INTERNATIONAL AND EUROPEAN TAX MOOT COURT COMPETITION - KU LEUVEN Academic Year 2014/15 First Round: The Alphabet letters Case A. Entities A is a world-known leading investment portfolio company. It was created in 2000 as a result of a merger of several investment companies. Since its formation in 2000, its seat and place of effective management have been located in state A. It was incorporated as a public limited liability company. It is liable and subject to corporate income tax in state A. B is a small private (multi-employee, multi-employer) pension fund. It was incorporated as a foundation, and was formed and operates in accordance with state B s domestic law. It is considered, for tax purposes, as resident in state B. Its growth rate is historically higher than comparable pension funds (mainly due to the adoption of a bolder investment strategy). Due to that fact, and to the slightly higher returns offered, it receives (pension) premium funds from many countries. Given its geographic proximity, it receives many premiumsfrom state C, such that more than 50% of its income comes from state C. Given that it is incorporated and operates in accordance with domestic law, it is exempt from corporate income tax. C is a public limited liability company that is resident in state C. It is a leading company in its sector. It is in sound financial standing and is regarded as one of the drivers of the economy of its region. Since its formation (in 1995), it has made pension premium payments on behalf of its employees in order to provide them better pensions in the future (and also because these payments may be deducted from the tax base in state C). Many employees of this company also have additional pension plans, at more favourable terms in state B (actually, these favourable conditions are granted to all individuals whose employers make direct contributions to B). B. Legal framework B.1. At the conventional level: tax treaties Between A and C There was a tax treaty in force since 1995. It was negotiated and patterned on the 1992 version of the OECD Model Convention (hereinafter: OECD Model). The main deviation was found in article 10(2)(1), under which the applicable tax rate was 0%. This treaty was terminated with effect from 31 December 2005. Currently, there is no tax treaty in force. Authorities of both countries have stated, in a press release, that they are waiting for the final results of the OECD s base erosion and profit shifting (BEPS) project before deciding how to proceed with negotiating a new treaty. Between A and B There has been a tax treaty in force since 1995. It was negotiated and patterned on the 1992 version of the OECD Model. The main deviation is found in article 10(2)(1), under which the applicable tax rate is 0%. The treaty partners opted for article 23A (exemption method). 1
Between B and C A tax treaty was in force between 1995 and 31 August 2014, and was negotiated and patterned on the 1992 version of the OECD Model. It was replaced by another tax treaty that entered into force on 01 September 2014 (already patterned on the 2014 OECD Model). Article 10(2)(a) contains no deviation from the OECD Model. However, there is a deviation in article 11(2), such that the tax rate is 5%. The treaty partners opted for article 23A (exemption method) B.2. At the conventional level: bilateral investment treaties There are bilateral investment treaties in force, between A and B, B and C, but not between A and C (the latter having been terminated at the same time as the tax treaty). The latest version of these treaties entered into force in 2012 and they are patterned on the 2012 version of the US model bilateral investment treaty: http://www.state.gov/documents/organization/188371.pdf. B.3. At the domestic level B.3.1. Domestic legislation of State A The domestic corporate income tax rate (also applicable to dividends) is 30%. Before paying dividends or interest to a non-resident subject, a corporate resident is obliged to withhold taxes (under domestic law or, if applicable, the relevant tax treaty). The resident paying agent must verify compliance with the applicable tax treaty before applying the more favourable conditions contained therein. Resident paying agents are jointly (solidarity principle) responsible for any tax not correctly withheld. In addition to meeting the requirements under the treaty, non-residents must also provide a certificate of tax residency to the resident paying agent. This certificate (required since 2006 by an act of the parliament) must include the following: (i) full identification of the company, (ii) statement of its residence for tax purposes and the criterion based on which that classification was based, (iii) statement that for tax purposes, and under the terms of an income tax treaty concluded with a third state, the company is not considered as a resident for tax purposes in a third state, (iv) statement that the company is subject to corporate income tax, without any possibility of option or exemption. The legislature justified the requirement of the tax certificate with its need to combat tax fraud and avoidance, as well as to ensure international tax transparency. There is a domestic exemption for dividends obtained by pension funds formed and operating in accordance with domestic law. Since 2000, resident entities subject to corporate income tax must fulfil certain substance requirements, namely: (i) have a registered address and office in state A, (ii) be registered with the national chamber of commerce, (iii) have a board of directors at least half of the members of which, with a right to take decisions, are resident in state A, (iv) the most significant board decisions are taken in state A, (v) the main bank account is located in state A, (vi) the bookkeeping of the company takes place in state A and (vii) the company has a level of equity which is in line with its activities. B.3.2. Domestic legislation of State B 2
The domestic corporate income tax rate (also applicable to dividends) is 10%. Pension funds are mentioned as taxable subjects in the corporate income tax code. A different act (not the corporate income tax code, but rather the tax incentives code) states that income received by pension funds, insofar as formed and operating in accordance with domestic law, is exempt from corporate income tax. There are no (explicit) substance requirements regarding pension funds. B.3.3. Domestic legislation of State C The domestic corporate income tax rate (also applicable to dividends, interest and royalties) is 30%. Payments made for pension premiums, on behalf of the employees, are considered as costs and therefore excluded from the tax base (under the framework of the corporate income tax). Pension funds formed and operating in accordance with domestic law are also exempt from corporate income tax. There are several substance requirements regarding corporate income tax subjects (also applicable to pension funds - equal to those in force in State A). C. Other clarifications None of the states registered any observations or reservations to the OECD Model (nor expressed any similar statement, by any other means). None of the states are EU or EEA/EFTA Member States. A and C (but not B) are OECD member countries. All of the countries are members of the United Nations. The Vienna Convention on the Law of Treaties has been in force in all of the relevant states at least since 2000. The Council of Europe / OECD Convention on Mutual Administrative Assistance in Tax Matters has been in force since 1 January 2001, and the Protocol thereto since 1 January 2006. All states subject residents to tax on their worldwide income, while non-residents are taxed on the income sourced in the territory of the state. The legal systems of these countries do not correspond specifically with the civil law or common law model, but rather combine elements of the two systems. State A and state C are monist states, while state B is a dualist state. Regarding the nature of the income: the income paid from A to B is clearly regarded as a dividend (by both states), while the income paid from B to C is clearly regarded as interest (by both states). The statute of limitations in state A allows that country s tax administration to audit and assess the periods at issue in this case. There are no further indications regarding interpretation of the above-mentioned provisions or of general principles of law, by the case law of the states involved. None of the states has domestic (unilateral) rules for the relief of economic double taxation. D. Transactions sub judice Due to allegations of mismanagement, in 2006 the board of directors of C was completely 3
replaced. The new board of directors decided to implement a new business strategy that has already yielded sound results. Among others, they have implemented the following measures: due to the termination of the A-C tax treaty, the board decided to sell its position in A (a shareholding of 16%); this position was bought by B; and due to the market situation, a receivable was not needed for either new investments or dividend distribution (as that would lead to a huge dividend payment which would disrupt the normal history of dividend payments). Accordingly, the board first contemplated allowing a payment in instalments; however this proposal was rejected. As in the discussions with B the latter had mentioned that it would seek a bank loan in order to obtain the funds needed to pay for the shares, they decided to offer the loan to A, at the same market conditions that a bank would grant. B accepted this and obtained the loan (and effectively used the loan to pay the shares). Among other things, C explained to its shareholders that the main reason for selling the position in B was the termination of the A-C tax treaty, which would increase the tax burden on the dividends received. Therefore, and from a commercial perspective, this was no longer attractive. Regarding these deals - They were effected in separate documents, although signed on the same date. - Negotiations were held separately, although executives took advantage of the last business trips to negotiate also the conditions for the loan. - It is agreed that all negotiations started with C s intention to sell its shareholding in A; the loan agreement arose as a result of the cash flow needs faced by B, due to that acquisition (expressed in the course of negotiations). - Termination or breach of one of the agreements does not trigger any consequences regarding the other agreement. - The deal was structured such that the repayment of interest (by B, to C) matches the average historic payment of dividends by A, over the last 5 years; - An additional clause states that if A does not pay dividends, B may defer the payment of interest to C (add one extra year to the total repayment period / years). - Another clause states that if the amount of dividends paid by A is 3% higher or lower that the amount of the fixed interest stipulated between B and C, the amount of the payable interest must be adjusted to the amount of the dividends (the necessary corrections would be made in the last year(s) of the repayment of the loan). - The payment of interest must be done within 30 days after the receipt, in B s bank account, of the dividends paid by A. Furthermore, all parties (including the tax authorities) concluded that the fixed interest rate loan was at arm s length conditions (i.e. market conditions). Regarding the payments Dividends have been always paid from A to B. Up to the present, the amount of the dividends has always been in the 3% range of the negotiated fixed interest. 4
E. Some known pleadings of the parties E.1. Tax authorities They carried out an audit regarding the payments of dividends between A and B between 2010 and 2014 (as allowed under the domestic statute of limitations). They concluded that A had erroneously applied the A-B tax treaty (the withholding tax rate mentioned therein): First, the tax authorities noted that the certificate presented (mentioning only the residence of B, due to its seat and place of effective management in state B) was not what is required under domestic law as, namely, (i) it did not mention that B was not a resident of any other state under a treaty signed by state B with another jurisdiction, and (ii) although it mentioned that the company was subject to tax, it did not mentioned that the company was (or not) exempt or had any possibility of option. Although the tax authorities acknowledged the evidence presented during the proceedings by A and B (namely showing that B could never be considered a thirdstate resident and that it was subject to corporate income tax), in any case the certificate was missing. The tax authorities expressed doubts as to whether the pension fund could be considered entitled to treaty benefits and whether it could even be regarded as the beneficial owner of the income. In an excerpt from the audit report, they mentioned that in order to assess the issue of beneficial ownership, the proper version of the Commentary on the OECD Model to be used is that of the moment when the treaty was being negotiated. The tax authorities expressed doubts as to whether this company had sufficient substance in order to be considered a genuine business. E.2. Taxpayer The taxpayer asserts that the pension fund is entitled to tax treaty benefits and, therefore, that it has withheld the correct amount of tax. Therefore, no extra tax or penalty may be imposed. The taxpayer asserts that the pension fund is the beneficial owner and that the standards that should be used for interpretation are those of the current (2014) version of the Commentary on the OECD Model. F. Current procedure The case is now pending before the court. The court in which you are filing the petition (and before which you will later plea orally) assesses both facts and law. Assume that you are in a rule-of-law country, where rules as well as general principles of law may be invoked. For the written memoranda, please bear in mind that you are writing as if you were filing the protest on 1 December 2014. Feel free to elaborate more on known arguments presented by the parties or to consider other (tax) arguments, even if they are not mentioned in this fact pattern. Even if you conclude that the case may be resolved based on a specific set of grounds, you should explore, at least secondarily any other arguments that might be considered by the parties. 5