Search

This is an Opinion Statement prepared by the CFE ECJ Task Force on the PRA Group Europe case, in which the EFTA Court delivered its decision on 1 June 2022. At issue in PRA Group Europe was the interaction of the Norwegian "interest barrier rule" ("interest limitation rule"), which generally limit the deductibility of interest payments to affiliated resident and non-resident entities to 30% of EBITDA, and the group contribution rules, which permit tax effective transfers between group members, but are limited to Norwegian entities. As group contributions also increase the EBITDA of the recipient Norwegian entity (and decrease it at the level of the paying Norwegian entity), companies in the Norwegian tax group can achieve interest deductions under the interest barrier rules where profits ("tax EBITDA") and interest expenses are distributed unevenly between the companies in the group, while a similar opportunity to escape (or lessen the impact of) the interest barrier rules is not available to cross-border groups. The EFTA Court took a combined perspective on the interaction of those rules and found them to constitute an unjustified restriction of the freedom of establishment under Articles 31 and 34 of the EEA Agreement. The EFTA Court's decision is particularly interesting from an EU law perspective, as the interest barrier rule of Article 4 of the Anti-Tax Avoidance Directive (ATAD) similarly foresees the option for Member States to introduce a domestically-limited "interest barrier group" to permit a calculation of exceeding borrowing costs and the EBITD at the local group level. The CFE ECJ Task Force welcomes the EFTA Court's progressive impetus on fundamental freedoms doctrine: PRA Group Europe AS makes it clear that for purposes of identifying a restriction, for establishing comparability and for justification, a combined perspective on the interaction of two sets of rules – here the interest barrier on the one hand and the group contribution regime on the other – is necessary. From that perspective, the interaction of the Norwegian rules on the "interest barrier" and on group contributions leads to unjustified discrimination in cross-border situations. However, if asked to decide on a similar case, the CJEU might take a different approach. First, the CJEU could take a different perspective on the available grounds of justifications and, e.g., accept the coherence of the tax system as such ground. Second, Article 4 ATAD gives the Member States the option to treat an "interest barrier group" as a single taxpayer and to limit the group perspective to domestic settings. Even if such an option in the ATAD is not viewed as "exhaustive harmonization", one could wonder if the mere existence of the ATAD and the value judgments made by the EU legislature therein could lead to a different outcome in the EU (CJEU) vis-à-vis the EEA (EFTA Court).

Income from invested capital and from making assets available for the use by others is covered by Article 10-12 OECD and UN MC: Dividends (Article 10); interest (Article 11) and royalties (Article 12). These provisions cover the allocation of tax jurisdiction of income received by both private individuals and enterprises. With regard to dividends, the standard of both MCs is that the tax jurisdiction is shared. The State of source has been granted a limited tax jurisdiction. Its taxation is credited by the recipient's State of residence, even when it otherwise applies the exemption method (Article 23A(2) OECD and UN MC). Shared taxation in connection with an ordinary tax credit is also the system applied to interest under the OECD and UN MC, and to royalties under the UN MC. However, under the OECD MC, tax jurisdiction in respect of royalties is exclusively allocated to the recipient's State of residence. Tax sharing is a typical compromise to settle a clash between the State of source and the State of residence in cases in which both believe that they have justified claims to tax jurisdiction that they do not want to forgo completely. This is especially true in respect of dividends, interest and/or royalties. On the one hand, the State of residence may put forward as justification that the invested capital or the assets allowed to be used emanate from its national wealth. On the other hand, the State of source may emphasize that the income is produced by means of its infrastructure, labour force, etc. These conflicting interests emerge especially in the relationship between typical capital-exporting States, like most of the OECD member countries, and typical capital-importing States, like developing countries. From a budget perspective, there is a real need for capital-importing States to impose and collect taxes on dividends, interest and royalties received by non-residents (see, e.g., no. 8 UN MC 2011 Comm. on Article 10). The 1971 Andean Model deviates from the OECD and UN MC. It exclusively allocates tax jurisdiction on dividends, interest and royalties to the State of source. The UN MC did not adopt this approach; however, it has some flavour of it because it leaves open the maximum rates at which the State of source may tax dividends, interest and royalties. Developing States pleaded for exclusive taxation by the source State (see, e.g., no. 8 UN MC 2011 Comm. on Article 10; no. 9 UN MC 2011 Comm. on Article 11 no. 9 UN MC 2011 Comm. on Article 12). Consensus could not be reached. No winner of the ‘battle of distribution’ between the State of source and the State of residence can be designated. The battle is only transferred to another level. With regard to other items of income, tax jurisdiction is allocated to one Contracting State exclusively or primarily. They may be taxed at full domestic tax rates of the State concerned. Here, tax sharing is not the applied policy, neither in the MCs nor in tax treaty practice. The major drawback of tax sharing is the transfer of tax benefits granted to investors by the State of source to the State of residence as a result of crediting the State of source's tax. Even the UN MC does not provide for a solution of this disadvantage. As a consequence, capital-importing States do not have the opportunity to stimulate economic policies by means of tax incentives in the context of dividends, interest and royalties. A tax sparing credit or a matching credit can remove this drawback. In their DTCs with developing States and subject to certain conditions, European countries, Canada, and Japan have included such credits. The US does not adopt this approach. Currently, the prevailing view under OECD member countries is that tax incentives are not an efficient and effective way to attract foreign direct investments. They will allow tax sparing credits only with respect to certain identified incentives or activities, and will limit in time the application of the tax sparing provisions). Another solution to this drawback would have been the adoption of the solution suggested by Georg von Schanz. In 1892, he suggested a tax sharing at a tax base level and not at the level of the amount of taxes. His proposal was that, e.g., three quarters – or some other part – of the foreign source income would be allocated to the State of source and taxed on the basis this State's domestic tax law. The other quarter – or another counterbalance as the case may be – would be allocated to the State of residence. Von Schanz's suggestion was only applied once: Article 15 of the 1939 DTC between France and the US. The structure and the wording of some parts of Articles 10-12 are rather similar. These provisions therefore have a number of common interpretation issues. This chapter discusses four of these common issues: The terms ‘paid to’ and ‘beneficial owner’; the ‘permanent establishment proviso’ and the procedures for reducing tax at source. An outlook to the future is the final section of this chapter.

European Union law overlaps and interacts with both the OECD’s Base Erosion and Profit Shifting project (BEPS) and its implementation and the member states’ tax treaties between them and with third countries, and there is also an area where all three fields meet. This intersection of EU law, BEPS and member states’ (mostly) bilateral tax treaties is the subject of this report. First, it should be noted that the Union’s competence under article 115 TFEU not only covers purely internal situations, but the Union can also use its internal competence to specify the treatment of non-EU investors or third-country investments, and it has done so, e.g., in the Anti-Tax Avoidance Directive (ATAD). This has potential impact also on tax treaties between the member states and with third countries: Given the supremacy of EU (secondary) law, domestic law implementing Directives (e.g., the ATAD) might, under certain conditions, arguably take precedence over (pre- and post-accession) tax treaties between the member states, even if that implementation is detrimental to taxpayers and irrespective of whether the specific tax treaty was concluded before or after a provision of a Directive entered into force. As for tax treaties with third countries the TFEU contains a differentiating rule, as article 351 TFEU (ex-article 307 EC) grandfathers (only) member states’ treaties with third countries, including tax treaties, that a member state concluded before 1 January 1958 or, for acceding states, before the date of their accession, so that EU law arguably takes precedence over post-accession tax treaties with third countries and, therefore, may directly affect the relevant member state’s (but of course not the third country’s) tax system. Second, the European Commission has issued various Recommendations with regard to post-BEPS tax treaties of the member states. A 2012 Recommendation “on aggressive tax planning” addressed (also) tax treaty-based double non-taxation and encouraged member states to include an appropriate subject-to-tax clause in their double taxation conventions. The Commission’s 2016 Recommendation dealt with the inclusion of a subject-to-tax clause in tax treaties, the definition of “permanent establishments” to prevent their artificial avoidance (article 5 OECD MC) and the use of an EU-compatible Principal Purposes Test (PPT), which refers to “a genuine economic activity” as a carve-out to align the clause with the case-law of the Court of Justice of the European Union as regards the abuse of law. Third, the OECD BEPS project has established a (political) minimum standard regarding measures against treaty shopping (article 7 MLI and article 29 OECD MC), and the Limitation on Benefits (LoB) clause in particular raises issues with regard to its compatibility with the EU fundamental freedoms. In particular, LoB clauses are confronted with continuing doubts regarding their compatibility with the freedom of establishment. These concerns have also found expression not only in various documents of the European Commission but also in the BEPS Action 6 Final Report, where the OECD noted that some countries may have “concerns based on EU law that prevent them from adopting the exact wording of the model provisions that are recommended in this report”, further specifying those concerns by recognizing “that the LOB rule will need to be adapted to reflect certain constraints or policy choices concerning other aspects of a bilateral tax treaty between two Contracting States” such as “concerns based on EU law”. Indeed, the “ownership clauses” in LoB provisions face scrutiny because the company’s residence state has agreed to give better conditions to companies held by shareholders resident in its own territory as compared to the ones resident elsewhere in the EU and the EEA. In such circumstances and in light of the Open Skies judgments, LoB clauses could thus be regarded as the immediate source of the discriminatory treatment. It is, however, unclear whether other – objective or subjective – tests in a typical LoB clause make them “EU compatible”, and if the source state’s perspective might require a different analysis in light of the ECJ’s decision in ACT Group Litigation. Fourth, and while the OECD BEPS project has not established a minimum standard with regard to mandatory binding arbitration, the 2017 Tax Dispute Resolution Directive (TDRD) has established a mechanism for binding arbitration with regard to tax “disputes”. While the TDRD does not address double taxation outside of a tax treaty context, it is a huge step towards the removal of double taxation caused by diverging interpretation and application of tax treaties between member states. Fifth, the OECD BEPS project has addressed situations of treaty-based non-taxation, which might also raise state aid questions under article 107 TFEU in cases where the misapplication of a tax treaty leads to “white income”. While generally “the need to avoid double taxation” would be a basis for a possible justification, it might indeed be asked if a double taxation convention must be interpreted, in light of article 107 TFEU, to not give rise to “white income” (e.g., through an unconditional exemption of untaxed income) or to “overcompensation” (e.g., through a tax sparing credit). That rather extreme path, however, was not (yet) taken by the Commission in the McDonald’s case: Indeed, to show selectivity, the Commission attempted merely to prove that Luxembourg had misapplied the applicable tax treaty. It did not rely on the alternative argument that double non-taxation resulting from the application of a tax treaty ipso facto amounts to state aid.