The applicable notion of treaty abuse is now being discussed for many years. When the Commentary on Art. 1 of the OECD Model Convention was amended in 2003, two opposite positions were accepted in matters of treaty abuse. According to some States, treaty abuse must be determined under domestic law. This is because taxes are actually imposed by virtue of domestic rules and, therefore, any abuse of a treaty, which reduces taxation, is in fact an abuse of domestic law. The argument on the basis of which the OECD has accepted this position is that a conflict between domestic anti-abuse rules and treaty provisions cannot occur (2).
At the opposite, according to other States the abuse of a treaty can only be determined by interpreting treaty provisions directly. Therefore, according to these States a conflict can arise between domestic anti-abuse rules and treaty provisions. When such a conflict arises treaty provisions must prevail.
As a consequence of the legitimacy of these two opposite solutions, it is possible that the same transaction is considered as treaty abuse in a State and, on the contrary, as non-abusive in another State. An example of this situation is given by the approach taken by Canada and the Netherlands on cash box structures.
A cash box structure is substantially used in order to avoid taxation of dividends. This result can be obtained in many different ways. Most commonly, an operating subsidiary distributes dividends to the holding company. In turn, this holding company transfers the shares to another holding company which has been incorporated by the same shareholder. Consequently, the first holding company becomes a mere cash box company. As this cash box company is sold (typically to a bank), capital gains arise instead of dividends. This result is convenient for individual shareholders when taxation of dividends is higher than taxation of capital gains.
While these transactions are classified as treaty abuse by Canada on the basis of domestic anti-abuse rules (3), at the opposite, the Dutch Supreme Court has excluded that cash box structures (4) are in conflict with tax treaties. This is because the Dutch Supreme Court does not automatically apply the fraus legis doctrine for treaty purposes (5). More specifically, a re-characterization of facts (including legal facts) on the basis of the fraus legis doctrine cannot apply for treaty purposes when this re-characterization is in conflict with the applicable treaty provisions. This is clearly explained by the Dutch Supreme Court in a leading case decided in 1993 and concerning the tax treaty concluded by the Netherlands and the United States in 1948: “3.3 Under Article VII,[ ] Clause 1, of the Treaty … dividends paid by a body in one of the states … to a resident … of the other state, are taxed in the former state at a rate as referred to in this Article. Neither the text of the Treaty nor the notes of the signatories show that they had the joint intention, for the purpose of the application of the aforementioned Article VII (6), Clause 1, to include in the definition of dividends benefits – such as those at issue here, to which benefits the fraus legis doctrine in the national law of the State in which the body referred to in Article VII, Clause 1, is established could be applied. No support can be found in the text of the Treaty, or in the notes of the parties that are signatories to the Treaty, for the view submitted by the State Secretary … that the purpose and intent of the Treaty would be misrepresented if the benefits in question cannot be taxed in the Netherlands(7), (8).
As it is clear from the cash box structures example, the position taken by the OECD in the 2003 Commentary on Art. 1 has favored a high fragmentation of the notion of treaty abuse, which may even result at the opposite in different Contracting States. For example, under the tax treaty concluded between Canada and the Netherlands the same transaction, i.e. a cash box transaction, will be considered as abusive when the treaty is applied by Canada and as non-abusive when the treaty is applied by the Netherlands. This result may determine a significant unbalance between taxpayers covered by the same tax treaty.
For this reason, the position taken by the OECD in the final report on Action item 6 (treaty abuse) (9) , and incorporated in the 2017 Draft Commentaries (10), is particularly relevant. In the final report on Action item 6, as well as the 2017 Draft Commentaries, by taking a position already maintained by the author of the present contribution (11), the OECD expressly states that a conflict between domestic anti-abuse rules and treaty provisions can actually occur. In particular, this is the case when the application of domestic anti-abuse rules triggers the taxation of an item of income or capital which would not be taxed under the applicable tax treaty (12). According to the OECD, in case of conflict between treaty provisions and domestic anti-abuse rules, treaty provisions must prevail by virtue of the pacta sunt servanda rule, as expressed in Art. 26 of the Vienna Convention on the Law of Treaties.
This position taken by the OECD is particularly important as it represents a fundamental step towards the international coordination of the notion of treaty abuse (13). In turn, this international coordination can favor a better equilibrium between the need to effectively fight against treaty abuse, on the one hand, and the need of avoiding unbalanced treatments of taxpayers covered by the same tax treaty, on the other.
Certainly, this result will also depend on the position of the individual Contracting States. Therefore, the reservations and observations to the new Commentary on Art. 1 will be very relevant (14).
- (1) Carla De Pietro works as Assistant Professor at the Fiscal Institute of Tilburg University.
- (2) See paragraph 22.1 of the 2003 OECD Commentary on Art. 1: “[s]uch rules [including ‘substance-over-form’, ‘economic substance’ and general anti-abuse rules] are part of the basic domestic rules set by domestic tax laws for determining which facts give rise to a tax liability; these rules are not addressed in tax treaties and are therefore not affected by them. Thus, as a general rule and having regard to paragraph 9.5, there will be no conflict [emphasis added].”
- (3) See RMM Canadian Enterprises Inc. and Equilease Corporation v. The Queen  1 CTC 2300 (TCC).
- (4) Although as from 1997 in the Netherlands dividends and capital gains are taxed at the same rate (exactly in order to avoid these transactions), cash box structures are still relevant in an international context in order to mitigate Dutch dividend withholding tax.
- (5) Hoge Raad, 15 December 1993, 29 296, BNB 1994/259; Hoge Raad, 29 June 1994, 28 734, BNB 1994/294; Hoge Raad, 6 December 2002, 36 773 and 36 774, BNB 2003/285.
- (6) This was the “Dividends” article in the 1948 tax treaty between the Netherlands and the United States.
- (7) Hoge Raad, 15 December 1993, 29 296, BNB 1994/259, paragraphs 3.3/3.5. The translation is of IJzerman. See R.L.H. IJzerman, ‘Netherlands’, in Form and Substance in Tax Law, Cahiers de droit fiscal international, vol. LXXXVIIa, 2002 Oslo Congress (Kluwer Law International, 2002), p. 468.
- (8)See also Hoge Raad (15 March 1995), 26 531, BNB 1995/150, paragraph 3.4; Hoge Raad (29 June 1994), 28 734, BNB 1994/294, paragraphs 3.3-3.4.
- (9) OECD, Preventing the Granting of Treaty Benefits in Inappropriate Circumstances (Action 6: 2015 Final Report), 2015.
- (10) OECD, Draft Contents of the 2017 Update to the OECD Model Tax Convention, July 2017.
- (11) C. De Pietro, Tax Treaty Override, EUCOTAX Series on European Taxation, n. 40, Wolters Kluwer, 2014, p. 159.
- (12) OECD, Draft Contents of the 2017 Update to the OECD Model Tax Convention, July 2017, Commentary on Art. 1, para. 70. See also paras. 74, 77 and 78.
- (13) As it is well known, in Action item 6 the OECD also proposes treaty provisions in order to fight against treaty abuse (LOB clause and PPT rule). However, it is clear that the effective prevalence of treaty provisions over domestic law is fundamental in order to actually guarantee the international coordination of the notion of treaty abuse.
- (14) For an in depth analysis of this topic, see C. De Pietro, Taxpayer’s mobility in the context of tax treaty law: the need of a renewed balance between favouring the movement of persons and tackling treaty abuse, 2017 EATLP Report, in course of publication. See also, C. De Pietro, Tax Treaty Override, EUCOTAX Series on European Taxation, n. 40, Wolters Kluwer, 2014, pp. 105-162.