סקירה שהכנתי בנושא בשנת 2018 (חלק מעבודה
אקדמית):
Is the DPT covered tax in Australian and UK
DTAs?
DTAs are agreements between two states and
therefore, like any agreement, it is necessary to examine the text and the
intentions of the parties. Thus, the starting point is a review of the relevant
articles and definitions of the DTAs between Australia or the UK and other
countries. This will be done first by referring to the relevant definitions and
articles of the OECD Model Convention (OECD MC)[1].
Relevant articles and rules of interpretation
The relevant Article of the OECD MC is Article
2, which defines the taxes covered by the DTA. Article 2(1) provides that the DTA applies to
taxes on income and capital imposed on behalf of one State or its affiliates,
irrespective of the form in which they are imposed. The relevant part of
Article 2(2) provides that all taxes imposed on income or capital shall be
deemed to be such even if imposed on an element of income or capital. Article
2(3) provides the alternative of specifying taxes to be included in the DTA and
Article 2(4) provides that the DTA shall apply also to substantially similar taxes
imposed by any of the contracting states after the signing of the DTA.
There is no definition in the OECD MC (or its
commentary file[2]) of
what is income tax, nor is this defined in the domestic law of most countries.
Therefore, this is an interpretative question
that will usually be discussed by the judge in the relevant country.
However, it seems that there are conventions
regarding rules of interpretation of the provisions of the DTA and in
particular with respect to Article 2 - these conventions were also expressed in
local case law[3].
Among other, it is agreed that the formal name
of the tax is not the primary factor for its classification, and that it should
be made in accordance with accepted international taxation principles
(international language and reliance on courts abroad)[4]. It is
also agreed that in accordance with the provisions of the Vienna Convention[5], the
classification should be relevant to the date of signing of the relevant DTA[6].
With regard to the interpretation of Article
2(3) and 2(4), Ismer[7]
explains that there are two interpretative approaches - the micro-approach
according to which the "new" tax in dispute should be examined as one
of the specified taxes, and the macro-approach according to which the tax
should be examined as appropriate to the principles that emerge from the whole
of the taxes specified in Article 2(3). However, he emphasizes that according
to both approaches, the classification should be based on the taxes specified
in the relevant domestic law. For example, if an Australian income tax is
specified, the tax cannot be classified as income tax in an objective and
detached manner. Brandstetter[8] points
out another peculiarity of Article 2(3), namely that extraordinary new tax
cannot be included in a DTA which did not adopted it.
In this context, in Australia, the Federal
Court in Virgin[9] stated
in obiter regarding the interpretation of Article 2(3) that its preferred
interpretation of the term "Australian income tax" was "ambulatory
and not static". In the circumstances of the case there, it was held
that a capital gains tax is indeed part of the Australian income tax as defined
in the DTA with Switzerland.
From the general to the specific:
Australia and UK's DTAs do not generally
include the broad definitions in paragraphs 2(1) and 2(2) to the OECD MC but
specify taxes such as income tax (and corporate tax) 2(3).
The term "Income Tax" has a globally
and domestic accepted meaning and it applies to profits in accordance with the Haig–Simons
and with the emphasis of it being imposed on the recipient and not on the
payer. The common distinctions between this tax and other taxes are mainly the
distinction from tax on wealth or tax on a gifts or tax imposed on gross
receipts. It is also common to distinguish between tax and a fine.
In this sense, it appears that if the DPT is
not income tax (or corporate tax) specified in the DTAs, it is at least a
similar tax in the sense of Article 2 (4). However, in light of its special characteristics,
several counter-arguments have arisen, which should be discussed.
The HMRC[10]
noted that the DPT is not similar to corporate tax and has unique
characteristics such as a different tax rate and a different collection and
assessment procedure. This argument is likely to be used by the tax authorities
to support the claim that the tax is outside the scope of DTAs.
Ismer[11] and others relate to these claims and argue
that they should be rejected because the test is substantive and informal,
otherwise it will be very easy for states to avoid their obligations under the
DTAs. Examination of the tax (in both countries) shows that it is calculated in
the same manner as corporate tax, and the claim that it applies only to part of
the income of the taxpayer is also irrelevant because the same is true to
taxation of a "real" PE. Ismer also
refers to the argument of the different tax rate (with respect to corporate
tax) and rejects it on the grounds that there is a consensus that this element
is not critical to the classification.
However, it can also be argued that that the
difference is actually a penal component that is inherent to the tax component
or at least that the two can be separated. In
this context it should be noted that the tendency is generally to include the
accompanying component save for exceptional cases. The US-Australia DTA[12] is an
example of such an exception.
Wagman[13] also refers to a number of unique
characteristics of the DPT, and tough in relation to FCT in the US under
domestic law, it seems that he reaches a similar conclusion. Some of the
arguments he raises for discussion are that this is actually a tax liability on
a conceptual income and that is sometimes not taxed by the hands of the income
producer .But these are similar to CFC legislation and have already discussed
even by court. In the UK Bricom[14] case,
it was held that the provisions of a DTA do not apply to profits resulting from interest payments and
attributed up under the UK CFC rules, since the tax was not imposed on interest
as defined in the DTA. However, the reasons were not that this is a notional
income and the result may have been different if it were argued that the tax on
CFC income falls within the scope of Article 7 of the DTA (Business Profits).
Moreover, the court noted, in obiter, that the tax under the CFC rules was
corporate tax (in the UK sense).
Notwithstanding, in our case, a further obiter
in the judgment there is relevant and that is that the court mentioned that
since the UK law gives effect to the provisions of the DTAs, and since the UK
law[15] does
not refer to "similar taxes" as Art.2(4), similar articles in the UK
DTAs has no binding legal force. As detailed below, the question of legal
validity is not necessarily relevant to the question of whether similar taxes
are included in the DTA and therefore will be discussed separately.
Another argument that arises in this context
is that the DPT is mainly an anti-avoidance tool, and therefore the provisions
of DTAs do not apply to it anyway. Ismer[16] points
out that this question, too, is not relevant to the question of whether the tax
is covered under Art.2, and therefore it will also be discussed separately
(although maybe this is a semantic issue and it can be argued that
theoretically a tax agreed upon that is not supposed to be protected by the
provisions of a DTA is not a covered tax).
Conclusion and a possible distinction
Despite some unique characteristics, there
seems to be a consensus that the DPT in both countries is a tax that is at least
substantially similar to the income tax or corporate tax (in UK and Australia)
and therefore according to articles identical to 2(4), is covered by their
DTAs. Indeed, it is a tax on diverted profits.
In this context, and even if the result may
remain unchanged, I think that it is maybe possible to analyze differently the
two taxes:
As stated above, FCT will be granted against
the UK tax so one can argue that it is essentially a "residual" tax,
which constitutes a punitive component only and therefore is not covered.
On the other hand, from the same reason, it can be argued that the fact that a
foreign corporation tax credit is been granted, actually indicates that it is
essentially a corporate tax and thus covered.
Accordingly, with regard to the Australian tax
it can be argued that because it does not allow FCT as well as its high rate,
it is essentially a deterrent (like a fine) and therefore not covered. In
addition, it can be argued that since the tax is intended to apply only to SGE,
it is an extraordinary tax that is not covered (however, on the other
hand it can be argued that in view of the high corporate tax rate in Australia,
the "Mismatch conditions" are more easily met and thus it is a
covered tax).
DPT and "anti-avoidance"
As stated above, the tax in both countries is
designed to deal with MNI structures or transactions, which aims at tax
reduction (in Australia the DPT was even enacted in the anti-avoidance part
(IVA) of the ITAA36[17]).
Therefore, there is an argument that Australia
and the UK are not obliged to apply the DTAs provisions in respect of the DPT,
since such provisions were not intended to apply in these situations in the
first place[18]. This
argument is supported by the provisions of sections 9.3-9.5 of the Article 1
Commentaries to the OECD MC (2003) and its position on the application of CFC
rules. According to this argument, there is an implied consent in the DTAs that
the provisions will not apply in tax avoidance situations, or alternatively,
there is "justification" to violate DTAs provisions in these
situations.
Such an interpretation is ostensibly required
by the provision of Article 31 of the Vienna Convention - according to which
treaty should be interpreted in light of the principle of good faith. Thus,
this is seen as a correct interpretation or a legitimate goal in the eyes of
many. Wells[19], for
example, calls for the amendment of the FCT regulations in the US so as to
ensure that a credit is given for the DPT to protect UK income tax base from
the BEPS.
There are, however, considerable arguments
against this approach. First, the OECD position was presented only in 2003 and
it has since developed so it is impossible to say that the parties to a DTA
signed earlier have implicitly agreed on it. Second, and more importantly, the
position of one party to the DTA as to what is tax evasion may not necessarily
be accepted as such by the other party. In
her book[20], De
Pierto points out that the OECD errs twice - when it
determines that there is no conflict between a domestic law against tax-evasion
and DTAs, and when it fails to state in what situations such legislation can be
justified.
Indeed, an example of such a conflict can be
found in our case. What is perceived by
one country as an attempt to prevent "diversion of profits" can be
interpreted by another state as renunciation of the provisions of the DTA and
erosion of its tax base. For example, in the Constructive PE scenario, Country
B may think that the taxation of profits is contrary to Article 7 of the DTAs
(OECD MC), which states that only PE profits shall be taxed by the source state
and Article 5 defines the conditions for the establishment of a PE. The
taxation of the "avoided" PE (taxation of company B) by definition
does not meet these conditions and therefore constitutes violation of the DTA.
Similarly, in the second scenario, states A decision not to allow expenses paid
to a related enterprise in another country (low taxed), just because the
property for which the expenses were paid was held there due to tax considerations
(Materiel Condition), and despite the fact that company B is indeed the legal
owner and carries the risks involved in such asset, may constitute violation of
Article 9 (Arm's length adjustments). A decision to deny deduction of royalty
expenses is de-facto taxation of such royalties, at source, in DPT rate, in
possible contravention of Article 12.
This argument is reinforced in light of the
existence of the BEPS project of the OECD and the MLI[21]. UK and Australia explicitly admit that they
deviate from the project and included reservations[22]
to Articles 10, 12-14 (PE -anti abuse PE). Therefore it cannot be said that the
conditions for extending the meaning of PE or for denying benefits are in
consensus. The fact that Australia does not agree[23]
for a binding international arbitration mechanism (Articles 18-26) with regard
to part IVA of the ITAA36 (and the fact that it enacted the DPT in this
section) indicates that it is aware its unilateral legislation.
Hence, Faulhaber
[24]probably
rightly indicates that the DPT is not only anti-avoidance tools but rather
"offensive tax competition measure".
Unilateralism and International Law
De-Pierto[25], explains that with regard to the treaty
override two legal systems must be distinguished - one in which international
tax treaties have independent validity and one in which treaties are validated
by their adoption by domestic law. In the later, when the legislator intends to
enact a law that bypasses a DTA the law cannot be challenged in court. However,
she emphasizes that even in such a scenario of "legislative override"
a violation of international law exists and "legal injury" and
"state responsibility" occurs.
Australia and UK belong to the second legal
system[26], and
therefore, since it appears that the legislator's intention is clear (to
deprive benefits under DTAs), then it will not be possible to challenge the
DPT. However, De-Pierto points out that,
international law derives its only power from states (in both the systems), and
therefore its violation (even by "legislative override") causes
serious damage to its validity.
Implications
Tax allocation violation
As discussed above, the imposition of the DPT
will often be contrary to the existing provisions of the DTAs (with regard to
the taxation of profits, royalties, interest rents, etc.), as long as Australia or UK has no right to tax
these profits (or their rights are limited to a certain tax rate). In such
situation, and due to the legal status of DTAs in both UK and Australia, as
well as the absence of binding dispute-resolution mechanisms in the DTAs
(Article 25 is not binding reservations been made to the MLI) - the taxpayer
will not be able to find relief.
Double taxation
In the event that tax was imposed by the
residence country (in the first scenario above - because there is no
"real" PE) or by the source country (in the second scenario - because
the income producer is the legal owner and there is some economic substance) –
a double taxation will also occur.
Although, in the UK (in contrast to Australia),
FCT will be probably granted, there may be exceptions where double taxation
will occur there too. This can happen for example when contracting state
imposes on some or all of the "profits" its own DPT (or similar tax)
and claims that they were diverted from its tax base. In such case, since the
HMRC's position is that the DPT is not similar to a corporate tax, it can be
assumed that no credit will be given for the foreign DPT.
Scope of the implications
As noted above, another difference between the
two countries is the corporate tax rate (20% versus 30%) that affects the
"Mismatch Conditions". Therefore, in general, the Australian DPT may
create conflict with a wider spectrum of countries (all countries where
corporate tax rate is lower than 24%) while, the UK DPT is ostensibly more
aimed at tax havens. However, Wegman[27]
demonstrates how in some cases it imposition may also create conflict with
countries with a higher tax rate such as the US (generally, when according to
domestic Transfer Pricing provisions the Contracting State attributes part of
the "diverted profits" to a resident company).
Potential reactions of taxpayers
Since the declared purpose of the DPT is to
prevent diversion of profits, the first obvious reaction of a MNI is to create
a "real" PE in the Target Country or ensure that the group's assets
are located there in order to avoid the punitive component. In the case of the
Australian DPT, since no FCT will be granted, there is another consideration
which is the desire to avoid double taxation.
In both countries, the DPT element of
deterrence, as well as the uncertainty of its imposition (due to the conceptual principles it is based on
regarding, inter alia when the Material provisions are met), may lead to the
creation of a real PE and/or to disposition of assets even where there is no
real economic justification to it (i.e., the "Material provision"
does not exist). In Australia case, given the risk of double
taxation, there is a higher probability of such reaction.
However, it is clear that these considerations
can also lead to the opposite reaction - namely, to reduce indirect activity
(or marketing activity) in the Target Country in order to prevent any chance
for the application of the DPT. This will achieve the opposite goal.
Good example of these possible two reactions
can be found in the case of Amazon, which immediately after the introduction of
the UK DPT shifted profits from Luxembourg[28]
to the UK, but in the context of another tax – new GST legislation which was
recently imposed in Australia[29] -
decided to block Australian consumers.
Potential reactions of contracting states
In the event of the imposition of the tax in
contravention of the DTA - and this seems to be the same as our case - the
Contracting State is not obliged to assist in the exchange of information
(Article 26) and there is no reason for it to do so. Cerioni[30] indicates that assistance in the transmission
of information may be important for the imposition of the DPT as data on market
share are usually more easily to the authorities of the Country of residence.
In such case the contracting state is also not
obliged to grant FTC for the DPT imposed against its tax. However, such a
credit may be granted by virtue of the provisions of domestic law and
regardless of the provisions of the DTA. This is a situation that is likely to
happen since, as mentioned above, the DPT is regarded as conventional income
tax. The reasons for such unilateral FCT may be the legal principle of
preventing double taxation or a desire to prevent the transfer of activity to
the target country (creating there a real PE). After all even without
collecting direct tax, the state of residence benefits from investments or from
related taxation and that is why preferential tax regimes exists.
An example of these considerations can be
found in the responses in the US to the imposition of the DPT: Some believe
that the old regulations on foreign tax credits should be amended to explicitly
permit a tax credit[31], some
believe that the regulations should be amended for the opposite purpose – to
prevent an illegitimate bite (without a minimal Nexus or contrary to the DTA)
at the tax base, and some believe that there is no need for a change[32].
Finally, another
possible response is the imposition of similar DPTs by other states. This can be done either in order to bite also the cake of low tax regimes (with
international legitimacy from precedents –maybe the case of Australia) or to
prevent transfer of investments and activity to the Target Country. In the
latter case, only a more aggressive tax will create an effective deterrence
balance and the result will be a race to the bottom. Alternatively, different taxes may be
imposed. For example, since the DPT is mainly relevant to e US MNI the US can
see this it inappropriately and impose taxes that are more oriented to
Australia such as steel and aluminum tariffs[33].
Conclusions and a view to the future
[1] OECD. Model Tax
Convention on Income and on Capital: Condensed Version 2017. Australia and
UK's DTAs usually based on the OECD MC. See for example Australian Tax Office Income tax: Interpreting
Australia's Double Tax Agreements, T1 2001/13.
[2] OECD,
Commentaries on the Articles of the Model Tax Convention. At: <https://www.oecd-ilibrary.org/taxation/model-tax-convention-on-income-and-on-capital-condensed-version_20745419>
[3] See Ostime v.
Australian Mutual Provident Society 1960 38 ITR 35 Cal and Thiel v Federal Commissioner of Taxation [1990]
HCA 37; 171 CLR 338; 94 ALR 647.
[4] Brandstetter, P.
(2010). The Substantive Scope of Double Tax Treaties - a Study of Article 2
of the OECD Model Conventions, Ph.D. WU Vienna University of Economics and
Business Avilable at: http://epub.wu.ac.at/2019
[5] Vienna Convention on
the Law of Treaties on 22 May 1969 – Art 31, 32.
[6] See Cerioni, Luca, 'The
New “Google Tax”: The “Start of the End” for Tax Residence as a Connecting
Factor for Tax Jurisdiction?', (2015), European Taxation, Vol 55.
[7] Ismer, Roland ,
Jescheck, Christoph, 'The Substantive Scope of Tax Treaties in a Post-BEPS
World: Article 2 OECD MC (Taxes Covered) and the Rise of New Taxes' (2017) 45
Intertax, Issue 5, pp. 382–390.
[8] See 8 above (p 65)
[9] Virgin Holdings SA
v Commissioner of Taxation
[2008] FCA 1503 (10 October 2008)
[10] See 1 above - in the
section dealing with the DPT procedure.
[11] See 11 above – he
refer to others (p 386).
[12] Convention between the
Government of Australia and the Government of the United States of America for
the Avoidance of Double Taxation and the Prevention of Fiscal Evasion with
Respect to Taxes on Income, [1983] ATS 16 - in its general definitions section.
[13] Wagman, Philip, 'The U.K. Diverted Profits Tax: Selected U.S. Tax Considerations' (2015) Tax Notes 1413
[14] Bricom Holdings Ltd
v Inland Revenue Commissioner,
[1997] BTC 471
[15] Section 788 to The
Corporation Tax Act 2010 (c.4)
[16] See 11 above.
[17] INCOME TAX ASSESSMENT
ACT 1936
[18] See Ross, Lauren Ann,
and Samuel M. Maruca. “Through the Looking Glass? The United Kingdom
Diverted Profits Tax' ( 2015) Tax Management Memorandum 56 (23): 449.
[19] Wells, Bret, 'The Foreign Tax Credit War', 2016 BYU L.
Rev. 1895 (2017). Available at:
https://digitalcommons.law.byu.edu/lawreview/vol2016/iss6/10
[20] De Pietro, Carla (2012) Tax Treaty Override, [Dissertation thesis], Alma Mater Studiorum Università di Bologna, AT: <http://amsdottorato.unibo.it/5140/1/carla_depietro_tesi.pdf>
[21] OECD. Multilateral
Convention to Implement Tax Treaty Related Measures to Prevent Base Erosion and
Profit Shifting done at Paris on 7 June 2017.
[22]Treasury Laws Amendment (Combating Multinational Tax Avoidance) Act 2017.Reservations list: <https://assets.publishing.service.gov.uk/government/uploads/system/uploads/attachment_data/file/725261/Final_list_of_UK_reservations_and_notifications_made_on_deposit_of_the_instrument_of_ratification.pdf>
[23] See Explanatory Memorandum, Treasury Laws Amendment
(OECD Multilateral Instrument) Bill 2018.
[24] Lilian V. Faulhaber, The
Trouble with Tax Competition: From Practice to Theory, 71 Tax L. Rev.
[25] See 24 above.
[26] See 19 above and in Australia s section 4(2) of the International Tax Agreement Act 1953 (Cth).
[27] See 17 above
[28] Roman Lanis, How
will Amazon navigate Australia’s taxation system? (October 11, 2017), The
Conversation < https://theconversation.com/how-will-amazon-navigate-australias-taxation-system-85323>
[29] The Guardian, Amazon
to block Australians from using US store after new GST rules (May 2018) < https://www.theguardian.com/australia-news/2018/may/31/amazon-to-block-australians-from-using-us-store-after-new-gst-rules>
[30] See 10 above.
[31] See 23 above
[32] See J. Clifton
Fleming, Jr., Robert J. Peroni & Stephen E. Shay, Two Cheers for the
Foreign Tax Credit, Even in the BEPS Era, 91 Tulane L. Rev. 1 (2016).
[33] Nassim Khadem, Potentially
dangerous': Ex-US official warns against tax on Amazon, Google (4 June
2018), The Sydney Morning Herald < https://www.smh.com.au/business/the-economy/potentially-dangerous-ex-us-official-warns-against-tax-on-amazon-google-20180604-p4zjdz.html>