FACULTAD DE DERECHO
INVESTIGACIÓN DIRIGIDA
TEXTO JURÍDICO
IBEROAMERICAN TAX MOOT COURT COMPETITION
APPLICANT MEMORANDUM (TAX PAYER)
PRESENTADO POR: ANDRÉS BERMÚDEZ DUCHAMP
DIRIGIDO POR: ELEONORA LOZANO RODRIGUEZ
I. List of Abbreviations
DTC Double Taxation Convention
OCDE Organization for Economic Cooperation and Development
MC
Model Tax Convention on Income and on Capital as published in 2010.
VCLT Vienna Convention on the Law of Treaties
CEO Chief Executive Officer
CFC Controlled Foreign Corporation
II. Table of Contents
I. LIST OF ABBREVIATIONS ... 2
II. TABLE OF CONTENTS ... 3
III. INTRODUCTION ... 4
IV. THE IBEROAMERICAN TAX MOOT COURT. ... 6
V. LEGAL PLEADINGS ... 8
1.1. TROPICON LEGAL STATUS UNDER OECD ... 8
1.2. THE VIENNA CONVENTION ON THE LAW OF TREATIES IS APPLICABLE TO THE CASE. ... 8
1.3. THE OECD COMMENTARIES ARE SOURCE OF INTERPRETATION ... 8
1.4. THE DETERMINATION OF THE RESIDENCE OF STRATO AND COALIS ... 9
1.5. THE RESIDENCE OF STRATO ... 10
1.6. THE CRITERIA FOR DETERMINING PLACE OF EFFECTIVE MANAGEMENT. ... 10
1.7. THE RESIDENCE OF COALIS ... 11
1.8. THE CRITERIA FOR DETERMINING PLACE OF EFFECTIVE MANAGEMENT. ... 11
1.9. THE REGULATION OF DIVIDENDS UNDER THE DTC ... 12
1.10. THE COMPLIANCE WITH ARTICLE 10.1 OF THE DTC. ... 13
1.11. DEFINITION OF BENEFICIAL OWNER. ... 13
1.12. TROPICON´S DOMESTIC LAW ... 15
1.13. THE ADEQUACY OF COALIS TO BE A BENEFICIARY OF FLAMANTE´S DOMESTIC HOLDING REGIME. 16 1.14. DEFINITION OF ADEQUATE ORGANIZATION OF HUMAN AND MATERIAL RESOURCES ... 17
1.15. HIERARCHY OF TROPICON´S LAWS ... 18
1.16. THE MAXIMUM TAXATION RATE APPLICABLE ... 19
1.17. THE DTC BETWEEN TROPICON AND MARINALIA ... 20
1.18. THE RESIDENCE OF BICLUSTER ... 21
1.19. THE CRITERIA FOR DETERMINING PLACE OF EFFECTIVE MANAGEMENT. ... 21
1.20. THE TAXATION OF REVENUES FROM IMMOVABLE PROPERTY ... 22
1.21. APPLICATION OF ARTICLE 6 OF THE DTC ... 24
1.22. NON-‐PROPERTY RELATED ACTIVITIES ... 25
1.23. APPLICABILITY OF ARTICLE 7 OF THE DTC. ... 25
1.24. APPLICABILITY OF ARTICLE 21 OF THE DTC. ... 26
1.25. THE APPLICATION OF THE CFC RULES ... 27
VI. BIBLIOGRAPHY ... 29
VII. ANNEXES ... 32
1.1. IBEROAMERICAN TAX MOOT COURT 2013 CASE COMPETITION ... 32
III. Introduction
Benjamin Franklin stated, "In this world nothing can be said to be certain, except death and taxes." Although these immortal words were pronounced in 1789, they are now more valid than ever. Not only individuals, but also corporations must comply with the legal obligation to pay taxes on a regular basis. Even long before Benjamin Franklin, States have always exercised their legal right and sovereign power to levy taxes on the individuals - natural and juridical- who obtain wealth or consume goods and services within their territory. Given the huge advances made in technology, communications and transport, not only the amount of international transactions has increased exponentially, but also the international production of goods and services. According to the WTO, in 2012 the total amount of world merchandise exports summed up to 17930
billions of dollars1, whilst the United Nations Conference on Trade and Development,
forecasts that the total global foreign direct investment for 2014 will be of about 1.6
trillion of dollars2.
The massive increase in production, as well as in trade has consequently raised the income for States derived from the levying of taxes in productive activities. Nevertheless, the dynamic and constant exchange of goods and services has also made much more complex the taxation of income, as we are now facing products “Made in
the World”3 and not in a single taxation jurisdiction. Given that the production is
becoming each time more “Globalized” and the legal taxation boundaries are becoming each time more blurry due to conflicting tax jurisdictions, the problem that must be faced is ¿Where shall an item of income be taxed?
Multinational and Transnational companies seem to have solved the problem from a purely cost efficient perspective. A company must pay taxes in the State or jurisdiction that has the lowest taxation rates. As taxes are part of the expenses of a company, the lower the expenses incurred in the production of goods or services, the lower the final
1 World Trade Organization, International Trade Statistics 2013. WTO International Trade and Market Access Data, 2013. http://wto.org/english/res_e/statis_e/its2013_e/its13_toc_e.htm. Pg. 22. Retrieved 12 May 2014.
2 United Nations Conference on Trade and Development, World Investment Report 2013. http://unctad.org/en/publicationslibrary/wir2013_en.pdf. Retrieved 12 May 2014.
3 World Trade Organization, Made in the World Initiative. WTO International Trade and Market Access Data, 2013. http://wto.org/english/res_e/statis_e/miwi_e/miwi_e.htm. Retrieved 12 May 2014.
price to the consumer, and utterly the greater the market share and revenues for the corporation. Thus, in their rush to obtain the lower possible cost of production, companies have engaged in an aggressive campaign of re – domiciling their production plants or using façade companies to obtain lower taxation rates ensuring their product competitiveness. In a win – win situation, companies have been hosted by several jurisdictions where they are deemed as residents and obtain appealing tax benefits for establishing therein, to the detriment of third States who have seen their income from taxes reduced substantially due to tax practices of questionable legality.
For these reasons, States have had to enact aggressive tax legislations that consecrate the taxation of several sources of income, even if they have not been materially accrued
within its boundaries. The inclusion of concepts such as Residency4, or Permanent
Establishment5 among others has led to the taxation of one source of income in two or
more different tax jurisdictions. The phenomenon of double taxation has generated serious harm in taxpayers, as they must pay twice with respect to the same subject matter and for identical periods. Conscious of the harm that double taxation makes for all tax payers, different leagues of States, such as the OECD or the UN have decided to enact models of international treaties to eliminate, or at least restrain the nocuous effects of double taxation.
Although the UN model of convention was enacted in similar basis as the OECD model convention, the majority of the Double Taxation Conventions signed and ratified by
States - whether members or not of the Organization - follow the OECD model6.
The mission of the Organization for Economic Co-operation and Development (OECD) is to promote policies that will improve the economic and social well being of people around the world. The OECD provides a forum in which governments can work
4 According to the definition of resident as determined in article 4 of the OECD, Model Tax Convention on Income
and on Capital 2010 Full Version. OECD Publishing, 2012.
5 According to the definition of permanent establishment as determined in article 5 of the OECD, Model Tax
Convention on Income and on Capital 2010 Full Version. OECD Publishing, 2012.
6Miller, Angharad, and Lynne Oats. "Chapter 7 Double Tax Treaties."Principles of international taxation. 3rd ed.
together to share experiences and seek solutions to common problems. The OECD sets international standards on a wide range of topics including taxation.7
“The OECD has recognized that international juridical double taxation8 has harmful effects on the international exchange of goods and services and cross-border movements of capital, technology and persons. In recognition of the need to remove this obstacle to the development of economic relations between countries, as well as of the importance of clarifying and standardising the fiscal situation of taxpayers who are engaged in activities in other countries, the OECD Model Convention on Income and on Capital provides a means to settle on a uniform basis the most common problems that arise in the field of international juridical double taxation”9.
Although there have been several versions of the OECD model, the latest is the 2010 version of the Model Tax Convention10. In the case presented for discussion, all of the
legal references will be made from the OECD 2010 Model Tax Convention.
IV. The Iberoamerican Tax Moot court.
The Iberoamerican Tax Moot Court is a competition held as part of the annual meeting of the Iberoamerican Observatory of International Taxation (OITI). The observatory was founded in 2010 and since its incorporation it has served as a tool for the collection, analysis and interpretation of existing information about international taxation,
especially the one affecting Iberoamerican countries11.
The Moot Court competition was established as a mechanism to train law students in international taxation and double taxation conventions. Given a hypothetical case of international taxation, students are firstly required to present two written memoranda, assuming on one side a role as taxpayers and on the other as the tax administration of a
7 Op. Cit. OECD, About the OECD. Our Mission. http://www.oecd.org/about/ Retrieved 12 May 2014.
8 Generally defined as the imposition of comparable taxes in two (or more) States on the same taxpayer in respect of the same subject matter and for identical periods. OECD.
9Op. cit., OECD, “OECD Model Tax Convention on Income and on Capital - an overview of available products” .http://www.oecd.org/tax/treaties/oecdmtcavailableproducts.htm Retrieved 12 May 2014.
10 Ibid.
11 Observatorio Iberoamericano de Tributación Internacional. Quienes Somos., 2014. http://www.oiti.org/index.php/quienes-somos. Retrieved 12 May 2014.
fictious State or Jurisdiction. The memorial here presented is for the applicant, assuming the role of the Tax Payer. Once the written memoranda are submitted, the jury members evaluate these and choose the best 8 teams to proceed to the oral rounds. In the oral phase, teams are randomly assigned to a role and must plead accordingly. The four teams with the highest-ranking score shall proceed to the Semi Final round. The two best teams are then called to plea in the final round. The best team will be the winner. For all rounds both the written memoranda and the oral round score will be
taken into account12.
The memorandum that follows below was the one submitted by Universidad de los Andes´ team for the II Iberoamerican Tax Mootcourt Competition, which was held at
the Levin College of Law of University of Florida from the 29th to the 31st of October
2013. In this opportunity, the central theme of the contest was the double taxation of dividends, revenues and other income in jurisdictions with low or null taxation. The case and the clarifications on which this memorandum is based can be found at the end as annexes.
12 Observatorio Iberoamericano de Tributación Internacional. II Iberoamerican Tax Moot Court Competition. Official
V. Legal Pleadings
1.1. Tropicon Legal Status under OECD
(1) Tropicon as a sovereign13 and independent State is not a member of the OECD, and
therefore none of the decisions adopted by the international organization are of mandatory compliance to the Government. Nevertheless, in the use of its sovereign power, the Tropicon State has decided to follow the OECD Model Tax Convention on Income and on Capital as published in 2010, to regulate the International juridical double taxation with the States of Flamante and Marinalia.
1.2. The Vienna Convention on the Law of Treaties is applicable to the case.
(2) Given that the Double Taxation Conventions (DTC´S) signed and ratified by
Tropicon are fully operating international treaties14, the Vienna Convention on the law
of treaties (VCLT) binds these instruments and the States signing them. It is irrelevant whether the State of Tropicon has signed and ratified the VCLT, as this international instrument is of mandatory compliance for both signing and for all non-signing States,
as it contains all the international consuetudinary laws about treaties15. Thereafter, all of
the DTC´s signed and ratified by Tropicon must comply with the provisions set in the VCLT, and must specially follow the rules of interpretation established in article 31 of the VCLT.
1.3. The OECD commentaries are source of interpretation
(3) It is worth mentioning that the commentaries given by the Committee of Fiscal
Affairs of the OECD about the articles on the Model Tax Convention on Income and on
Capital have a non-binding status16. Nevertheless, given the fact that the DTC´s signed
and ratified by Tropicon are international treaties regulated by the VCLT, the
13 We assume that the State of Tropicon has been recognized by the International Community, as the matter at issue is not the sovereignty of States.
14 Lang, Michael. Introduction to the law of double taxation. 2 ed. Amsterdam: International Bureau of Fiscal Documentation, 2013. Pg. 27. Print.
15 Finnerty, Chris, Paulus Merks, Mario Petriccione, and Raffaele Russo. Fundamentals of International Tax
Planning. Amsterdam: International Bureau of Fiscal Documentation, 2007. Pg. 17. Print. & Rohatgi, Roy. Principios Básicos de la Tributación Internacional. Bogotá: Editorial Temis, 2008. Pg. 49. Trans. Idrovo, Juan Manuel. Print.
16 Ward, David A. "Is there an obligation in International Law of the OECD member countries to follow the commentaries on the model." Trans. Array Conflict of norms in International Tax Law series: The Legal Status of the OECD Commentaries. Amsterdam: IBFD, 2008. Pg.80-82. Print.
commentaries on the articles of the convention are part of the “context” for interpretation, and thereafter, legally binding as part of the rule of interpretation of
treaties17. This means, that it is mandatory for States when interpreting the DTC´s that
follow the 2010 OECD Model Tax Convention on Income and on Capital, to use the commentaries made to the articles of the Model Tax Convention as a source of
interpretation of treaties. “Although there is wide disagreement, the most common view
seems to be that since the OECD Model and Commentary are taken into account when negotiating the treaty, they constitute special meaning in the sense of Art. 31(4) of the VCLT”18.
(4) It is also relevant to highpoint the fact that the OECD 2010 Model Tax Convention
on Income and on Capital has its own rules of interpretation featured in article 3.2, but as the rule of interpretation contained in the OECD Model becomes part of the ratified
treaty, this article is as well subject to the rules set in the VCLT19.
1.4. The determination of the residence of Strato and Coalis
(5) The Tax Administration of Tropicon alleges that Strato, as resident of Tropicon failed
to comply with its duty to act as a withholding agent to withhold on the dividends paid to Coalis, resident of Flamante. Given that there is a DTC in force between the States of Tropicon and Flamante, and that this DTC follows the OECD Model Tax Convention on Income and on Capital except for dividends, it is mandatory to determine if the corporations in question are residents of the contracting States according to the Model Tax Convention, and thus, if the DTC between Flamante and Tropicon covers the dispute set by the tax agency. According to Article 4 of the Model Convention, the
residence of any person (natural or juridical) shall be determined under the laws of the
State. In this particular case, the national legislation of Tropicon establishes that the criteria to determine the residence of a person other than an individual shall be the place
of incorporation and the place of effective management20. Simultaneously, these two
rules are also the ones applied to determine the residence in Flamante.
17Ibid. Finnerty, Chris et al Pg. 19 & Ibid Rohatgi, Roy Pg. 78 & Ibid Lang, Michael Pg. 43 18Ibid. Finnerty, Chris et al Pg. 18
19Ibid. Finnerty, Chris et al Pg. 20 & Ibid Rohadki, Roy Pg. 86.
20 Observatorio Iberoamericano de Tributación Internacional. II Iberoamerican Tax Moot Court Competition. Clarifications for the Case. Bogotá, 2013. Pg. 2 Print.
1.5. The Residence of Strato
(6) Given that Strato was incorporated in Tropicon in January 2009, this would configure
a strong indication that Strato is resident in Tropicon and not in Flamante. Nevertheless, the rule that will utterly determine the place of residence of Strato is the place of effective management of the company. As article 4 of the DTC between Flamante and Tropicon does not bring any definition or criteria on what does place of effective management mean, it is mandatory to apply the rules of interpretation set by the VCLT. Therefore, to define the place of effective management concept, it is compulsory to refer to the commentary made by the Committee of Fiscal Affairs of the OECD on the matter. The referral to the commentaries made by Committee of Fiscal Affairs on the MC is essential, as they constitute the authorized interpretation to the special meaning
of words under the VCLT21.
1.6. The Criteria for Determining Place of Effective Management.
(7) According to the commentary made to article 4 of the MC, which was adopted by
Flamante and Tropicon in their DTC
“Competent authorities having to apply such a provision to determine the residence of a legal person for purposes of the Convention would be expected to take account of various factors, such as where the meetings of its board of directors or equivalent body are usually held, where the chief executive officer and other senior executives usually carry on their activities, where the senior day-to-day management of the person is carried on, where the person’s headquarters are located, which country’s laws govern the legal status of the person, where its accounting records are kept, whether determining that the legal person is a resident of one of the Contracting States but not of the other for the purpose of the Convention would carry the risk of an improper use of the provisions of the Convention etc.”22.
(8) According to the preceding rules set up by the Committee of Fiscal Affairs it is
undoubtedly visible that Strato is a resident of Tropicon and not of Flamante. Although it is uncertain where do the meetings of the board of directors take place, or where does
21Op. cit., Lang, Michael. Pg. 45
22 OECD, Model Tax Convention on Income and on Capital 2010 Full Version. OECD Publishing, 2012. Pg. C (4) – 9. Print.
the CEO carry out his activities, it is clear that the laws that govern the legal status of Strato are the ones of Tropicon, as it was incorporated in this State. Additionally, given
the heavy network of infrastructure that is required for coal extraction activities23 it is
foreseeable that the person’s headquarters, the day-to-day management and the accounting records are done and kept in this State. Nevertheless, it must be reminded that according to the commentary made to article 4 of the MC, it is enough to prove the
compliance with some of the criteria outlined by the Committee of Fiscal Affairs24, (as
it has been proven in this case) and thereafter it is not necessary to prove the concurrence of all the criteria. Finally, given that the place of effective management of Strato is in Tropicon and not in Flamante, there is no need to appeal to article 4.3 of the DTC in force between the contracting parties, as there is no double residence of the entity. This, given that under the national criteria of Flamante, this State is not the place of effective management of Strato, and thus Strato has a unique residence in Tropicon.
1.7. The Residence of Coalis
(9) On the other hand, regarding the residence of Coalis, it has to be ascertained that that
the residence of this legal entity is in Flamante only. For this, and knowing that for both States (Flamante and Tropicon), the criteria set out for determining the residence of a company is both the place of incorporation and of effective management, it is required to refer again to the commentaries set out by the Committee of Fiscal Affairs of the OECD. In this sense, firstly, it shall be taken into account that Coalis was incorporated in Flamante, and this constitutes an indication of the place of residence. Secondly, according to the criteria of the Committee of Fiscal Affairs, the residence of Coalis is in fact in Flamante.
1.8. The Criteria for determining Place of Effective Management.
(10) Following the criteria set out in the commentary of article 4 of the MC, for Coalis,
the meetings of the board of directors are made in Flamante, the CEO of the company carries out his activities full time in Flamante, the day to day management is taken place
23 Yaxley, Nigel. European Union. European Comission.Market for Solid Fuels in the European Union in 2010 and
the Outlook for 2011. Brussels: European Comission Publisher, 2011. Web.
<http://ec.europa.eu/energy/coal/studies/doc/2011_eu_market_solid_fuels_2010.pdf>. Retrieved 12 May 2014. & Daft, Richard. Organization Theory and Design. Tenth Ed. Mason, Ohio: Cengage Learning, 2010. Print. 24Op. cit., OECD, . Model Tax Convention on Income and on Capital 2010 Full Version. Pg. C (4) – 9. Print.
in Flamante25, the records are kept in that State and the legal status of the Corporation is regulated by Flamante´s national law. Thereafter, and fulfilling almost all of the requisites set up for determining the place of effective management, it cannot be doubted that Coalis is resident in Flamante. Although Coalis does not have any relevant asset in this State, this does not dismiss the fact that it´s place of effective management is in this State.
1.9. The Regulation of Dividends under the DTC
(11) Given that the both the Corporation distributing and the Corporation receiving
dividends are residents of either Flamante or Tropicon (which are the contracting parties of the DTC in mention), the Convention ratified by these States is fully applicable, specially article 10 which regulates the transference of dividends between contracting States. It is imperative to mention that in the ratified convention the contracting parties detached from the MC with respect to the regulation of dividends, and thus, they decided to include a different clause to control the taxation of dividends. Article 10.1 of the DTC between Flamante and Tropicon states:
(12) “Dividends paid by a company which is a resident of a Contracting State to a
resident of the other Contracting who is the beneficial owner of the dividends holding 20% or more of the voting stock or capital in the paying entity shall be taxable only in that other State”26.
(13) Specified that the DTC between Flamante and Tropicon is in force, and that article
10.1 is fully applicable to the case, the plea made by Tropicon´s Tax authority is unfounded, as Strato did not have the responsibility to withhold taxes on the dividends paid to Coalis.
(14) Article 10.1 of the DTC between Flamante and Tropicon establishes that the
dividends shall be taxable only in the Contracting State where the beneficiary of the dividends has its residence. For the application of such rule, article 10.1 requires the fulfillment of the following three requisites:
25 Observatorio Iberoamericano de Tributación Internacional. II Iberoamerican Tax Moot Court Competition. Case
Competition. Bogotá, 2013.Pg. 1 Print.
i) That the distributing company is resident of a contracting State and that the beneficiary of the dividends is resident of the other contracting State.
ii) That the company receiving the dividends is the beneficial owner of the dividends.
iii) That the beneficiary company holds at least 20% of the voting stock or capital of the paying entity.
1.10. The compliance with article 10.1 of the DTC.
(15) In the present case, it has been tested extensively that the distributing company
(Strato) is resident of a contracting State (Tropicon), and the beneficiary of the dividends (Coalis) is resident of the other contracting State (Flamante). Therefore, there is a full compliance of the first requisite determined by Art. 10.1. Regarding the third requisite, it has been accepted by all parties in the dispute that Coalis owns 100 per cent
of Strato´s shares27 and therefore conforming with the minimum burden of article 10.1
which obliges the beneficiary company (Coalis), to hold at least 20 per cent of the voting stock of the paying entity (Strato).
1.11. Definition of Beneficial Owner.
(16) Regarding the second requisite, the Tax Administration of Tropicon recklessly
accuses Coalis of engaging in abusive behavior, as the company cannot be considered the beneficial owner of the dividends distributed. The appreciation made by the Tax Administration of Tropicon is completely erroneous as it is assuming that the condition of beneficial owner is inevitably tied to the fact that the Capital of the corporation is owned by a third party to the DTC in mention.
(17) According to the official commentary on “Beneficial Ownership”28:
It would be inconsistent with the object and purpose of the Convention for the State of source to grant relief or exemption merely on account of the status of the immediate recipient of the income as a resident of the other Contracting State.
27Op. cit., Observatorio Iberoamericano de Tributación Internacional. Case Competition. Pg. 2
(18) Therefore, although beneficial owner still remains an undefined concept,29 it is clear
that it requires that the entity or person receiving the dividends does not act only as a
recipient (legal ownership)30, but also that the entity owns certain degree of economic
risk31. This means that there cannot be a full economic risk transfer32, but that the
recipient entity retains at least part of the economic ownership33. According to
Guglielmo Maisto:
(19) “Any person receiving a payment might/may/should/would/will pay the sum received
ultimately to another person. An individual receiving his salary may be surrounded by debts that require him to use the money to pay the butcher/the baker/ the candlestick maker/ his ex wife/ and his mortgage lender. However, he is still the beneficial owner of his salary. Equally, a company may/will use the dividends received to: pay interest on its debts; pay its suppliers; pay its staff; pay on a dividend to its shareholders etc. If the beneficial ownership is tested by asking whether the recipient of a dividend will, in practice, pay it to another person, then we are virtually none of us beneficial owners of the income we receive. If, however, it is tested by asking whether there is a binding legal, contractual or fiduciary obligation to pay the actual dividend received to another person, then that properly identifies the essence of the beneficial ownership limitation”34.
(20) According to the criteria set out by Maisto, Coalis is undoubtedly the beneficial
owner of the dividends, as the company has total discretion as to the distribution of dividends. Coalis is not bound by any legal obligation that forces the entity to distribute its dividends in an automatic manner. Although Coalis has regularly distributed dividends in a term not exceeding two months, there is no legal instrument or binding agreement that forces Coalis to distribute its profit as dividends within a time limit. The beneficial ownership of Coalis could be questioned if “the recipient does not have the
29 Vega Borrego, Felix Alberto. Limitation on Benefit Clauses in Double Taxation Conventions. Eucotax Series on European Taxation. Volume 12. The Hague: Kluwer Law International, 2006. Pg. 82. Print.
30 Van Bladel, M.L.L. Beneficial Ownership in the OECD model tax treaty. Breukelen, The Netherlands: 2012. Web. <http://www.oecd.org/ctp/treaties/BENOWNMLL_vanBladel.pdf>. Retrieved 12 May 2014.
& Op. cit., Vega Borrego, Felix Alberto. Pg. 83. 31 Ibíd.
32 Ibíd.
33Op. cit. Vega Borrego, Felix Alberto. Pg. 84.
34 Maisto, Guglielmo. Taxation of Intercompany Dividends under Tax Treaties and EU Law. Amsterdam: International Bureau of Fiscal Documentation, 2012. Pg. 93. Print.
full right to use and enjoy the dividend”35, which is not the case. In the present case, Coalis as an independent corporation has absolute freedom to determine the use that it will give to the dividends accrued, and it may use them deliberately to fulfill the purpose of the entity, or to pay within Flamante the legal obligations that might arise. As a consequence, Coalis is indeed the beneficial owner of the dividends that it receives from Strato, although it might posteriorly apportion its profit as dividends to the shareholder sitting in a third party State to this Convention.
(21) Given that the three requisites outlined in article 10.1 of the DTC in force between
the parties are fully met, this article becomes entirely applicable. As a consequence, the dividends shall be taxable only in the Contracting State where the beneficiary of the dividends has its residence. This means that the allegations made by the Tax Administration of Tropicon are unfounded. According to the DTC in force, the dividends shall be taxable only in Flamante, which is the State of residency of the beneficiary entity. Therefore, there is no place for a tax accrual in Tropicon, and subsequently Strato did not have the legal obligation to act as withholding agent of the dividends distributed to Coalis.
1.12. Tropicon´s domestic law
(22) According to Tropicon´s Tax Administration, the action raised against Strato for the
failure to act as a withholding agent, is based on an internal regulation of Tropicon, which states that when applying any DTC, this should not lead to double taxation nor null taxation. What Tropicon´s Tax Administration pretends in this case is to tax the dividends paid by Strato to Coalis, as they will presumably not be taxed in Flamante.
(23) The performance made by Tropicon tax authorities is illegal, as it is presumptuous
about the taxing behavior of Coalis in Flamante. Tropicon´s tax administration is assuming that Coalis is a beneficiary of Flamante´s domestic holding regime exemption and therefore is not paying any tax for the dividends received from Strato. It must be clarified that since it´s incorporation, Coalis has not paid any corporate tax in Flamante, but this by no reason means that Coalis has not paid any tax for the dividends received. It is a fallacy to believe that corporate tax and the tax imposed to dividends are
35 Ibíd.
necessarily analogous, as in the second one, the corporation is not acting as an income producing entity, but as a shareholder.
(24) In addition, the existence of the domestic holding exemption regime in Flamante is
conditional to the existence of an adequate organization of human and material resources. The authorities of Tropicon have failed to demonstrate that Coalis actually has the adequate organization of human and material resources needed to be a beneficiary of the regime, or in other words, Tropicon Tax authorities have failed to demonstrate that Coalis is truly being benefited from this exemption regime. Consequently, the imposition by Tropicon of the withholding agent regime to Strato is erroneous, as it is applying a domestic law to avoid null taxation, when the authority has faulted to demonstrate that there is actually null taxation. Therefore, if Coalis is not a beneficiary of the domestic holding regime of Flamante, Tropicon would not be able to tax the dividends accrued, as it would be incurring in double taxation over the same object.
1.13. The adequacy of Coalis to be a beneficiary of Flamante´s domestic holding regime.
(25) Although it is Tropicon´s Tax Authority responsibility to demonstrate the existence
of null taxation (which as it has been shown they have faulted grossly), even under the proof that Coalis is a beneficiary of the domestic holding regime of Flamante, and hence of the exemption regime, Tropicon does not have the legal right to tax the dividends delivered to Coalis. As it has already been said repeatedly, for a company to be beneficiary of the domestic holding regime of Flamante it must have an “adequate organization of human and material resources”36. Given that the jurisprudence in Flamante´s courts is hesitant and unclear, there is not a univocal criterion to determine the existence of adequate human and material resources. Subsequently it would be the job of each court to determine the existence of adequacy in each case.
1.14. Definition of adequate organization of human and material resources
(26) Given that the domestic holding regime exemption of Flamante is part of the internal
regulation of the State, it is not covered by the VCLT and therefore it shall not be interpreted in accordance to articles 31 and 32 of the VCLT. The interpretation rules set out in the national Flamantean regulations are the ones that must establish the meaning of the expression in question. Contesting Tropicon´s Tax Authority, the applicant believes that Coalis does have adequate organization of human and capital in Flamante.
Although Coalis does not have any relevant asset located in Flamante37, it cannot be
affirmed that the existence of human and capital organization is intimately linked to the existence of assets.
(27) Reminding that the purpose of Coalis is to make investments and perform financial
activities, an adequate human and capital organization for this type of corporation is
fairly specific38. A company dedicated to the performance of financial activities can
perfectly operate under a “light structure of heavy weights”. This expression refers to the fact that in a financial corporation such as Coalis, the key factor to success is in the quality of the decisions made, and not on the quantity of the individuals involved. Given that the financial business is of great risk, Coalis requires the existence of few (light structure) but highly knowledgeable people (heavy weights) that can make fully informed decisions. Therefore, the existence of a rented office and a CEO is more than adequate for the correct development of the corporate purpose. It would be foolish to believe that a corporation with the characteristics of Coalis would demand a great number of employees or major quantities of real estate property, as these would be adequate for a manufacturing company, but highly inadequate for a nascent company
that is dedicated to investments39. The adequacy of the human and capital organization
depends entirely in the type of business analyzed and the stage of the company within
the organizational life cycle.40 In addition, it must be considered that Coalis was
incorporated in 2008, which means that it does not have more than 5 year of existence. This results in the fact that the company is still within its take off phase, as it is widely
37Ibid.
38 In accordance with the United States Investment Companies Act & Regulation (EU) No 575/2013 of the European Parliament and of the Council.
39Op. cit., Daft, Richard. Pg. 343
accepted that the Entrepreneurial (take off) stage of a company goes up to the 6th year of
functioning. 41 These arguments allow the conclusion that the human and capital
organization that Coalis has in Flamante is more than adequate for the moment of the
company within its life cycle42 and for the realization of investment and financial
activities.
1.15. Hierarchy of Tropicon´s Laws
(28) Regardless of whether one assumes (such as Tropicon did), or proves (such as we as
applicants did) that Coalis has adequate organization of human and capital organization in Flamante, and it is thus entitled to the granting of the exemption regime, Tropicon has no right to tax the dividends distributed from Strato to Coalis, as international DTC law prevails over domestic law. As it has been detailed by the action against Strato, Tropicon claims the existence of a national rule within Tropicon, which says that there should not be double nor null taxation in the application of any DTC.
(29) What the Tax Administration of Tropicon ignores is that according to the
Constitution of Tropicon “domestic law should never be in breach of international
treaties”43. Reminding that a DTC is an international treaty, any domestic law, rule or regulation that goes against the DTC shall be not applicable. In the situation at hand, it is clear that Tropicon´s rule (which is of national origin) contravenes the dispositions of the DTC in force between Flamante and Tropicon. According to article 10.1 of the DTC between these States - and if the requisites there established are complied - the dividends shall be taxed only in the State that receives the payments. Henceforth, there is manifest contradiction between international law and Tropicon´s domestic law, as the DTC is stating that the dividends shall be taxed to Coalis, whilst the national Tropiconean rule is saying that the paying entity should be Strato. Recalling that
according to Tropicon´s Constitution44 domestic law should never be in breach of
international treaties, Tropicon´s Tax Administration cannot apply the domestic rule as it pretends or they will be in a gross violation of their own Constitution.
41 Ibid. 42 Ibid.
43Op. cit., Observatorio Iberoamericano de Tributación Internacional. Clarifications for the Case. Pg. 9 44Ibid.
1.16. The maximum taxation rate applicable
(30) Tropicon tax authority claims that it has the power to impose a tax of 25 per cent to
the distributed dividends due to the DTC in force with Flamante and to their national regulations in the matter. Although Tropicon´s right to tax the dividends originating in Strato has already been disdained, even if Tropicon had the right to tax the dividends in mention, the tax rate of 25 per cent is excessively high and would go against the provisions of the DTC in force.
(31) It is clear that in the DTC between Flamante and Tropicon the contracting States
have chosen not to follow the OECD MC, but instead they decided to include their own tailor made provision. Nonetheless, the model as a whole does follow the OECD MC, which means that regarding to dividends, the commentaries made to the MC shall be utilized as source of interpretation when they do not expressly contradict the article that departs from the MC. As Michael Lang asserts, “In the opinion of some tax authorities, the OECD model and the commentary of the OECD committee of fiscal affairs should also be taken into account for the interpretation of DTCs that do not follow the OECD model”45. Bearing this in mind, the commentaries made to the article 10 of the MC of
the OECD, especially with regard to the maximum taxable rates are fully applicable, and should not be violated by any of the contracting States. According to the commentary:
(32) “The rate of tax is limited to 15 per cent, which appears to be a reasonable
maximum figure. A higher rate could hardly be justified since the State of source can already tax the company’s profits”46.
(33) As a consequence, although Tropicon and Flamante have decided to include a
different provision for the regulation of dividends between contracting parties, the spirit of the article remains identical to the one recognized in the MC. This means that given the identity of the spirit of both dispositions, and specially that as a whole the DTC in force follows the OECD MC, all of the commentaries made to the MC shall be applicable unless they expressly contradict the articles that the contracting parties have decided to modify. Henceforth, the imposition by Tropicon of a tax rate of 25 per cent is
45Op. cit. Lang, Michael. Pg. 44
absurdly disproportionate, and in flagrant contradiction of the commentaries made by the OECD to the regulation of dividends. As specified in the commentary, a rate higher to 15 per cent would be hardly justified, as it would impose a disproportionate burden to the corporation distributing dividends. In the present case, Tropicon is taxing 10 per cent over the maximum limit established, which constitutes a violation of the DTC.
(34) As a result, although Tropicon has no right at all to tax the dividends distributed by
Strato to Coalis as it has been extensively demonstrated, in the remote case that the court finds that Tropicon has the right to tax the dividends that are being distributed, the tax rate cannot under any circumstance be 25 per cent. In the worst-case scenario, Tropicon could tax the dividends distributed up to a 15 per cent rate, on pain of violating the DTC, international law and utterly the Constitution of Tropicon.
1.17. The DTC between Tropicon and Marinalia
(35) Leaving aside the action against Strato, Tropicon´s Tax Administration on the other
hand decided to impose a 25 per cent tax rate on the revenues obtained by Bicluster for the mining activities it develops in Marinalia. According to Tropicon, they are entitled to the taxation of such revenues, as Bicluster is resident in their State.
(36) Firstly, as it will be shown later, the present controversy shall not be solved
according to Tropicon´s domestic law, but according to international law as Bicluster is not resident of Tropicon but of Marinalia. Secondly, it is of great importance to remember that Tropicon has a fully operative DTC with Marinalia, and thus any dispute arising between the contracting parties with respect to the subject covered by the DTC shall be solved according to the regulations adopted in the DTC. Thirdly, the DTC in force between these States follows the 2010 OECD MC completely, and none of the ratifying States has made any reservation to the application of the DTC. Fourthly, the DTC between Tropicon and Marinalia, as well as the DTC between Flamante and Tropicon are legal instruments of international law, and consequently they are subject to the VCLT and to the commentaries made by the Committee of Fiscal Affairs of the OECD as the arguments given for the DTC between Flamante and Tropicon are equally fully applicable to the DTC between Tropicon and Marinalia.
1.18. The Residence of Bicluster
(37) Tropicon´s Tax Administration decided to impose a 25 per cent tax on the revenues
accrued by Bicluster, arguing that Bicluster is resident in Tropicon and not in Marinalia. This is false, as since its incorporation Bicluster has been resident in Marinalia. According to article 4 of the DTC in force between the contracting parties, the concept of residence shall be determined according to the criteria adopted in the domestic laws
of each State47. As determined by Marinalia´s domestic legislation, the criterion to
determine the residence of a corporation is exclusively the place of incorporation of the
entity48. For Tropicon, the residence of a corporation is determined by the place of
incorporation and by the place of effective management49. Given that Bicluster was
incorporated in Marinalia in July 201050 and that the only criteria for determining the
residence in Marinalia is the place of incorporation, Bicluster is undoubtedly resident of Marinalia.
(38) Nevertheless, as Tropicon alleges that Bicluster is also resident in Tropicon,
Bicluster would be facing a double residency for taxation purposes. In accordance with article 4.3 of the DTC in force between the contracting States, in cases such as these, where a corporation is deemed to be resident of both contracting States, the dispute must be resolved by considering the corporation resident of the State in which its place of effective management is situated.
1.19. The Criteria for Determining Place of Effective Management.
(39) The place of effective management has not been defined within the article in
question, and according to the Committee of Fiscal Affairs of the OECD, the place of effective management must be determined according to various factors that have already been mentioned previously. As determined by these factors, although the meetings of the board of directors are held regularly in Tropicon, the CEO and the full senior team of the company carry on their activities and the day-to-day management in Bicluster and the laws that govern the legal status of the person are the ones of Marinalia, where it was incorporated. As well, it is undoubted that the headquarters of
47Op. cit. OECD, Model Tax Convention on Income and on Capital 2010 Full Version. Pg. C (4) – 2. Print. 48Op. cit., Observatorio Iberoamericano de Tributación Internacional. Clarifications for the Case. Pg. 2 49 Ibíd.
the company is located in Marinalia and not in Tropicon. Notwithstanding the fact that most of the senior meetings are held in Tropicon, this fact alone does not suffice the criteria to determine that the headquarters are located in Tropicon. In consistency with article 31.1 of VCLT, which demands that the interpretation of words shall be done according to their ordinary meaning, the ordinary meaning of Headquarters cannot be
other than “the place or building serving as the managerial and administrative center
of an organization”51.
(40) Given that the senior members of Bicluster work in Marinalia and the day-to-day
managerial decisions are taken in such State, it cannot be doubted that the Headquarters are located in Marinalia. It is vital to mention that the board of directors and the management team are not the same, and whilst the members of the board of directors are employees of Strato, the members of the management team are obviously employees of Bicluster. The definition of Headquarters makes reference to the place where the high managerial and administrative decisions are made, and not where the shareholders of the company meet, and thereafter, given that all of the administrative execution of Bicluster is done in Marinalia, the Headquarters of the company is in Marinalia.
(41) Specified that Bicluster has substance in Marinalia, and that the place of effective
management is in this State, in accordance with article 4.3 of the DTC between Tropicon and Marinalia, Bicluster must be deemed resident only of Marinalia.
1.20. The Taxation of Revenues from Immovable Property
(42) According to Tropicon´s Tax Authority, given that Bicluster is resident of Tropicon
it should tax 25 per cent of the revenues that it obtains from the development of its activities in Marinalia. Although Tropicon´s tax authority has failed to determine which is the activity that Bicluster is performing from which the revenues are obtained, there is no legal ground under any type of activity to entitle Tropicon to tax such revenues.
51 "Headquarters", Oxford American English Dictionary. 2013.
<http://oxforddictionaries.com/definition/american_english/headquarters?q=headquarters>. Retrieved 12 May 2014.
(43) Given that Bicluster was incorporated in Marinalia due to the high reserves of
Molybdenum present in the Country, it is reasonable to believe that the object and purpose of the company is the exploration and extraction of this metal. Under these circumstances, the taxation of the revenues obtained by the extraction of such mineral shall be done in accordance with article 6 of the DTC between Tropicon and Marinalia.
(44) If the main object of Bicluster is the exploitation of Molybdenum, this shall be
considered as income from immovable property. The glossary of tax terms from the
OECD defines immovable property as: “Also known as real property, immovable
property comprises land, houses and buildings”52. Following this definition, a mineral mine (regardless of the type of exploitable mineral or metal) constitutes immovable property, as the mine from where the extraction is made is inevitably tied to the soil or ground where it has been found and hence it cannot be moved. Although both the direct exploitation and the right to work mineral deposits are considered income from immovable property by the DTC, in the present dispute the revenue obtained by Bicluster is derived from the direct exploitation of the mineral mentioned, and is not gained by the lease or sale of the right to work mineral deposits.
(45) Given that the exploitation of Molybdenum is a direct use of the immovable
property, and this use is generating revenue for the company, it shall be taxed in accordance to article 6 of the DTC. According to paragraph 4 of article 6 of the DTC the provisions of the article are also applicable when the income is derived from immovable property of an enterprise.
(46) As a result of all the preceding arguments, the taxation of the revenues obtained by
Bicluster from the exploitation of Molybdenum cannot be made according to Tropicon´s internal regulations, but it must de done in accordance to article 6.1 of the DTC. Article 6.1 of the DTC says:
(47) Income derived by a resident of a Contracting State from immovable property
(including income from agriculture or forestry) situated in the other Contracting State may be taxed in that other State.
52 "Immovable Property" Glossary of Tax Terms. 2013. <http://www.oecd.org/ctp/glossaryoftaxterms.htm>. Retrieved 12 May 2014.
1.21. Application of article 6 of the DTC
(48) From a primary lecture of article 6.1 an unaware reader would note that the income
deriving from immovable property might be taxed in any of the two contracting States, as the articles explicitly says “may” and it does not say “must”. Nevertheless, according to the commentary approved by the Committee of Fiscal Affairs
(49) “It should be noted in this connection that the right to tax of the State of source has
priority over the right to tax of the other State and applies also where, in the case of an enterprise, income is only indirectly derived from immovable property”53.
(50) Having that the State of source is the State where the immovable property is
located54, it is therefore Marinalia the State who is entitled to tax the revenues obtained
by Bicluster as it has priority over Tropicon as for the taxing rights of immovable property.
(51) In addition to the commentary of article 6, article 23 A of the DTC expressly
requires that the first State whom may tax the income must exempt that income from tax. Such disposition states:
“Where a resident of a Contracting State derives income or owns capital which, in accordance with the provisions of this Convention, may be taxed in the other Contracting State, the first-mentioned State shall, subject to the provisions of paragraphs 2 and 3, exempt such income or capital from tax”55.
(52) Reading through articles 6 and 23, it is clear that Tropicon would be the first
contracting State (as it assumes that Bicluster is resident of Tropicon), and Marinalia which is where the immovable property is located would be the second State, or the
State who may tax as well immovable property. According to article 23 A, Marinalia
would be entitled to the taxation of income derived from immovable property situated within its territory, and Tropicon will be obliged to grant an exemption of such income to Bicluster in the case is considered resident therein.
53Op. cit., OECD, Model Tax Convention on Income and on Capital 2010 Full Version. Pg. C (6) – 2. Print. 54 Ibid.
1.22. Non-Property related Activities
(53) If on the other hand, Tropicon considers that the main activity carried out by
Bicluster is not related with mining, and hence is not derived from immovable property, the applicable articles would be article 7 or article 21 depending on the interpretation given to the key concepts of article 7. Either way, as it has been demonstrated that Bicluster is resident of Marinalia and not of Tropicon, when applying either article 7 or article 21 the country holding the prerogative to tax is exclusively Marinalia.
1.23. Applicability of article 7 of the DTC.
(54) Article 7 of the DTC between Tropicon and Marinalia regulates the taxation
arousing from Business Profits. According to this article, such profits shall be taxable
only in the State of residence of the business56, unless there is a permanent
establishment in the other contracting party. The difficulty of the applicability of this article to the case in mention is whether the definition of profit includes revenues, or if article 7 relates only in a strict sense to profit, and not to other items within income. According to the commentary made to this article
(55) “As already explained, Article 7 does not deal with the computation of taxable
income but, instead, with the attribution of profits for the purpose of the allocation of taxing rights between the two Contracting States. The Article therefore only serves to allocate revenues and expenses for the purposes of allocating taxing rights and does not prejudge the issue of which revenues are taxable and which expenses are deductible, which is a matter of domestic law as long as there is conformity with paragraph 2”57
(56) Given that the purpose of article 7 is to regulate Profit, and not only one element of
profit (Revenue), one cannot stand that the revenues obtained by Bicluster shall be taxed in accordance with article 7 of the DTC. As it is known, “revenues (or total revenue) refer to the value of output sold, that is the number of units times the price per
56Op. cit. OECD, Model Tax Convention on Income and on Capital 2010 Full Version. Pg. M - 22. Print. 57Ibid., Pg. C (7) – 25.
unit”58, which in other words is the income obtained from the ordinary activities of the company. On the other side, profit is defined as “the excess of revenue over expenditure”59. As a consequence, and under the interpretation of article 7, it is clear that what article 7 pretends to regulate is the taxation of profits, which is a very specific rubric within accounting, and it is not the same as the revenues obtained by the company.
1.24. Applicability of article 21 of the DTC.
(57) Henceforth, and given that there is no other article that treats revenues in a special
manner (unless they are derived from immovable property), the applicable clauses will be the ones contained in article 21 which relates to other income. Given that in the present argument we are assuming that the activities hold by Bicluster are not related to mining, article 21 is applicable as it regulates all income not treated in other articles. As revenue is normally the biggest item of income, and it has not been regulated in any other article, this article is meant to fully apply.
Article 21.1 of the DTC between Tropicon and Marinalia rules that:
Items of income of a resident of a Contracting State, wherever arising, not dealt with in the foregoing Articles of this Convention shall be taxable only in that State.
(58) In the present case, as it has been repeatedly asserted, Bicluster is resident of
Marinalia due to the criteria tested above, and according to article 21, in the case of other income, that income shall be taxed only in the State of residence. Therefore, Tropicon´s Tax Authority is in breach of the DTC when it imposes a tax of 25 per cent on the revenues obtained by Bicluster, as Marinalia is the only State entitled to charge for the revenues obtained.
58 "Revenue", Glossary of Statistical Terms. 2013. <http://stats.oecd.org/glossary/detail.asp?ID=3303>. Retrieved 12 May 2014.
1.25. The Application of the CFC Rules
(59) Finally, it is worth mentioning that the Tax Authority of Tropicon by fortune
decided not to apply to the present dispute the new Controlled Foreign Corporation Rules or CFC rules. Although these rules where not applied in the present dispute, it is mandatory to make note of the flagrant violation to the DTC between the contracting parties if these rules were ever applied. According to the domestic CFC rule
(60) “All the revenues and expenses of a foreign subsidiary controlled by a company
resident of Tropicon, must be included in the tax calculation of the parent company in the financial year in which they are recognized for commercial accounting purposes in the foreign controlled subsidiary.
No distinction shall be allowed regarding to the kind of income or the kind of entity.
If the subsidiary has effectively paid taxes over that income, the parent may be able to take a tax credit for the tax paid without exceeding the tax to be paid in Tropicon over that income”
(61) As it is expressly stated in the CFC rule, what this rule pretends is to tax every single
type of revenue and expense obtained from a subsidiary that is controlled by a company resident of Tropicon. The DTC in force between Tropicon and Marinalia brings a set of rules, which determines under which circumstances shall each of the contracting States be invested with the power of taxation and in which cases not. The application of a domestic CFC rule such as the one enacted in Tropicon goes against the mere essence of the DTC as it is taxing without differentiation, any type of revenue or expense, wherever and whenever arousing. The application of such rule would override completely the DTC in force, as it would breach each and every one of the articles contained in the international treaty ratified. If the revenues accrued by a subsidiary controlled by a Tropiconean company would have to be included in the holding
company, this would be in breach of the whole DTC as it would rule de facto that the
(62) The Constitutional concern derived from this legal figure relies in the fact that
Tropicon´s Constitution expressly determines that domestic law shall never be in breach of international treaties. If the CFC rule were applied, a massive breach of international law and of Tropicon´s Constitution would happen, which would lead to a degeneration and utterly absolute inapplicability of the DTC that both contracting parties decided to ratify.
VI. Bibliography
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• Finnerty, Chris, Paulus Merks, Mario Petriccione, and Raffaele
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• “Immovable Property", Glossary of Tax Terms. 2013.
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• Lang, Michael. Introduction to the law of double taxation. 2 ed. Amsterdam:
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• Maisto, Guglielmo. Taxation of Intercompany Dividends under Tax Treaties
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• Miller, Angharad, and Lynne Oats. "Chapter 7 Double Tax Treaties."
Principles of international taxation. 3rd ed. Haywards Heath, West Sussex: Bloomsbury Professional Ltd. , 2012. . Print.
• Observatorio Iberoamericano de Tributación Internacional. II Iberoamerican
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