then be denied using the dividend withholding tax as a tax credit.
Before the laws were amended, these strategies could not successfully be parried by invoking the treaty term “beneficial owner” since the text of the treaty does not state that the beneficial owner must also be the owner of the underlying shares; after the laws were amended, treaty benefits could be denied by relying upon Dutch statutory law, albeit most likely only in the most flagrant cases.
6.2.2 Consequences for the application of fraus legis/tractatus
It may no longer be possible to make a successful claim of fraus legis when confronted with treaty shopping casu quo dividend stripping. By specifying the circumstances that disqualify a taxpayer from using dividend withholding tax as a credit against income or corporate tax, there may be no room for anything beyond objective and mechanical application of those rules. Fraus legis would appear to have been codified with regard to treaty shopping, or rather, partially codified (leaving out its subjective element). Marres has conjectured that
66 See footnote 25.
fraus legis can still be applied to an article of law that is itself a codification of fraus legis, either because a situation does not fall precisely within the scope of the provision, or if the aim and purpose of the fraus legis-inspired article itself is frustrated. Fraus legis on fraus legis.68
I have been unable to find any recent Dutch jurisprudence that could support this conjecture with regard to either article 9.2-2 IB2001 or article 25-2 Vpb1969, but in a 2001 case69, a market maker – this time based in Amsterdam - turned a quick and tidy profit by exercising calls and puts on shares in a publicly traded company right around the time a dividend was to bedeclared. The market maker’s firm was ultimately able to credit the ensuing withholding tax against its corporate tax liability even though the tax authorities felt that it was obvious that the dividends it had collected were the fruits of dividend stripping - carried out by some foreign party that otherwise had no right to treaty benefits. It would be going too far to attribute a third party’s attempts to avoid dividend tax withholding to whomever purchased the stocks – apparently even if the buyer is a market-savvy professional trader.
Fraus tractatus remains an unknown quantity, never successfully invoked before the HR and apparently not even very frequently attempted.
7. What if the BEPS project had already been a done deal decades ago?
Inasmuch as “source” states may rightly get worked up about the tax income they miss out on, treaty shopping is a situation that needs to be addressed. Until such time that all the world’s tax jurisdictions, in multilateral harmony, reach agreement on how to apportion the right to tax commercial profits when they are passed along to investors, tariff disparities will remain ripe for exploitation. Perhaps the MLI is a step in that direction, but we won’t hold our breaths.
What we can wonder about, is whether the minimum standard, however it is configured, will work in the previously described quintessential cases of treaty-facilitated dividend stripping.
Working from the general to the specific, which is incidentally the OECD’s default position:
68 Marres, “Fraus legis blijft een krachtig wapen tegen winstdrainage”, Weekblad fiscaalrecht, 2008/1431. 69 HR February 21, 2001, ECLI:NL:HR:2001:AB0156.
7.1 PPT
7.1.1 Strategy #1: the Marketmaker gambit
The facts of the Marketmaker case contain several further illuminating details. It came out at trial that the Luxembourg entity that sold its dividend coupons literally split the difference with the London market maker. The agreed-to sale price was roughly 80% of the declared dividend and both parties to the transaction figured the 10% rebate on withholding tax into their calculations. Ergo, the Luxembourg entity, which otherwise stood to have 25% of the dividend withheld as a final levy wasn’t taxed at all and only incurred expenses totaling 20%, leaving 80% of the dividend in pocket, was 5%-points better off. The market maker collected the entire dividend which had been purchased for 80% of face value, and had 25% withheld of which 10% was rebated. A net profit of 5%-points remained, identical to the spread enjoyed by the Luxembourgers.
Whether this was negotiated beforehand or was such well-established practice that it didn’t even need to be discussed, it would be difficult to argue that the series of transactions wasn’t carried out with the specific goal of dodging the full amount of dividend withholding tax.
Step 1:
A benefit was sought: the source state (the Netherlands), had an obligation stemming from its treaty with the UK, to reduce its rate of dividend tax withholding from 25% to 15% if the beneficial owner was a treaty resident of the UK.
Dividend coupons were sold below face value (1), the market maker cashed them in (2), and collected a rebate on the withholding tax (3). An arrangement was entered into.
Is it reasonable (for the Netherlands’ tax authorities) to conclude, weighing the relevant facts and circumstances, that gaining that benefit was one of the principal purposes of the
arrangement entered into by the Luxembourg entity and the London market maker?
Certainly. It would be difficult to come up with a competing explanation.
Step 2:
Can the taxpayer (the market maker) establish that granting the benefit in these circumstances would be in accordance with the aim and purpose of the relevant treaty provisions?
