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1. Treaties: A New Balance? Have Governments Become More Focused on Preventing Fiscal Evasion than Avoiding Double Taxation? U.S.-Latin America Tax Planning.

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Presentation on theme: "1. Treaties: A New Balance? Have Governments Become More Focused on Preventing Fiscal Evasion than Avoiding Double Taxation? U.S.-Latin America Tax Planning."— Presentation transcript:

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2 Treaties: A New Balance? Have Governments Become More Focused on Preventing Fiscal Evasion than Avoiding Double Taxation? U.S.-Latin America Tax Planning Strategies June 6, 2014 Sonia Velasco Menal, Co-Chair, Cuatrecasas, Gonçalves Pereira (Spain) Emin Toro, Co-Chair, Covington & Burling LLP (USA) Juan Carlos Garantón, Torres Plaz & Araujo (Venezuela) Gianni Gutierrez, Ferrere (Uruguay) Adrián Rodríguez, Lewin & Wills (Colombia) Guillermo O. Teijeiro, Teijeiro & Ballone, Abogados (Argentina) Richard Winston, Richard L. Winston P.A. (USA) 2

3 3 Overview  Recent OECD Comments on Treaty Abuse  Exchange of Information Developments  GAARs – Case Law Developments on Treaty Limitations  Resolving Conflicts Between Domestic Laws and Treaties

4 4 Recent OECD Comments on Treaty Abuse

5 5  July 2013 – at request of G20, OECD publishes Action Plan on Base Erosion and Profit Shifting Action 6 (Prevent Treaty Abuse) “Develop model treaty provisions and recommendations regarding the design of domestic rules to prevent the granting of treaty benefits in inappropriate circumstances. Work will also be done to clarify that tax treaties are not intended to be used to generate double non-taxation and to identify the tax policy considerations that, in general, countries should consider before deciding to enter into a tax treaty with another country. The work will be co-ordinated with the work on hybrids.”

6 6 Recent OECD Comments on Treaty Abuse  March 2014 – OECD publishes Public Discussion Draft – “BEPS Action 6: Preventing the Granting of Treaty Benefits in Inappropriate Circumstances” Proposes adoption of Limitation on Benefits provisions similar to those found in US (and some Japan and India) treaties Proposes general anti-abuse provision (discussed below) Proposes change to preamble to clarify intent not to result in double non-taxation

7 7 Recent OECD Comments on Treaty Abuse  Proposed general anti-abuse provision “Notwithstanding the other provisions of this Convention, a benefit under this Convention shall not be granted in respect of an item of income if it is reasonable to conclude, having regard to all relevant facts and circumstances, that obtaining that benefit was one of the main purposes of any arrangement or transaction that resulted directly or indirectly in that benefit, unless it is established that granting that benefit in these circumstances would be in accordance with the object and purpose of the relevant provisions of this Convention.” (Emphasis added) Illustrations included in discussion draft

8 8 Recent OECD Comments on Treaty Abuse  Proposed change in preamble “(State A) and (State B), Desiring to further develop their economic relationship and to enhance their cooperation in tax matters, Intending to conclude a Convention for the elimination of double taxation with respect to taxes on income and on capital without creating opportunities for non-taxation or reduced taxation through tax evasion or avoidance (including through treaty shopping arrangements aimed at obtaining reliefs provided in this Convention for the indirect benefit of residents of third States) Have agreed as follows:” (Emphasis added)

9 9 Exchange of Information Developments

10  10 INFORMATION EXCHANGE Council Directive 77/799/EEC of 19 December concerning mutual assistance by the competent authorities of the Member States in the field of direct taxation.  Council Directive 2003/48/EC of 3 June 2003 (“Savings Directive”) on savings income.  Bilateral tax treaties. All treaties signed by Spain include an exchange of information clause based on the wording of Article 26 of the OECD Model Convention on Income and on Capital. Spain has signed over 100 treaties.  Tax information exchange agreements Once a tax information exchange agreements enters into force, the country or territory is automatically excluded from the “black list” of tax havens. Countries like Panama, Barbados, Bahamas have ceased to be treated as tax haven jurisdictions for Spanish tax purposes. #6722232

11  11 INFORMATION EXCHANGE FATCA  On May 14, 2013, Spain and the United States signed an agreement to improve tax cooperation and to implement FATCA (IGA MODEL 1). AUTOMATIC INFORMATION EXCHANGE  Spain have reached a compromise with other 44 countries to implement an automatic exchange of information. Argentina, Belgium, Bulgaria, Colombia, Croatia, Cyprus, Czech Republic, Denmark, Estonia, Finland, France, Germany, Greek, Hungary, India, Iceland, Irland, Letonia, Liechtenstein, Lithuania, Malta, Mexico, The Netherlands, Norway, Poland, Portugal, Romania, Slovack Republic, Slovenia, Sudafrica, Spain, Sweden, UK, Isle of Man, Guernsey, Jersey, Unido de Anguila, Islas Bermudas, BVI, Cayman, Gibraltar, Montserrat and Turcks and Caicos. #6722232

12  12 RECENT EXPERIENCES TAX INFORMATION REQUIREMENTS  Interest expenses were tax deductible in Spain.  The Dutch tax authorities were asked if the interest paid by SPAINCO was taxed in the Netherlands.  The answer was affirmative. However, the Dutch authorities did not indicate that the interest income paid by SPAINCO was “eroded” through the interest expense derived from the loan with a Cayman company. DUTCHCO Ints. 0% WHT SPAINCO Loan TREATYCO CAYMAN Ints. 0% WHTLoan #6722232

13 EXCHANGE OF TAX INFORMATION

14 Why? Uruguay had been in the black, in the grey and finally in white list. Because the OCDE pressures and… Argentina Was looking for taxpayers with: Real estate in Punta del Este Agribusiness Trading activities Banks deposit The blame and shame policy had a great success In the last 5 years Uruguay has signed 13 TIEAs and 12 DTCs. EXCHANGE OF TAX INFORMATION

15 Are there any advantages related to the DTCs for a country like Uruguay? Just a few. Did it foster investments? No. Did it eliminate double taxation situations? For a developing country - with source income principle - there are not so many advantages in signing DTCs. Same situation in Paraguay and Bolivia… The main target of DTCs was to reach the OECD standard and avoid being in the “bad boys’ list”. Section 26 of the MODEL and TIEAs Global Forum report made several observation to Uruguay.

16 To reach the OECD standards great changes had to be done to Uruguayan tax and legal system: Until 2010, this were the main facts regarding exchange of information: o Uruguay did not exchange information even regarding international criminal prosecution. o Bank secrecy could only be lifted for local criminal prosecution. o Uruguay only taxes income generated in Uruguay. o The signature of TIEAs with Argentina depended on Argentina’s fulfillment of MERCOSUR agreements. To accomplish the OECD standards a series of changes had to be done: o Lifting of bank secrecy. o Identification of shareholder of corporations with bearer shares. o Signature of TIEAs with Argentina and Brazil.

17 Main requirements for information exchange:  It requires a petition, it does not work automatically.  Prior to any information exchange, the taxpayer has an opportunity to oppose.  To lift bank secrecy a judicial process, where the taxpayer is heard, is necessary.  All the agreements protects lawyers secrecy. But Uruguay’s concept of “professional secrecy” includes CPAs.  Argentina is being requiring some information; however, in some cases the requirement has involved situations that were not included in the agreement’s scope. In the last 5 years Uruguay has signed 13 TIEAS and 12 DTC. Challenges for Uruguay

18 Overcome phase II of the Peers review: difficult task The exchange of information standards are still changing:  Automatic exchange of information.  Constitutional obstacles. Treaties are under constitutional level and have the same level as the laws. There is a constitutional principle which establishes that before taking any administrative resolution the citizen should be heard; this would be violated if the agreements operated automatically. Challenges for Uruguay

19 Exchange of Information – Colombia TIEA COL – US (Reviewed Constitutional Court) IGA. OECD Multilateral Convention on Mutual Administrative Assistance in Tax Matters (Reviewed by the Constitutional Court).

20 Exchange of Information – Colombia Tax Haven List was finally issued (September 2013 / Applicable 2014). 33% withholding. Deductibility limitation. Transfer-pricing. Certain countries were gray listed (Subject to a TIEA) (e.g. Panamá).

21 Exchange of Information – Venezuela Covered in all Tax Treaties in place (29) Untested / No intent from the Tax Authorities to advance on the same Just 5 treaties cover Assistance in Collection NL, Norway, Belgium, Denmark and Indonesia Under domestic law (Master Tax Code) both EI and AC are allowed / solve et repete 21

22 Exchange of Information – Venezuela Currently there are no TIEAs in place (none are under negotiation) Not a party to the Global Forum on Tax Transparency and Exchange of Information for Tax Purposes FATCA / Little chance of negotiation of an IGA 22

23 23 GAARs – Case Law Developments on Treaty Limitations

24 24 APPLICATION OF GAARs IN A TREATY SETTING – OECD MC  A Copernican twist from 1977 to 2003 version of the OECD MC text of commentaries  1977 Model: GAARs may not be applied in a treaty setting unless the DTC expressly allows so, i.e., to resort to domestic GAARs for recharacterization or reassignment of income (redetermination of the taxpayer)  2003 Model: GAARs apply unless the DTC text expressly prohibits it (commentaries on article 1, par. 22, subpar. 22,1-2)  Current Model (2010): same position

25 GAARs IN SELECTED LATAM COUNTRIES PROVIDED IN DOMESTIC LEGISLATION APPLICATION IN TREATY SETTING ARGENTINAYES BRAZILYES (No yet implemented) Only SAAR (i.e., thin cap.) CHILENO (GAAR included in tax reform under congressional consideration NO COLOMBIAYESNO CASES YET MEXICO Technically no, but income tax law authorizes re- characterization of sham transactions by MNEs SCJN also applies fraud legis principle Procedural rule requires taxpayers claiming treaty benefits to confirm that income is taxable in home country GAAR specially allowed in certain treaties e.g., Bahrain, Ukraine. There are no application precedents 25

26 GAARs IN SELECTED LATAM COUNTRIES PROVIDED IN DOMESTIC LEGISLATION APPLICATION IN TREATY SETTING PARAGUAYNO PERUYES (2012)NO URUGUAYNO 26

27 27 ARGENTINA  LOBs and GAARs  Argentine DTTs lack limitation of benefits (LOB) rules, but in recent years the tax authorities have resorted aggressively to domestic GAARs to recharacterize income or redetermine the beneficiary in a treaty setting, particularly in case of outbound (round trip) investment  GAARs are applied regardless of express treaty authorization

28 28 ARGENTINA  Best scenario (inbound or outbound) would be a holding jurisdiction that combines a DTT in force with Argentina with a suitable holding regime in the treaty-partner jurisdiction. For this purpose Dutch BVs, UK LLPs, and Spanish ETVs are worth considering.  Foreign treaty-partner holding must have legal as well as economic substance  The Netherlands recently issued substance regulations particularly addressed to the sublicensing of IP rights, including to residents in tax treaty foreign countries

29 29 GAARs APPLICATION ABSENT EXPRESS TREATY AUTHORIZATION / DEBATED ISSUE  Fully applicable if Argentina is country of residence of a taxpayer whose abusive behavior is to be challenged. That means that income might be recharacterized or beneficiary redefined  If Argentina is source country (1) unrestricted income recharacterization (accord. Art. 3,2), but (2) limited power to redefine beneficiary is benefit recipient is recognized as resident by treaty-partner country Query whether outcome is different is express: treaty authorization is provided for GAARs application (e.g., MOU new Spanish treaty)

30 30 PRECEDENTS ON INBOUND STRUCTURES  Ruling AFIP 57/94 (January 30, 1996) recharacterization of insurance premium paid to foreign insurers under loan agreement as additional interest (higher borrowing cost); DTTs Spain and Italy

31 PRECEDENTS ON INBOUND STRUCTURES PARTICIPATED LOANS (DNI MEMORANDUM 3/06) DEG exemption/DTT with Germany - Although interest paid to DEG, DEG acts as collecting agent of principal and interest corresponding to participated financial entities so that exemption does not apply on said interest; DEG is not the beneficial owner of the interest income 31 Argentine borrower DEG Participant

32 32 PRECEDENTS ON OUTBOUND STRUCTURES  Memorandum DNI 64/09: Facts and Findings  According to the Austrian DTT (no longer in force), the Argentine resident´s holding in AH and dividends received from AH were no taxable in Argentina by personal assets tax and income tax. Only 15% WHT on dividends applied on actual distribution in Austria  FIF (domestic fiscal transparency rules) were avoided by interposition of AH  Fact findings showed that AH was a phantom (shell) company without any economic substance Argentina Resident Austrian Holding B.V.I. Corp. 99% 100%

33 33 PRECEDENTS ON OUTBOUND STRUCTURES  Memorandum DNI 64/09: Decision  The decision qualified the situation as an abuse of the treaty and made reference to the possibility of applying GAARs in that context, in accordance with (i) Opinion of U.N. Expert Committee on International Tax Cooperation, Subcommittee on Improper Use of Treaties, and (ii) Commentaries to Article 1, OECD MC, 2008 (reproduced in OECD MC, 2010)

34 34  By applying GAARs, the Argentine competent authority disregarded the interposed company in the treaty country jurisdiction and treated the holding of the shares in and income obtained by B.V.I. Corp. as if the interposed company did not exist

35 35  Memorandum DNI 799/10: Fact Pattern  Operating Subs (third countries) were domiciled in LATAM jurisdictions having no DTT with Argentina. Participation in operating subs help trough Chilean holding which enjoyed a special (no-tax) holding regime in Chile. The Chilean DTT did not expressly exclude privileged holding companies from the concept of residents.  By interposing the Chilean Holding the Argentine taxpayer avoided taxation on dividends in Argentina; dividends that were made up with profits coming from the second-tier operating subs, otherwise fully taxable in Argentina (i.e., if paid directly by operating subs to Parent Co)

36 36  Memorandum DNI 799/10: Opinion  The Argentine DNI sustained that:  DTTs should not be utilized by taxpayers to ameliorate or eliminate the tax burden through legal forms that would not be adopted but for the tax advantages deriving therefrom  Domestic GAARs (economic reality principle as contemplated in Section 2, law 11,683) may and should be applied to avoid abusive schemes even in a treaty setting

37 37  Memorandum DNI 799/10: Opinion  Considering the Chilean Platform company regime and the DTT rules attributing tax jurisdiction to the parties thereto, the reason to interpose the holding was to deviate dividend income coming from Uruguay and Peru (where the operating subs were domiciled), that would otherwise have been taxed in Argentina, with the end result of benefiting from a double non-taxation  Double non-taxation, obtained by interposing a Chilean Platform company between the Peruvian and Uruguayan subs, on one hand, and the Argentine Parent on the other, contradicts the DTT and implied an abusive conduct which might be challenged under domestic GAARs

38 38  Memorandum DNI 799/10: Opinion  From a different perspective, DTT are aimed at avoiding double taxation and to that end, treaty-partners should maintain an income tax of general application. The Chilean Platform company regime was strange to the income system of general application in Chile  The Platform company was beyond the scope of the Chilean DTT. It does not qualify under Article 1 of the DTT (taxes covered) as that article refers to subsequent amendments and replacing taxes using an analogous tax basis and not to promotional regimes resulting in double non-taxation

39 39 MOLINOS RIO DE LA PLATA TAX COURT (TFN) August 14, 2013 ARGENTINA URUGUAYAN SUB. PERUVIAN SUBS. PLATFORM CO (HOLDING) MOLINOS RIO DE LA PLATA S.A. CHILE Dividends

40 40 LEGAL HOMEWORK AND FACT PATTERN  DTT Argentine / Chile patterned after Andean Pact: income solely taxed at source; dividends paid by Chilean company taxed in Chile exclusively  Platform Co. only taxed on Chilean source income. Foreign source income (profit distributions from operating foreign) non taxable  Dividends received by Platform Co. from op. subs. were immediately distributed to Molinos  Dividends were received by Molinos free of tax; if distributed directly by Peruvian and Uruguayan subs would have been taxed in Argentina

41 41 DISCUSSION AND HOLDING  There was an abuse of the treaty; AFIP’s tax assessment taxing dividends in Argentina affirmed  To find the existence of an abuse, tax court applied domestic GAARs and considered that Platform Co was not the effective beneficiary of the dividend paid out by the operating subs  Deemed “effective beneficiary” concept built in GAARs (DTT did not contemplate that concept)  A DTT may be used to mitigate or reduce the tax burden but not to eliminate the tax burden in its entirety (double non-taxation)

42 42  Critical Assessment of Molinos Rio de la Plata – Findings and Conclusions  Application of Argentine GAARs should not have resulted in a successful challenge of the Platform Company under the fact and circumstances of the case  Argentine GAARs/economic reality principle) consist of a sham-type provision according to which whenever a manifest discrepancy exists between the legal forms used and the economic substance of the transaction, the latter prevails to recharacterize the transaction or redefine the parties thereto for tax purposes  If that discrepancy exists, the legal forms are to be discarded regardless of the intention of the taxpayer, i.e., regardless of whether the intention was to avoid taxes or to pursue a legitimate business purpose. On the contrary, if such discrepancy does not exist, the legal transaction may not be challenged, whatever its purpose, unless it is evidenced that the taxpayer acted in fraud legis

43 43  Pursuing a tax advantage or benefit under the DTT (e.g., double non-taxation) is not, per se, enough to ignore the intermediate holding, as argued in connection with the Chilean Platform company  To legitimately challenge the structure under GAARs, the Tax Court should have either evidence that the Chilean holding was not the actual owner of the dividends received from the Peruvian and Uruguayan subs, and/or lacked economic substance (i.e., it was a paper company which exercises no effective management or administration of the holdings). None of that was undoubtedly evidenced in the case

44 44  Moreover, if the preceding conditions are met (the Chilean Platform company used and enjoyed the dividend income, and managed the equity participations held) the Chilean holding might not be deemed to be interposed in fraud legis nor would fail meeting the substance test. It was not evidenced that dividends received by Chilean Platform were not its own (i.e., that holding was constrained to pass the dividends on to parent)  In that context, Argentine GAARs could not be resorted to legitimately ignore the Chilean company as a treaty beneficiary, even if, as it appears to be the case, the structure was designed to save taxes (it was a tax-geared structure)

45 Developments on GAARs - Colombia Colombia adopted a GAAR in 2012: Tax abuse: Entering into transactions or using entities with the sole purpose of obtaining tax advantages. Tax Ruling: “treaty shopping,” dividends paid to non- residents in the Andean Community / Context (Andean Community Decision 578). Constitutional Court: C-51977 /2005. Application of Domestic GAAR in a tax treaty context / OECD MC commentaries – BEPS (active role).

46 Venezuela / GAAR and Treaties GAAR rule covered in domestic tax law (MTC and ITL inter alia) Intent is critical / main purpose of transaction is to reduce tax burden and instrument used is openly inadequate to the economic reality pursued. Piercing Corporate/contractual veil recognized by Tax Courts (when substance is clearly inconsistent with form) 46

47 Venezuela / GAAR and Treaties Tax treaties rank higher than tax laws Economic substance should be followed when reviewing and characterizing a transaction for tax treaty purposes. Should it be followed to justify countering treaty shopping? Treaty shopping does not necessarily entail lack of substance. 47

48 Venezuela / GAAR and Treaties Choice of jurisdiction (holding vehicle inter alia), even when the same is accompanied by an intent to reduce or defer taxation, would not meet the test. So far no authority with regards to application of GAAR to disallow tax treaty benefits OECD CFA Commentaries may be a guide, not authoritative. Which Commentaries? 48

49 Venezuela / GAAR and Treaties Certainty and predictability should be chief. The use of tax treaty SAARs such as Beneficial Owner and L.O.B. provisions seems a more reasonable approach even when much harder to implement. 49

50 50 Resolving Conflicts Between Domestic Laws and Treaties

51  51 TAX TREATIES: ANTI ABUSE PROVISIONS SPANISH POLICY IN THE NEGOTIATION OF TAX TREATIES MC OCDE 1977 NO beneficial ownership clause YES beneficial ownership clause MC OCDE 1990

52  52 TAX TREATIES: ANTI ABUSE PROVISIONS SPANISH POLICY IN THE NEGOTIATION OF TAX TREATIES  EEUU (1990 Tax Treaty (revised in 2013 –pending to be approved).  From 2004, Spain starts introducing LOB provisions in our tax treaties following the OECD Model. Not all new treaties have such clause.

53  53 EXAMPLES IFF CASE (T.S. 22-03-2012)  Anti Abuse Clause (art. 13.1 g) LIRNR): The Parent Subsidiary Directive does not apply even if NL1 had personal, rendered services to its affiliates, was engaged in a business activity.  The Spanish-Dutch Tax Treaty applies (5% WHT). No penalties were applied. 5% WHT NL-US Tax treaty SP NL1 100% 0% WHT Parent Subsidiary Directive NL2 US 100%

54  54 EXAMPLES EMIRATES CASE (TEAC 28-09-2009)  Anti abuse (art. 13.1 g) LIRNR): no applicable since the UK Co lacks substance.  Beneficial owner clause in the UK-Spanish tax treaty: tax rate of 10% is denied by the TEAC but in the High Court based on the “reformatio in peius” doctrine the 10% tax rate is accepted.  Penalties were imposed. SpainCo UKCo 100% 0% WHT Parent Subsidiary Directive Emirates

55 Interaction between domestic law and tax treaties – Colombia 2012 Tax Reform (Act 1607 /2012) Tax residency criteria: incorporation, domicile and place of effective management. Tie-breaker rule (DTA). Anti-Avoidance rule (treaty context and non- treaty context). Dual residency conflicts (If no treaty applies).

56 2012 Tax Reform (Act 1607 /2012) Thin capitalization rule or deductibility limitation. Applies on foreign and national indebtedness. Applies on related and unrelated party indebtedness. Applies on debts with banks. Interaction with transfer-pricing rules. Interaction with DTAs. Not Covered by Article 24 (Non-discrimination clause). Not Covered by Article 9 (Associated Enterprises). Interaction between domestic law and tax treaties – Colombia

57 Colombian source income (technical services, technical assistance and consultancy supplied in Colombia or “from abroad”) / 10% withholding. DTAs: Technical services, technical assistance and consultancy included in the royalties definition: Domestic definition (expanded definition). Royalties: Commentaries: Software (acquisition of a software copy for a limited used Article 7 / DIAN Royalties (article 12) Ruling: 081572/2011. Interaction between domestic law and tax treaties – Colombia

58 58 Why Do the Local Tax Authorities Sometimes Disregard Treaty Principles (Mexican Example)?  Sale of Goods: Why should a local Latin American government believe that it has the right to fully tax a nonresident company selling goods to its own resident?  Example: An American company sells a mobile phone to a customer located in Mexico on “DDP” (delivered duty paid) incoterms.  The actual place of “sale” takes place within the borders of Mexico, but the product was located in Mexico for only 48 hours before the sale.  The mobile phone manufacturer developed its intellectual property in the United States, and most of its employees will be located in the United States.  The mobile phone manufacture incurred billions of dollars of expense within the United States for its development activities.  Common sense suggests that the American government (not the Mexican government) should retain the right to tax the company on most of its worldwide profits.  Why should Mexico be entitled to tax the proceeds from the mobile phone sale merely because the actual sale takes place in Mexico (the product was located in Mexico for “one day”)?  Should the U.S.-Mexican Tax Treaty provide some relief because the U.S. company does not maintain the typical attributes of a “permanent establishment” in Mexico (no physical presence and no dependent agents)? Article 7 relief (limited profits “attributable to” Mexico)?  The Mexican position is that Article 5 of the treaty (Permanent Establishment) does not protect a nonresident company from taxation from an actual “sale” of goods taking place in Mexico (the treaty protects against the maintenance of goods in Mexico for storage, processing, display, delivery, and advertising, but not an actual sale).  What are the policy considerations? The Mexican tax authorities cannot accept the nonresident exploitation of the Mexican customer base.  Should the imposition of VAT (imposed on the local customer for the “use” of the product) solve this problem?

59 59 Why Do the Local Tax Authorities Disregard Treaty Principles? (Cont’d)  Sale of Services (Brazil Example)  A nonresident rendering services from abroad to customers located in Brazil, Uruguay, Argentina (partially), Colombia (partially), and Chile may be subject to local withholding tax when the payment is made abroad.  When a tax treaty applies, most jurisdictions will accept that the “source country” of the services (i.e., the place where the services are rendered) retains jurisdiction to tax the “business profits” earned by the source company rendering the services.  Brazil disagrees (for now)  The main problem with Brazil’s position is that most “source country” governments will refuse to subsidize the Brazilian withholding tax by granting a foreign tax credit to the non-Brazilian company rendering the services.  Those source country governments will “double tax” the income that they deemed properly allocated to their home jurisdiction (i.e., the place where the services were rendered).  Treaties were intended to mitigate double taxation between taxpayers doing business in two high-tax jurisdictions.  Even though many of Brazil’s tax treaties were concluded before Brazil created its newest domestic rules on withholding taxes, the policy of those tax treaties has always been evident.  The Brazilian tax authorities lack the experience to understand the basic principles of double taxation conventions.

60 60 Brazilian Taxation of Nonresident Services (New Developments) The Brazilian Federal Revenue Attorney General’s Office (PGFN) recently published a formal Opinion (No. 2.363/13) ratifying a Superior Court of Justice (STJ) decision (Copesul) that provides that certain Brazilian payments for technical services without the transfer of know-how made by Brazilian residents to residents of jurisdictions with which Brazil has entered into a tax treaty should not be subject to withholding tax (WHT). For many years, Brazilian taxpayers have tried to classify such service payments rendered from abroad (in a treaty jurisdiction) as (Article 7) “business profits” taxable only in the country where the services are rendered. Based on Normative Act 01 of 5 January 2000 (Declaratory Act COSIT 1/2000), the tax authorities have asserted that service payments remitted abroad should be classified as “other income” (subject to Brazilian tax). The tax authorities claim that the “business profits” section applies only to income earned on a “net” basis (“revenue minus expenses”). Services payments are made on a “gross payment” basis (without a reduction for “expenses”). The PGFN Opinion was issued in response to a potential threat by the Finnish government to terminate the existing Brazil-Finland tax treaty if Brazil were to seek to withholding tax for payments made by a Brazilian resident taxpayer for technical services rendered in Finland by a Finnish company. The new PGFN Opinion, which is not binding on the tax authorities, would not apply in cases where Brazil has tax treaties that recharacterize the transfer of technical services as “royalties” (which would be subject to a different level of withholding taxes and/or CIDE). 60

61 61 Brazilian Taxation of CFC Income (New Developments) In 2013, the Brazilian Supreme Court (“STF”) ruled by a small majority vote (broadly) that the CFC regime was not in conflict with the constitution, but the Court did not decide the issue of whether Brazil’s CFC regime is compatible with double tax treaties concluded by Brazil. On April 25, 2014, the Superior Tribunal da Justiça (“STJ”) held that the previous version of the Brazilian CFC regime is overruled by the business profits article of Brazil’s tax treaties with Belgium, Denmark and Luxembourg. Under the respective treaties with Belgium, Denmark, and Luxembourg, the “business profits” of the subsidiaries of Vale could be taxed only once in those countries (not twice in both those respective countries and Brazil at the same time). The decision confirmed that the international tax treaties signed by Brazil should prevail over domestic law provisions. On the other hand, the business profits of Vale, for example, in Bermuda could be taxed immediately in Brazil under the normal CFC rules. The STJ also analyzed how the Brazilian corporate investor should treat the income earned by a CFC. Under current regulations, Brazilian corporate investor must include in its taxable profits the positive result of the “equity method” as applied to its foreign subsidiaries and affiliates on 31 December of each year. Under the “equity method,” profits earned by a subsidiary are added to the investment value recorded by the parent (dividends and other distributions reduce the value). The decision did not appear to change the older view of how the “equity method” should be applied. All of these decisions may be moot in light of the new CFC regime enacted by the Brazilian legislature in 2014 (PM 627/2013--Lei 12.973/14) The new CFC rules do not necessarily use tax treaties as the basis of their application. 61

62 62 Nondiscrimination Provisions in Latin American Country Tax Treaties The underlying objective of the “nondiscrimination clauses” in tax treaties is to ensure that the country where an investment is made treats both resident and nonresident investors similarly under the income tax rules. Taxpayers may also try to use both bilateral investment treaties and/or trade agreements to create nondiscriminatory treatment with respect to the application of VAT principles. OECD, Article 24 (Nondiscrimination) Article 24(1) (General Rules): Nationals of a Contracting State shall not be subjected in the other Contracting State to any taxation or any requirement connected therewith, which is more burdensome than the taxation and connected requirements to which nationals of that other State are or may be subjected. Article 24(5) (CFCs): Enterprises of a Contracting State, the capital of which is wholly or partly owned or controlled, directly or indirectly, by one or more residents of the other Contracting State, shall not be subjected in the first-mentioned State to any taxation or any requirement connected therewith which is more burdensome than the taxation and connected requirements to which other similar enterprises of the first-mentioned State are or may be subjected.

63 63 Nondiscrimination Provisions in Latin American Country Tax Treaties (Cont’d) Some anti-avoidance rules (directed at nonresidents) have been successfully challenged by taxpayers who invoke nondiscrimination clauses in tax treaties. Thin capitalization rules are generally established to prevent a nonresident investor from “stripping” the earnings of a local subsidiary by overcapitalizing the subsidiary with debt (generating high levels of deductible interest payments that are subject to lower withholding tax rates). Certain treaties with Argentina, for example, have been used to neutralize the effects of thin capitalization rules. Restrictions on the deductibility of related party payments are usually implemented to prevent affiliates from “stripping” the earnings of a local entity by allowing for deductible intercompany service payments that may not be subject to any withholding taxes. For example, Colombian DIAN Ruling 77842/2012 removed the limitations on the deductibility of foreign expenses paid to Spanish affiliates (normally capped at 15% of net income). Withholding taxes on dividends paid to nonresidents. Such withholding taxes must be consistent with domestic law principles on the taxation of dividends (see e.g., Volvo case in Brazil decided by the STJ in 2012 under the Brazil-Sweden Tax Treaty, considering “old” Brazilian Law Law 8.383/1991).

64 64 Nondiscrimination Provisions in Latin American Country Tax Treaties—The Brazilian Royalty Example  Under Brazilian law, nonresidents investors must register all transfers of technology in Brazil (except software) with the Brazilian Patent and Trademark Office (INPI). Under these longstanding rules (dating back to 1966), Brazilian companies may not make royalty payments to related parties that exceed 5% of the amount of the earnings from the transfer of technology. In the case of unrelated parties, the Brazilian company may not deduct any payments that exceed 5% of the amount of the earnings from the transfer of technology. These rules create havoc for “high-tech” foreign multinationals doing business in Brazil.  The “3M Corporation” is presently facing a challenge in the United States because the IRS wishes to use its transfer pricing rules to tax (fictional) royalty income that 3M could not legally receive from its Brazilian subsidiary. See 3M Co. v. Commissioner, T.C. Dkt. No. 5186-13. The IRS position is based on the concept that most of 3M’s IP and employees are located in the United States. On the other hand, the Government of Brazil has made it nearly impossible through its licensing rules (dating back to the 1960s) for nonresident technology companies to properly exploit their technology in Brazil.  Question: Could a nonresident company situated in a treaty jurisdiction with Brazil litigate the validity of the royalty restrictions under the nondiscrimination clause of a Brazilian tax treaty (e.g., Israel)?

65 65 Thank you! Panel Co-Chairs: Emin ToroFirm: Covington & Burling LLP Email:etoro@cov.cometoro@cov.com Sonia VelascoFirm:Cuatrecasas, Gonçalves Pereira Email:sonia.velasco@cuatrecasas.com Speakers: Juan Carlos GarantónFirm:Torres Plaz & Araujo Email: jgaranton@tpa.com.ve jgaranton@tpa.com.ve Gianni Gutiérrez Firm:Ferrere, Montevideo Email:GGutierrez@ferrere.com Adrián RodríguezFirm:Lewin & Wills Email:agonzalez@lewinywills.com Guillermo O. TeijeiroFirm:Teijeiro & Ballone, Email:guillermo.teijeiro@te-ba.com Richard Winston Firm:Richard L. Winston P.A Email: Richard@winstonpa.com

66 66 Appendix

67 67 GAARs – Case Law Developments on Treaty Limitations

68 68 IMPROPER USE (ABUSE) OF TREATIES “Guiding principle... benefits of a [tax treaty] should not be available where the main purpose of entering into certain transactions or arrangements was to secure a more favorable tax position and obtaining that more favorable treatment in these circumstances would be contrary to the object and purpose of the relevant provisions” (OECD, MC, Commentary on article 1, par. 9,5)

69 69 FIGHTING ABUSE OF TREATIES/OECD MC 3 different tools: Beneficial ownership concept LOB provisions Application of domestic GAARs Beneficial ownership and GAARs sometimes overlap in practical application

70 70 WHAT DOES THE EXPRESSION “BENEFICIAL OWNER” MEAN? Traditionally, 3 different interpretation lines: It excludes agents and nominees exclusively (accord. Commentaries, article 10, par. 2, 12,1) The concept coincides with the prevailing meaning in common law countries Beneficial owner refers positively to the person to whom the income is attributable for tax purposes, either under the laws of the residence country or under the law of the source country

71 71 BENEFICIAL OWNERSHIP: WHEN INTRODUCED, WHERE AND HOW EXPRESSED When: As from OECD Model 1997 Where: articles 10 (dividends), 11 (interest) and 12 (royalties) How: expressed “…such dividends/interest) may also be taxed in the (source state)… according to the laws of that state, but if the beneficial owner of the (dividends/interest) is a resident of the other contracting state, the tax so charged shall not exceed:…” (articles 10, 11 OECD Model, par. 2)

72 72 BENEFICIAL OWNERSHIP: WHEN INTRODUCED, WHERE AND HOW EXPRESSED (cont.) “Royalties arising in a contracting state and beneficially owned by a resident of the other contracting State shall be taxable only in that other State” (article 12, par. 1) So, functionally, reduced source taxation is denied if the recipient residing in the other contracting State is not the beneficial owner of the dividend, interest or royalty income

73 73 BENEFICIAL OWNERSHIP LEADING PRECEDENTS: ECONOMIC OR LEGAL SUBSTANCE APPROACH  Indofood (Court of Appeals, Decision UK, 2006) – Economic Approach Beneficial owner is an international tax concept No single and clear test available (reference is made to the substance of the matter) Analysis is to be made on a case-by-case basis considering all facts and circumstances Indofood was an extreme interest case: (i) identical amount of principal and interest in both segments (notes and loan); (ii) interposed company bypassed for cash repayments of principal and interest; (iii) interposition of company solely due to tax reasons.

74 74 SUBSIDIARY IN MAURITIUS Indofood Indonesia Notes placed with foreign inventors (1)Funding Notes guarantee Reduced withholding tax DTT Indonesia / Mauritius Loan of funding obtained trough placement (2)

75 75  Prevost: Dividends case (TCC 2008, confirmed FCA, 2009) – Legal Approach “Beneficial owner of dividends is the person who receives the dividends for his or her own use and enjoyment and assumes the risk and control of the dividend he or she received … One does not pierce the corporate veil unless the corporation is a conduit for another person and has absolutely no discretion as to the use or application of funds” Absence of substance: office/employees is not an issue Legal owner is the beneficial owner unless it is a conduit (FCA)  Velcro: Royalties case (TCC 2012): Similar reasoning

76 76 49% Volvo Sweden PREVOST Canada DHC The Netherlands Henlys U.K. 49% 51% 100% DHC was beneficial owner because (i) it has tittle on the shares; (ii) dividends Received from Prevost were its own; (iii) Volvo and Henlys might not dispose Of the dividends received by DHC until actually distributed by DHC

77 77  OECD CFA clarification of the meaning of beneficial owner / discussion draft: April 29, 2011 / Revised: October 19, 2012 Dividends: “In these various examples (agent, nominee, working party conduit company acting as a fiduciary or administrator) the recipient of the dividend is not the “beneficial owner” because that recipient’s right to use and enjoy the dividend is constrained by a contractual or legal obligation to pass on the payment received to another person …where a recipient of a dividend does have the right to use and enjoy the dividend unconstrained by a contractual or legal obligation to pass on the payment received to another person, the recipient is the beneficial owner of that dividend…” (draft commentaries on article 10, subpar. 12,4)

78 78 “The fact that the recipient of a dividend is considered to be the beneficial owner of that dividend does not mean, however, that the limitation of tax provided for by paragraph 2 must automatically be granted … (the concept of beneficial owner)… does not deal with other cases of treaty shopping and must not, therefore, be considered restricting in any way the application of other approaches to address such cases” (draft commentaries on article 10, subpar. 12,5)

79 79 “…Where the recipient of interest does have the right to use and enjoy the interest unconstrained by a contractual or legal obligation to pass on the payment received to another person, the recipient is the beneficial owner of such interest…” (draft commentaries on article 11, subpar. 10,2) “The fact that the recipient of an interest is considered to be the beneficial owner of the interest does not mean, however, that the limitation of tax provided for by paragraph 2 must automatically be granted … there are many ways of addressing conduit company, and, more generally treaty shopping situations, these include specific anti- abuse provisions in treaties, general anti-abuse rules and substance over from economic substance approaches… (the concept of beneficial owner)… must not, therefore, be considered as restricting… the application of other approaches to address such cases” (draft commentaries, art. 11, par, 10,3)

80 80 Royalties: “…Where the recipient of royalties does have the right to use and enjoy the royalties unconstrained by a contractual or legal obligation to pass on the payment received to another person the recipient is the “beneficial owner” of these royalties” (draft commentaries on article 12, subpar. 4,3) Paragraph 4.4 adds that the beneficial owner concept does not limit application of other anti-treaty shopping approaches (text is similar to that being included in the commentaries on articles 10 and 11)

81 81 APPLICATION OF GAARs IN A TREATY SETTING – OECD MC  A Copernican twist from 1977 to 2003 version of the OECD MC text of commentaries  1977 Model: GAARs may not be applied in a treaty setting unless the DTC expressly allows so, i.e., to resort to domestic GAARs for recharacterization or reassignment of income (redetermination of the taxpayer)  2003 Model: GAARs apply unless the DTC text expressly prohibits it (commentaries on article 1, par. 22, subpar. 22,1-2)  Current Model (2010): same position

82 82 APPLICATION OF GAARs IN A TREATY SETTING – OECD MC “Other... possible ways to deal with… (abuses), including “substance over form”, “economic substance” and general anti-abuse rules have also been analyzed, particularly as concerns the question of whether these rules conflict with tax treaties”… (commentaries on article 1, par. 22)

83 83 APPLICATION OF GAARs IN A TREATY SETTING – OECD MC “…as a general rule… there will be no conflict: for example, to the extent that the application of these rules… results in a recharacterization of income or in a redetermination of the taxpayer who is considered to derive such income, the provisions of the Convention will be applied taking into account these changes” (commentaries on article 1, subpar. 22.1)

84 84 APPLICATION OF GAARs IN A TREATY SETTING – OECD MC “Whilst these rules do not conflicts with tax conventions, there is agreement that member countries should carefully observe the specific obligations enshrined in tax treaties to relieve double taxation as long as there is no clear evidence that the treaties are being abused” (commentaries on article 1, subpar. 22.2)

85 85 BEPS action 6: preventing the granting of treaty benefits in inappropriate circumstances 14 th March / 9 th April, 2014 It includes entitlement of benefits clause model in line with that contained in article 22, US MC

86 GAARS IN SELECTED LATAM COUNTRIES PROVIDED IN DOMESTIC LEGISLATION APPLICATION IN TREATY SETTING ARGENTINAYES BRASILYES (No yet implemented) Only SAAR (i.e., thin cap.) CHILENO (GAAR included in tax reform under congressional consideration NO COLOMBIAYESNO CASES YET MEXICO Technically no, but income tax law authorizes re- characterization of sham transactions by MNEs SCJN also applies fraud legis principle Procedural rule requires taxpayers claiming treaty benefits to confirm that income is taxable in home country GAAR specially allowed in certain treaties e.g., Bahrain, Ukraine. There are no application precedents 86

87 GAARS IN SELECTED LATAM COUNTRIES PROVIDED IN DOMESTIC LEGISLATION APPLICATION IN TREATY SETTING PARAGUAYNO PERUYES (2012)NO URUGUAYNO 87

88 88 ARGENTINA  LOBs and GAARs  Argentine DTTs lack limitation of benefits (LOB) rules, but in recent years the tax authorities have resorted aggressively to domestic GAARs to recharacterize income or redetermine the beneficiary in a treaty setting, particularly in case of outbound (round trip) investment  GAARs are applied regardless of express treaty authorization

89 89 ARGENTINA  Best scenario (inbound or outbound) would be a holding jurisdiction that combines a DTT in force with Argentina with a suitable holding regime in the treaty-partner jurisdiction. For this purpose Dutch BVs, UK LLPs, and Spanish ETVs are worth considering.  Foreign treaty-partner holding must have legal as well as economic substance  The Netherlands recently issued substance regulations particularly addressed to the sublicensing of IP rights, including to residents in tax treaty foreign countries

90 90 GAARS APPLICATION ABSENT EXPRESS TREATY AUTHORIZATION / DEBATED ISSUE  Fully applicable if Argentina is country of residence of a taxpayer whose abusive behavior is to be challenged. That means that income might be recharacterized or beneficiary redefined  If Argentina is source country (1) unrestricted income recharacterization (accord. Art. 3,2), but (ii) limited power to redefine beneficiary is benefit recipient is recognized as resident by treaty-partner country Query whether outcome is different is express: treaty authorization is provided for GAARs application (e.g., MOU new Spanish treaty)

91 91 PRECEDENTS ON INBOUND STRUCTURES  Ruling AFIP 57/94 (January 30, 1996) recharacterization of insurance premium paid to foreign insurers under loan agreement as additional interest (higher borrowing cost); DTTs Spain and Italy

92 PRECEDENTS ON INBOUND STRUCTURES PARTICIPATED LOANS (DNI MEMORANDUM 3/06) DEG exemption/DTT with Germany - Altough interest paid to DEG, DEG acts as collecting agent of principal and interest corresponding to participated financial entities so that exemption does not apply on said interest; DEG is not the beneficial owner of the interest income 92 Argentine borrower DEG Participant

93 93 PRECEDENTS ON OUTBOUND STRUCTURES  Memorandum DNI 64/09: Facts and Findings  According to the Austrian DTT (no longer in force), the Argentine resident´s holding in AH and dividends received from AH were no taxable in Argentina by personal assets tax and income tax. Only 15% WHT on dividends applied on actual distribution in Austria  FIF (domestic fiscal transparency rules) were avoided by interposition of AH  Fact findings showed that AH was a phantom (shell) company without any economic substance Argentina Resident Austrian Holding B.V.I. Corp. 99% 100%

94 94 PRECEDENTS ON OUTBOUND STRUCTURES  Memorandum DNI 64/09: Decision  The decision qualified the situation as an abuse of the treaty and made reference to the possibility of applying GAARs in that context, in accordance with (i) Opinion of U.N. Expert Committee on International Tax Cooperation, Subcommittee on Improper Use of Treaties, and (ii) Commentaries to Article 1, OECD MC, 2008 (reproduced in OECD MC, 2010)

95 95  By applying GAARs, the Argentine competent authority disregarded the interposed company in the treaty country jurisdiction and treated the holding of the shares in and income obtained by B.V.I. Corp. as if the interposed company did not exist

96 96  Memorandum DNI 799/10: Fact Pattern  Operating Subs (third countries) were domiciled in LATAM jurisdictions having no DTT with Argentina. Participation in operating subs help trough Chilean holding which enjoyed a special (no-tax) holding regime in Chile. The Chilean DTT did not expressly exclude privileged holding companies from the concept of residents.  By interposing the Chilean Holding the Argentine taxpayer avoided taxation on dividends in Argentina; dividends that were made up with profits coming from the second-tier operating subs, otherwise fully taxable in Argentina (i.e., if paid directly by operating subs to Parent Co)

97 97  Memorandum DNI 799/10: Opinion  The Argentine DNI sustained that:  DTTs should not be utilized by taxpayers to ameliorate or eliminate the tax burden through legal forms that would not be adopted but for the tax advantages deriving therefrom  Domestic GAARs (economic reality principle as contemplated in Section 2, law 11,683) may and should be applied to avoid abusive schemes even in a treaty setting

98 98  Memorandum DNI 799/10: Opinion  Considering the Chilean Platform company regime and the DTT rules attributing tax jurisdiction to the parties thereto, the reason to interpose the holding was to deviate dividend income coming from Uruguay and Peru (where the operating subs were domiciled), that would otherwise have been taxed in Argentina, with the end result of benefiting from a double non-taxation  Double non-taxation, obtained by interposing a Chilean Platform company between the Peruvian and Uruguayan subs, on one hand, and the Argentine Parent on the other, contradicts the DTT and implied an abusive conduct which might be challenged under domestic GAARs

99 99  Memorandum DNI 799/10: Opinion  From a different perspective, DTT are aimed at avoiding double taxation and to that end, treaty-partners should maintain an income tax of general application. The Chilean Platform company regime was strange to the income system of general application in Chile  The Platform company was beyond the scope of the Chilean DTT. It does not qualify under Article 1 of the DTT (taxes covered) as that article refers to subsequent amendments and replacing taxes using an analogous tax basis and not to promotional regimes resulting in double non-taxation

100 100 MOLINOS RIO DE LA PLATA TAX COURT (TFN) August 14, 2013 ARGENTINA URUGUAYAN SUB. PERUVIAN SUBS. PLATFORM CO (HOLDING) MOLINOS RIO DE LA PLATA S.A. CHILE Dividends

101 101 LEGAL HOMEWORK AND FACT PATTERN  DTT Argentine / Chile patterned after Andean Pact: income solely taxed at source; dividends paid by Chilean company taxed in Chile exclusively  Platform Co. only taxed on Chilean source income. Foreign source income (profit distributions from operating foreign) non taxable  Dividends received by Platform Co. from op. subs. were immediately distributed to Molinos  Dividends were received by Molinos free of tax; if distributed directly by Peruvian and Uruguayan subs would have been taxed in Argentina

102 102 DISCUSSION AND HOLDING  There was an abuse of the treaty; AFIP’s tax assessment taxing dividends in Argentina affirmed  To find the existence of an abuse, tax court applied domestic GAARs and considered that Platform Co was not the effective beneficiary of the dividend paid out by the operating subs  Deemed “effective beneficiary” concept built in GAARs (DTT did not contemplate that concept)  A DTT may be used to mitigate or reduce the tax burden but not to eliminate the tax burden in its entirety (double non-taxation)

103 103  Critical Assessment of Molinos Rio de la Plata – Findings and Conclusions  Application of Argentine GAARs should not have resulted in a successful challenge of the Platform Company under the fact and circumstances of the case  Argentine GAARs/economic reality principle) consist of a sham-type provision according to which whenever a manifest discrepancy exists between the legal forms used and the economic substance of the transaction, the latter prevails to recharacterize the transaction or redefine the parties thereto for tax purposes  If that discrepancy exists, the legal forms are to be discarded regardless of the intention of the taxpayer, i.e., regardless of whether the intention was to avoid taxes or to pursue a legitimate business purpose. On the contrary, if such discrepancy does not exist, the legal transaction may not be challenged, whatever its purpose, unless it is evidenced that the taxpayer acted in fraud legis

104 104  Pursuing a tax advantage or benefit under the DTT (e.g., double non-taxation) is not, per se, enough to ignore the intermediate holding, as argued in connection with the Chilean Platform company  To legitimately challenge the structure under GAARs, the Tax Court should have either evidence that the Chilean holding was not the actual owner of the dividends received from the Peruvian and Uruguayan subs, and/or lacked economic substance (i.e., it was a paper company which exercises no effective management or administration of the holdings). None of that was undoubtedly evidenced in the case

105 105  Moreover, if the preceding conditions are met (the Chilean Platform company used and enjoyed the dividend income, and managed the equity participations held) the Chilean holding might not be deemed to be interposed in fraud legis nor would fail meeting the substance test. It was not evidenced that dividends received by Chilean Platform were not its own (i.e., that holding was constrained to pass the dividends on to parent)  In that context, Argentine GAARs could not be resorted to legitimately ignore the Chilean company as a treaty beneficiary, even if, as it appears to be the case, the structure was designed to save taxes (it was a tax- geared structure)

106 Richard L. Winston

107 107 Primary Goals of Double Tax Conventions (“Tax Treaties”)  The primary goals of double tax conventions are to: Prevent double taxation The same taxpayer should not be subject to taxation on the same income in two countries. The rules found in tax treaties are intended to provide for the proper allocation of income to each treaty partner. Provide clear and predictable results to taxpayers engaging in cross-border transactions Tax treaties generally set forth clear rules to define whether (and how much) a treaty country may tax a particular type of income. Tax treaty provisions are intended to override the “domestic tax laws” of each of the treaty partners. Prevent tax evasion by requiring the sharing of tax information between the treaty partners (e.g., to ensure that a taxpayer is claiming consistent positions in each country).

108 108 Who Enters Into Double Tax Conventions?  High-tax countries generally enter into comprehensive tax treaties only with other high-tax jurisdictions. The intent of a tax treaty is to reduce double taxation, not to allow for low taxation or zero taxation. In theory, taxpayers are less likely to engage in tax avoidance transactions when shifting of income between two high-tax countries. High-tax countries have no reason to enter into comprehensive tax treaties with low-tax jurisdictions (although high-tax countries may enter into limited “exchange of information” agreements with low- tax jurisdictions). Tax treaties between high-tax and low-tax countries tend to be highly restricted in scope (e.g., transportation or social security treaties).

109 109 When Do Tax Treaties Provide for Less Than Single Taxation (or “Zero Taxation”)?  Planning opportunities are often presented for taxpayers when the government officials of one high-tax country miscalculate the tax system of their so-called “high-tax” treaty partner.  Tax treaties work best when income is allocated between two high-tax jurisdictions, but when one high-tax jurisdiction offers its tax residents a low-tax (or zero tax) option, the income earned by a taxpayer in a cross-border transaction may escape all taxation. For example, a Barbados IBC qualifies for tax benefits under the Barbados-Venezuela tax treaty even though the Barbados IBC pays no more than 2.5% corporate income tax in Barbados (the regular corporate tax rate in Barbados is 25%). If taxpayers move income from Venezuela to Barbados (through deductible payments from Venezuela), they will be subject to tax at a 2.5% Barbados tax rate rather than a 34% Venezuelan tax rate. Brazil once terminated its tax treaty with Portugal when it discovered that taxpayers were exploiting a loophole by establishing tax planning vehicles in the Portuguese territory of Madeira.

110 110 Withholding Taxes Under Tax Treaties – Policy Considerations  Tax treaty rates on dividends, royalties, and interest represent another form of “allocation” of taxes between two high-tax countries.  The jurisdiction in which the payor (of dividends, royalties, and interest) is located will withhold and remit the proper amount of taxes as agreed by the parties to the treaty. For example, when Argentina agrees with the Netherlands that it will withhold 12% on interest payments made to a Dutch company (rather than the normal 35% Argentine domestic tax), Argentina is reserving the right to keep 12% of the payment. The assumption, however, made by the Argentine government is that the interest will be paid to the Dutch company, and the Dutch government will impose 25.5% Dutch corporate income taxation on the interest (offset by a foreign tax credit for the Argentine taxes paid). Final allocation of taxes = 12% to Argentina and 13.5% to the Netherlands = 25.5% taxes. In reality, good tax planning will often change the result.  Mexico has recently paid close attention to “earnings stripping” schemes that rely on the movement of Mexican-source income to low-tax regimes (often using a tax treaty).  Under 2014 Mexican Tax Reform rules, Mexican payments of interest, royalties or technical assistance will not be deductible when (1) paid to a controlling foreign entity that is fiscally transparent, unless the shareholders or partners are subject to tax on the foreign entity’s income, and the payments are made at arm’s length, (2) the payments are not deemed to exist for tax purposes in the country or territory in which the entity is resident; or (3) the foreign entity does not properly accrue the taxable income under the applicable local tax rules.

111 111 Interest-Stripping Structure  U.S. Corp  or Tax Haven  Dutch  CV  Dutch BV  or  Cooperative  Argentine  S.A.  U.S.  LLC Argentine WHT -- Interest 12% (gives rise to a tax deduction against 35% income tax). --Treaty nondiscrimination clause may defeat “thin cap” rules. Back-to-Back Loan Small “spread” earned by Dutch BV (small Dutch tax rather than 25.5% tax, plus credit for Argentine taxes withheld )  99.9%  0.1%  Loan (0% Dutch interest WHT)  Equity  “ Disregarded”  Loan

112 112 THE END COMMENTS OR QUESTIONS? RICHARD L. WINSTON


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