Arbitration and Tax Abuse Cases – An Agenda for Further Research

Despite the existence of taxation carve-out provisions in international investment treaties (“IIAs”),^[1] tax abuse cases decided by arbitration tribunals are steadily growing (Yukos,^[2] Vodafone,^[3] Cairn Energy,^[4] Lone Star).^[5] The aforementioned cases show that arbitration tribunals verify whether the application of anti-abuse provisions, either on domestic law or bilateral double tax conventions to prevent double taxation (DTCs), may trigger a breach of the fair and equitable treatment standard (“FET’) in IIAs.

The tax literature has started to pay attention to the interaction between IIAs and tax abuse. The application of anti-avoidance measures by the tax administration, like a domestic general anti-avoidance provision (GAAR) or a GAAR included in a DTC,^[6] aims to protect the tax revenue of a State.^[7] Traditionally speaking, there has always been a clear fear of States allowing arbitrators to adjudicate tax cases, especially when anti-avoidance measures are at stake. Such reluctance towards arbitration in international taxation is visible within the dispute resolution mechanisms in the DTC network:

• Article 25 (5) of the OECD MC (2017) precludes access to arbitration if a decision on the unresolved issues subject to arbitration has already been rendered by a court or administrative tribunal.
• Many DTCs exclude the arbitration stage of a Mutual Agreement Procedure (´MAP´) to decide unresolved issues unless the taxpayer waives his domestic appeals.^[8]
• Many countries have opted out of arbitration to solve disputes in international taxation.^[9]
• Many States in their DTCs expressly exclude cases to be subject to an arbitration tribunal when anti-abuse provisions were applied.^[10]

In the field of investment law, as noted by Prof. Martín Jiménez, the angst is that the open-ended nature of anti-abuse provisions may yield aggressive application by tax authorities to tax schemes employed by the taxpayers, thereby leading to potential breaches of the FET standard.^[11] How to set legal boundaries in assessing the application of anti-avoidance legislation under the FET standard? Prof. Martín Jiménez and Prof. Danon have defended the interpretation and application of domestic and international law in the light of IIA standards, namely the FET standard, to reduce the uncertainties related to open-ended tax provisions such as a GAAR or the current PPT.^[12] This scholarly position derives from Article 31(3)(C) of the Vienna Convention of the law of the Treaties (“VCLT”), which avoids fragmentation of international law and advocates for an uniform interpretation of international economic law (investment, trade and taxation). Applying the FET standard to the DTCs truly enforces such a mandate under Article 31 (3) (C) of the VCLT.

In his piece, Prof. Danon argues that in the light of the FET standard, an alternative treaty benefit would be available in case of application of the PPT. This question, not solved in Article 29 (9) of the OECD MC, relates to cases where the tax administration applies the PPT in treaty-shopping scenarios and denies the preferential treaty benefit ultimately searched by the taxpayer (i.e., 0% withholding tax on the distribution of dividend). Can the taxpayer apply an alternative treaty benefit (15% withholding tax in the DTC) or conversely, is subject to higher withholding domestic rates for dividend distribution? Since a finding of abusive practice must not lead to a penalty (Occidental v. Ecuador), the FET principle could justify applying an alternative available treaty benefit, and not excluding the whole DTC when applying the PPT.

1. Assessment of tax abuse by arbitration tribunals applying FET: Cairn Energy and Lone Star

Cairn Energy is a good example of a careful application of the FET to an offshore transfer of shares. Despite the insistence of India making equivalent double non-taxation to tax avoidance, the arbitration panel concluded that India failed to prove the abusive nature of the arrangement (paragraphs 1260-591/paragraph 1813).^[13] The arbitration panel recognized the right of the taxpayer to plan their affairs to pay the least amount of tax possible. It thus was inclined to respect the form of transactions undertaken by the taxpayer.^[14] Perhaps the outcome of the case could have been different provided that India had demonstrated the wholly artificial nature of the arrangements and not solely the double-non-taxation outcome. The decision in Cairn Energy respects the rule of law and its formalistic reasoning tallies with tax scholarship supporting that an outcome of double-non-taxation is not per se abusive.^[15]

In Lone Star, Korean tax authorities denied treaty access (DTC between Belgium and Korea) for dividends received and capital gains derived from the alienation of shares in South Korean Companies by several Belgian purpose vehicles, controlled by Bermuda and US partnerships. Korean tax authorities applied an anti-avoidance doctrine (¨substance over form¨) to disregard the DTC. The claimant argued that the refusal to apply the DTC was arbitrary and discriminatory because the tax authorities´ criteria were not applied to other undertakings. Therefore, in their view, Korea failed to comply with the FET principle in the IIA between Korea and Belgium (paragraph 383).  The arbitration tribunal ruled that the application of the substance over form doctrine by the Korean courts was neither arbitrary nor discriminatory (paragraphs 410/469/476/487). Unlike in Cairn Energy, where the arbitrators comprehensively assessed the tax-avoidance nature of the arrangements, the arbitration tribunal in Lone Star fully relied on the decisions by the Korean judicial bodies to determine that there is no such breach of the FET principle without entering into an analysis of tax abuse. In a nutshell,the arbitration panel restrained itself to step into the examination of the “substance over form” doctrine applied by Korean courts.

2. Agenda for further research in the interplay of IIAs and DTCs

The interplay between IIAs and DTCs is thrilling, especially in cases involving tax abuse. The debate is still on finding legal solutions to face the fragmentation of international law. Although the topic of fragmentation in public international literature is no longer fashionable,^[16] the assessment of tax abuse cases by arbitration tribunals under FET standard revitalizes the interest in tax scholarship on it.

I can identify two clear paths of research. On one hand, the route already shown in tax literature and present at Cairn Energy, strives for applying the FET standard to interpret DTCs and thus modulate the high risks derived from open-ended provisions such as the GAARs. On the other hand, there is a need to explore judicial dialogue mechanisms between courts and arbitration tribunals.^[17] Is the self-restrained attitude adopted by the arbitration tribunal in Lone Star the suitable solution for tax abuse cases within the scope of IIAs? Can the arbitration tribunal deviate from the solutions reached in domestic litigation? Since there still exists strong resistance against arbitration to solve tax disputes, such resistance would disappear only after arbitration is fastened under the “dominium

^[1] As R. Danon noted, the majority of IIAs currently in force do not contain such exclusion. See R. Danon, ‘Interpreting tax treaties in light of investment agreements: the role of the principle of systemic integration in tax treaty disputes’ in P. Pistone (ed), Building Global International Tax Law: Essays in Honour of Guglielmo Maisto (IBFD 2022) 507-535.

^[2] Yukos case is referred in three cases: PCA, 18 July 2014, Case No. AA 227, Yukos Universal Limited (Isle of Man) v The Russian Federation; PCA, 18 July 2014, Case No. AA 226, Hulley Enterprises Limited (Cyprus) v the Russian Federation; PCA, 18 July 2014, Case No. AA228, Veteran Petroleum Limited (Cyprus) v Russian Arbitration.

^[3] PCA, 25 September 2020, Case No. 2016-35, Vodafone International Holdings BV v India,Final Award.

^[4] PCA, 21 December 2020, Case No 2016-07, Cairn Energy PLC and Cairn UK Holding Limited v The Republic of India.

^[5] ICSIS, 30 August 2022, Case No. ARB/12/37, ULSF-KEB Holdings SCA and others v Republic of Korea, (“Lone Star”).

^[6] See the Principal Purpose Test, (‘PPT”) included in Article 29 (9) OECD MC (2017).

^[7] R. García Antón & Toni Marzal, ‘Proportionality and the fight against international tax abuse: comparative analysis of judicial review in EU, international investment and WTO law’ (2022) 30 Asia Pacific Law Review 1.

^[8] This provision is included within the DTCs signed between Spain and Switzerland (2011), Spain-United Kingdom (2013) and Spain-Japan (2021).

^[9] From 100 countries signatories of the Multilateral Convention to Implement Tax Treaty Related Measures to Prevent Base Erosion and Profit Shifting (MLI) in 2017, only 30 jurisdictions opted in for arbitration.

^[10] See for example the reservation introduced by Spain to Article 28 (2) (a) MLI.

^[11]  A. Martin Jimenez, ‘International Investment Agreement and Anti-Tax Avoidance Measures:  Incoherencies in the International Law System, Systemic Interpretation and taxpayer Rights’ in P. Pistone (ed), Building Global International Tax Law: Essays in Honour of Guglielmo Maisto (IBFD 2022) 537-570.

^[12] ibid; Danon (n 1).

^[13] Antón and Marzal (n 7).

^[14] Jiménez (n 11).

^[15] A Martín Jiménez, ‘Tax Avoidance and Aggressive Tax Planning as an International Standard – BEPS and the “New” Standards of (Legal and Illegal) Tax Avoidance’ in AP Dourado (ed). Tax Avoidance Revisited in the EU BEPS Context (EATLP Volume 15, IBFD 2017) 32, 49; FD Martínez Laguna, ‘Abuse and Aggressive Tax Planning: Between OECD and EU Initiatives – The Dividing Line between Intended and Unintended Double Non-Taxation’ (2017) 9(2) World Tax Journal 189.

^[16] The relevant publications on fragmentation were released in the period 2000 – 2015). See for example the Report elaborated by Martti Koskenniemi, ‘Fragmentation of International Law : Difficulties Arising From the Diversification and Expansion of International Law : Report of the Study Group of the International Law Commission’ (United Nations 2006) < https://legal.un.org/ilc/documentation/english/a_cn4_l682.pdf> Accessed date 28.11.2022; M. Andenas, ‘Reassertion and Transformation: From Fragmentation to Convergence in International Law’ (2015) 46(3) Georgetown Journal of International Law 685; M. Young et al., Regime Interaction in International Law: Facing Fragmentation (CUP 2015); P. Webb, International Judicial Integration and Fragmentation (OUP 2013); E. Benvenisti & G.W. Downs, ‘The Empire’s New Clothes: Political Economy and the Fragmentation of International Law’ (2007) 60(2) Stanford Law Review 595; M. Koskenniemi & P. Leino, ‘Fragmentation of International Law? Postmodern Anxieties’ (2002) 15(3) Leiden Journal of International Law 553.

^[17] I have already made an attempt to build up judicial cooperation mechanisms between Human Right courts and arbitration panels. See R. García Antón, ‘The Fragmentation of Taxpayers’ Rights in International Dispute Resolution Settings: Healing Anxieties through Judicial Dialogue’ (2018) 10(1) World Tax Journal 131.