Hits Chapter 19.

International tax avoidance Introduction By now you will observe that much of statutory international tax law is concerned with combating tax avoidance where people and entities that embark upon international economic activity often do so by way of legal structures and income shifting, which minimizes their global tax liability. Consider, for example, the underlying purpose of controlled foreign companies' legislation, which was discussed in Chapter 1. In principle, it exists to prevent residents of Country R from adopting a legal construct to park income in foreign-resident intermediary entities, thereby avoiding taxation on that income in Country R, notwithstanding that the residents of Country R, in substance, own the income. The first part of this chapter is concerned with international tax avoidance arrangements and the role of DTAs in them. We canvas the use of conduit companies and base companies as intermediary entities employed by multinational entities in low- or nil-tax jurisdictions, or in ways that take advantage of the international DTA network, to enable total tax payable in all jurisdictions on the global income of the multinational entity to be minimized. Since the governments of (particularly) higher taxing states do not tolerate an undermining of their tax bases by such activities, they introduce counteracting measures into their domestic law and DTAs. These regulatory anti-avoidance rules are often buttressed by judge-made rules. Many of the provisions of DTAs are driven by an anti-avoidance objective. Some DTAs have specific anti-abuse articles, e.g. articles that limit the extent to which benefits are conferred by a DTA. More generally, parts of some substantive articles of DTAs are motivated by international tax avoidance concerns, e.g. articles dealing with the definitions of a permanent establishment; the beneficial ownership requirement in respect of dividends, interest and royalties; artiste companies utilized by entertainers and sports professionals; and transactions between associated enterprises. This chapter canvasses a selection of common tax avoidance arrangements in an international context, and the anti-avoidance mechanisms designed to counter them. On completion of this chapter, you should be able to: describe the use of conduit companies and base companies in treaty shopping activities undertaken by earners of cross-border income, and the motivation behind adopting such structures; illustrate other types of international tax avoidance arrangements, which do not necessarily involve intermediary entities; and explain the various statutory, judicial and DTA measures used by states to counteract international tax avoidance arrangements.

General observation on tax avoidance

Just as domestic tax avoidance undermines a country's tax base so does international tax planning. Consequently, most countries have judicial doctrines or base-maintenance statutory provisions, which are designed to prevent or limit tax avoidance. Such provisions are more readily applicable to domestic, rather than international, tax avoidance arrangements. This part of this chapter examines the principal means by which different jurisdictions attack international tax avoidance. However, you should consider these remedies in the context of Ward's accurate observation that, internationally, tax administrations and courts show some considerable variations in the levels of tax planning that they will tolerate, and the place where they draw the line at unacceptable tax avoidance. *153+ In other words, the point at which a taxpayer crosses from legitimately arranging its financial affairs in the most tax beneficial way to abuse of the tax law varies from one country to another: some countries (and judges) are more tolerant than others. In most countries, however, the fundamental issue concerning tax avoidance in both a domestic and international context comes down to whether the legal form of an arrangement, which a taxpayer designs to minimize the amount of tax that it must pay, prevails over the underlying economic reality of the circumstances of the case. Approaches to international tax avoidance International tax avoidance is about a taxpayer, which enters into international transactions, exploiting (i) the differences in tax base calculation methodology and tax rates in different jurisdictions, and (ii) the tax benefits offered by the international network of DTAs. To take advantage of these differentials and benefits, a multinational taxpayer uses legal constructions (often without any economic substance) in different jurisdictions as part of a treaty shopping exercise. Such legal constructions fall into two broad categories: (i) conduit companies and (ii) base companies. Where a series of two or more such companies form a chain through which income flows, they are often referred to as stepping stone companies. Conduit companies Conduit companies are simply companies that a multinational operator interposes between two or more other companies purely to obtain tax advantages. Conduit companies typically are name-plate companies only; they have no employees and only nominee directors and shareholders in the country in which they are registered. The power behind the manner in which conduit companies are governed is located in another jurisdiction. Instructions are sent to the nominal directors either electronically or by fax or telephone (if they are sent at all) and the books and records of the conduit company may be kept in its holding company's country of residence. Conduit companies are used to re-invoice sales or to siphon commissions on sales, to park profits in low- or no-tax jurisdictions, or to otherwise avoid tax under a country's domestic law, by taking advantage of DTAs and the absence of foreign exchange controls, as well as sometimes to conceal share ownership. We saw in Chapter 12 an example of the use of a conduit company established in a third state to facilitate the avoidance of US domestic withholding tax on interest (the Aiken Industries case).

Base companies By contrast, base companies, which are also situated in low- or no-tax jurisdictions, actually undertake some real activity on behalf of related companies in high-tax jurisdictions, such as management services, asset administration or financial services. Part of a multinational group's worldwide profits is transferred to the base companies by their charging for the services that they provide to other members of the group, which are situated in high-tax jurisdictions. Greater amounts of profits are able to be massaged between tax jurisdictions the higher the amounts charged for a base company's services, to the point where artificially high charges are made to achieve the tax avoidance purpose. To illustrate, suppose that Company R and Company S are two companies in the same multinational group of companies. Company R is a resident of Bahrain and Company S is a resident of Germany. Company R owns the intellectual property rights to an industrial design, which it assigns for a limited period and for a limited geographical application to Company S. In return Company S pays company R a royalty. Germany's domestic law imposes a withholding tax at source on the gross amount of royalty payments made to non-resident recipients of 21.1% of the gross amount of the royalty payments. Since there is no DTA between Germany and Bahrain, Germany's domestic withholding tax rate prevails. The situation is illustrated as follows:

However, France has DTAs with both Germany and Bahrain. Under the DTA between France and Germany, Germany as the country of source of the royalty is prohibited from imposing withholding tax. Under the DTA between France and Bahrain, no tax is payable in France on dividend payments from French-resident companies to shareholders resident in Bahrain. To avoid Germany's withholding tax, the multinational group decides to centralize the ownership and management of all of its intellectual property in one company in France, which employs staff to carry out that function on behalf of the whole group. To achieve this, Company R incorporates a company (Company T) in France. Company R transfers ownership of its intellectual property to Company T in consideration for share capital of equal value in Company T. Company T then grants the right to use the intellectual property to Company S, which now pays royalties to Company T in return for the use of the intellectual property. The situation is now:

Therefore, as a result of the imposition of the base company, Company T, to manage the multinational group's intellectual property from France, Germany has lost out on collecting tax on the royalty payments, which would otherwise have been imposed if the group had not restructured its intellectual property managing functions. Treaty shopping The above example is a manifestation of treaty shopping. *154+ Treaty shopping is defined as:

a situation where a person who is not entitled to the benefits of a tax treaty makes use in the widest meaning of the word of an individual or of a legal person in order to obtain those treaty benefits that are not available directly. [155] In the example above, Company R has shopped around for a combination of DTAs, which gives it the tax benefits that cannot be obtained by exporting its capital directly to Germany. Company R has found that, by using the FranceGermany DTA (1959), in conjunction with the BahrainFrance DTA (1993), it can reduce its German tax liability of 21.1% of the amount of royalties that it receives to zero. Some commentators (and revenue authorities) argue that treaty shopping is unethical and illegal. The contrary, prevailing view is that, provided that the domestic laws of the countries concerned are observed, and in particular there is no DTA anti-avoidance provision, there is nothing to prevent residents of third states gaining rights under a relevant DTA. Furthermore, the OECD report on conduit companies considered that a conduit vehicle typically used in treaty shopping is generally able to claim the benefits of a DTA. In response, many countries have introduced in their domestic law or DTAs anti-avoidance provisions to attack treaty shopping, which undermines their domestic tax bases. These measures include general anti-avoidance rules, beneficial ownership requirements and limitation on benefits clauses, which are discussed below. Hybrid entities The use of hybrid entities allows the international tax planner to take advantage of different definitions, and tax treatments, of certain entities in different countries. A hybrid entity is defined as: an entity that is characterised as transparent for tax purposes (e.g. as a partnership) in one jurisdiction and non-transparent (e.g. as a corporation) in another jurisdiction. [156] For tax purposes, a transparent entity itself is not a taxable subject, but we look through the entity to its underlying owners, and attribute the entity's income to, and tax, them. Hence, the term transparent. *157+ By contrast, non-transparent entities are stand alone entities, which are taxed on their income in their own right. They are legal and taxable subjects, which are taxed separately from their owners. Tax arbitrage in the context of hybrid entities arises because one country treats the entity as transparent, and does not tax it, while another country treats the same entity as nontransparent and taxes it. An example of this is the situation where residents of Country R are partners in a partnership established in Country T, which derives income from Country S (when that income is not attributable to a PE in Country S). Assume that Country S and Country T treat the partnership as a transparent entity, but Country R treats it as a non-transparent entity. Under the domestic law of Country S, the partners are taxable in Country S on the Country S sourced income. However, when the Country RCountry S DTA is applied (assuming that it follows the OECD model DTA), that income is not taxable in Country S because Art. 7 does not apply, there being no PE in Country S. Art. 10 also does not apply because, although Country R might treat the income from the non-transparent partnership as dividend income of

the partners under its domestic law, the (deemed) company paying the dividends is in Country T not Country S, to which the Country RCountry S DTA applies. Art. 21 of the Country R Country S DTA would apply to tax the income originally sourced in Country S only in Country R as other income. However, if Country R exempted from tax foreign (dividend) income derived by its residents, the business profits originally arising in Country S would not be taxed anywhere. Hybrids are often used to obtain more than one deduction in two countries for the same amount of expenditure; so-called double dipping. To illustrate, a partnership may be established in France as a socit en nom collectif (SNC), which can (by election) be taxed in France as a company. From the French perspective, the entity is therefore non-transparent. Suppose that the partners of an SNC are residents of the United Kingdom, which treats the partnership as a transparent entity. Also assume that the SNC pays interest on borrowings to acquire a profitable French corporation. The SNC obtains a deduction for its interest expense, which can be offset against the profits of the acquired company, effectively sheltering those profits from tax (to the extent of the interest deduction). Simultaneously, since the United Kingdom does not recognize the SNC as a separate entity, a UK partner can also claim a deduction for its share of the interest cost, which will shelter its income (to the extent of the interest deduction) from UK income tax. Therefore, a tax benefit from the same interest expense has been obtained twice: once in France and once in the United Kingdom. The laws of some countries, such as Germany, provide for so-called silent partnerships. A silent partner contributes assets to the partnership. In computing the partnership's income, a deduction is allowed for payments made to the silent partner, thus reducing the partnership's tax liability in the state of the partnership, i.e. Germany. If the state of residence of the silent partner taxes its residents on a territorial basis, e.g. Hong Kong, the payments made to the silent partner will not be subject to tax in that state. Thus, the partnership income distributed to silent partners is not subject to tax at all in either jurisdiction. The use of limited liability companies (LLC) in the United States, where a check-the-box election allows taxpayers to choose whether they want such entities to be taxed in the United States as corporations or as partnerships, similarly facilitates international tax arbitrage, where shareholders of the LLC are residents of countries that treat the LLC as a corporation while the election has been made to treat it as a partnership in the United States. Hybrid financial instruments Hybrid financial instruments used in cross-border transactions can also produce a characterization mismatch in different jurisdictions, which give rise to international tax avoidance. A hybrid financial instrument is an: instrument with economic characteristics that are inconsistent in whole or part with the classification implied by their legal form. Hybrid financial instruments normally contain elements [of] equity, debt and/or derivatives, the advantages of which they seek to combine in the same instrument. [158]

Convertible notes are a good example. They are interest bearing notes, exhibiting the features of debt, which convert into shares capital after a specified period, thus also exhibiting the features of equity. If the country in which the company that issues the notes is resident treats the notes as debt instruments for tax purposes, the company would normally obtain a tax deduction in that country for the interest paid to the noteholders. However, if a noteholder's country of residence treats the notes as equity and does not tax (foreign sourced) dividends, the resultant tax benefit is the deduction in one country without corresponding assessment of the income of the noteholder in another country. More commonly, a similar outcome can be achieved through the issue of redeemable preference shares, a hybrid financial instrument, which in one country is treated as equity because of its legal form and participation in the profits of the issuing company by way of dividend payments to its holders, and in another country treated as in-substance debt because of its redemption after a specified period. The benefits of use of such tax arbitrage are particularly obvious when the holder and issuer of the hybrid financial instruments are related parties. Counteracting measures to international tax avoidance To maintain the tax base of source states and to achieve the tax policy objectives of equity and neutrality of a country's national tax laws in an international environment, most countries want to combat these sorts of tax avoidance arrangements. In the context of conduit and base companies, the concerns of revenue authorities fall into two general categories: (i) to combat the use of pure conduit companies in DTA shopping arrangements, and (ii) to regulate the charges made for goods and services between entities within the same multinational group, which are located in different tax jurisdictions. These tax avoidance arrangements can be countered in one of two ways: by relying on judicial doctrines or by passing legislation. Let us take judicial doctrines first. Judicial doctrines Internationally, there are two broad approaches used by the courts to counter tax avoidance: abuse of law, used by civil law countries, and substance over form adopted by the common law countries. Abuse of law In civil law countries, [159] anti-tax avoidance principles are applied in practice through the doctrine of abuse of law (sometimes also referred to as the fraus legis doctrine). This doctrine is adopted in the absence of any general anti-avoidance statutory provision in Denmark, Finland, Greece, Norway, Russia and Switzerland (at the federal level), and in conjunction with a rather broadly worded general anti-avoidance statutory provision in each country's tax legislation in Bulgaria, Germany, Hungary and the Netherlands. [160] Although specific judicial criteria vary from country to country, the doctrine essentially allows a tax administration to disregard the legal form of an arrangement if the taxpayer's predominant motive is to avoid tax. This means that the actual form of a transaction or series of transactions

may be set aside if the form is not specifically contemplated by the law and the same economic results otherwise could have been obtained. Application of the doctrine usually requires some degree of artificiality or abnormality in the legal arrangement as well as a tax avoidance motive. Specifically, the criteria for the judicial application of the abuse of law doctrine typically encompass:

tax avoidance as the exclusive or primary purpose or motive for the taxpayer to enter into the transaction or action (the motive test); other than a reduction in taxation, the transaction has no real, practical meaning or economic value for the parties involved (the artificiality and absence of bona fide purpose test); and the intent and objective of the tax law would be violated if the transaction would not have the tax consequences that are stipulated in the law (the legitimacy test).

The result of applying the abuse of law doctrine is generally that the legal form of the arrangement is ignored and substituted by a form that is consistent with economic reality. It is the latter that serves as the basis of taxation. Substance and form The economic effects or consequences of a transaction are often referred to as the economic substance of the transaction. In a legal sense, substance typically refers to the underlying real feature of the transaction. When the form and substance of a transaction are not the same, the transaction may well have been structured so that the legal form does not refer to a critical underlying feature. The concept of substance over form has been applied to counter tax avoidance arrangements. This principle has been defined by the OECD Committee on Fiscal Affairs as the prevalence of economic or social reality over the literal wording of legal provisions *161+ Consider the case of an individual who is a resident of Kuwait, Mr K, and a shareholderemployee of a Polish company, Company P. Mr K visits Poland for 7 months during a fiscal year, working for Company P. He derives income of PLN 100,000 from his 7 months' work in Poland. His Polish income tax liability is PLN 20,000 (an effective tax rate of 20%). [162] To avoid this impost, Company P instead pays Mr K a dividend of PLN 100,000. Art. 10 of the PolandKuwait DTA (1996) restricts Polish tax on dividends paid to individuals who are residents of Kuwait to 5% of the gross amount of the dividend, so that Mr K's Polish tax liability decreases by PLN 15,000 to PLN 5,000. Company P would not have declared the dividend if Mr K had not continued to provide labour services to it. There is an attempt here to accomplish the economic objective (i.e. remunerating Mr K for the work he performs) by manipulation of Poland's DTA laws. The legal form of Mr K's receipt is dividend income, although in substance or reality the dividend is a payment for work; that is, it is a salary dressed up as a dividend.

Application of the doctrine of substance over form would deny Mr K the tax efficacy of the dividend payment arrangement so that, on the basis of its economic substance, the receipt, being a payment for work, and regardless of the legal form in which it is paid, would be taxed as payments for work are taxed, viz. as salary. Unlike the courts in civil law jurisdictions which apply the doctrine of abuse of law, common law jurists in countries other than the United States traditionally have not been prepared to interpret the taxing statutes in a way that imposes tax on the basis of the economic substance of a transaction, in the absence of a sham or an anti-avoidance statutory provision that directs otherwise. However, the United States is one common law jurisdiction that applies the antiavoidance doctrine of substance over form, i.e. the legal form of an arrangement or transaction is ignored and tax is instead levied in accordance with economic reality. The approach in the United States has embraced the step transaction doctrine, meaning that a transaction consisting of several steps is viewed in its entirety to determine its tax treatment. Economically meaningless steps are collapsed or ignored and the tax rules are applied to the resulting outcome of the overall arrangement. (See the example in Chapter 12 referred to above.) Application of the substance over form approach to tax avoidance invariably requires an examination of the business purpose that underlies the transactions at issue. The business purpose test, as it is sometimes called, requires that an arrangement must have a business purpose or have as one of its principal purposes a business purpose. In this sense, business purpose means a commercial justification other than simply tax avoidance. Domestic legislative remedies Governments of many countries have not been content to leave it to judicial doctrines alone to strike down tax avoidance schemes. Most countries have some anti-avoidance legislation, which targets specific matters. In fact, the Swiss federal government has issued a decree in respect of tax treaty abuse. In addition, many governments have also enacted general antiavoidance legislation. General anti-avoidance rules (GAAR) General anti-avoidance laws means statutory provisions that are designed to combat tax avoidance arrangements wherever they may arise, cf. provisions that are intended to defeat tax avoidance arrangements that come about in specific circumstances, which are described in the statute. Commonly, a GAAR renders a particular tax avoidance arrangement void for tax purposes and empowers the taxing authority to impose tax on the basis of the outcome of the transactions or events when the tax avoidance components or the arrangements are disregarded, i.e. by adopting a substance over form approach. Specific anti-avoidance legislation Most countries include specific anti-avoidance provisions in their domestic tax law to counter tax avoidance, including tax avoidance in an international context. The most common types of such measures are briefly canvassed below.

Residence definition The concept of residence was explained in Chapter 8. Residence refers to a person's legal status in relation to its attachment to a particular country. A country's domestic tax law definition of residence can be viewed from an anti-avoidance perspective. Where a country taxes the worldwide income of its residents, there is an incentive for taxpayers who are residents of high-tax jurisdictions to change their residence to a lower- or nil-tax jurisdiction. To thwart this type of avoidance, residence definitions in domestic tax laws tend to cast a wide net. For example, for individuals there are often two alternative tests: an objective arithmetic test of the number of days that a person is present in the country, e.g. if personal presence in the country exceeds 183 days in any 12-month period; and a subjective facts-and-circumstances test of economic and social attachments to the country, e.g. if the person has a permanent place of abode in the country (notwithstanding his or her actual physical presence there).

It is much easier to manipulate corporate residence for tax planning purposes. Therefore, the traditional notion of corporate residence being in the state in which a company is incorporated or established has been extended by many countries to encompass factors such as the state in which: the company has its centre of management or administration; the company's head office is located; control of the company by its directors is exercised.

Such rules are designed to ensure that, in a similar way to an individual, a company is a resident of the state in which its brain or real driving force operates, or in which its central functions are carried out by officers who have the necessary business knowledge to form proper judgements (and who are not puppets acting on someone else's instructions). This real connection with a country cannot be circumvented for tax purposes by merely incorporating the company in another jurisdiction. These rules are good examples of looking at the reality of the situation and applying substance over form. Controlled foreign company (CFC) rules Although statutory definitions of a resident are broad, their effect can nevertheless be avoided in tax planning which involves more than one company. We saw in Chapter 1 how CFC rules are designed to combat the standard technique to avoid tax in a high-tax country by establishing and controlling a separate legal entity (a subsidiary company or a trust) in a lowor nil-tax jurisdiction, and diverting and retaining in the foreign entity income from international transactions or investments.

CFC legislation is typically targeted at resident shareholders who directly or indirectly control more than 50% of a foreign company. Some countries require that the controlling interests are held by a small number of residents (e.g. no more than five) before the CFC rules are applicable. In addition, CFC rules usually require the interests of associated persons to be aggregated when applying the 50% control test. This obligation is to ensure that the 50% threshold cannot be circumvented by a person allocating his or her shareholding in the foreign company to other parties with which he or she is connected. Furthermore, a minimum shareholding interest (usually 10%) can also apply before CFC rules are applied to any particular shareholder. To determine whether CFC legislation is applicable in a particular case, tests may be applied to the level of foreign tax paid, e.g. a comparison of foreign tax paid with the tax that would otherwise have been paid on the same income if it were derived directly by the controlling shareholders in the home country. Thin capitalization rules Thin capitalization refers to the situation where a company has a low proportion of shareholder equity relative to its debt liabilities. Put the other way round, the company's gearing, leveraging or debt/equity ratio is high. Most countries allow a tax deduction for interest expenses incurred in conducting a business to derive taxable income, but few allow a deduction for dividend distributions to shareholders. This creates a bias in favour of debt financing over equity financing. Furthermore, in an international tax context, the withholding tax rates levied on interest payments made to nonresidents are generally lower than those imposed on dividend payments to non-residents. This difference augments the bias towards debt financing. [163] Thin capitalization is a particularly attractive international tax planning tool where the country in which the thinly capitalized entity is resident (i) allows a deduction for interest payable on debt obligations, (ii) does not allow a deduction for dividends payable in respect of shareholders' equity, (iii) imposes zero or low withholding tax on interest payments made to non-resident lenders, and (iv) imposes a high rate of withholding tax on dividend payments made to non-resident shareholders. To illustrate, assume that a company that is resident in Lebanon (Company R) has a profitable 100%-owned subsidiary company, which is resident in France (Company S). Company S's equity is EUR 1 million and its taxable profit is EUR 900,000. The French corporate income tax rate is 34.43%. Under the FranceLebanon DTA (1962), dividends and interest paid to a resident of Lebanon are taxable only in Lebanon. The corporate tax rate in Lebanon is 15%. The tax cost of distributing the after-tax profits of Company S to Company R is EUR 398,390, calculated as follows: Tax

EUR EUR Company S

Pre-tax profits 900,000 Less France tax (34.43%) (309,870) 309,870 After-tax profits available fordistribution to Company R 590,130

Company R

Gross dividend income taxable in Lebanon 590,130 Lebanon tax (15%) (88,520) 88,520 After-tax profits of Company R 501,610 Total tax payable 398,390 Effective tax rate 44.27%

Now assume that Company R advances EUR 9 million to Company S at an interest rate of 10%. Interest expenses, which are incurred to derive taxable income, are deductible in France. In the absence of thin capitalization rules, the interest payment eliminates the French tax liability and reduces the overall tax burden by EUR 263,390 (from EUR 398,390 to EUR 135,000, now giving an effective tax rate of only 15% and increases the net after-tax income of Company R to EUR 765,000), as follows: Tax EUR EUR Company S

Net profit before interest and taxes 900,000 Less: interest expense (900,000) Pre-tax profit 0 Less: France tax (34.43%) (0) 0

After-tax profits available for distribution 0

Company R

Interest income taxable in Lebanon 900,000 Lebanon tax (15%) (135,000) 135,000 After-tax profits of Company R 765,000 Total tax payable 135,000 Effective tax rate 15%

The tax cost is borne by the French government. Its tax revenue has fallen from EUR 309,870 to zero. This sort of tax planning illustrates why France and other countries in which foreign controlled companies are located have adopted thin capitalization rules. In essence, thin capitalization rules deny a deduction for interest paid by a resident company to its controlling non-resident shareholders to the extent that the interest relates to excessive debt financing. The excessive amount of interest is often re-characterized as a dividend and taxed accordingly. Whether or not debt financing is excessive is commonly determined objectively by its arithmetic relationship to equity. A typical, but by no means universal, threshold is a 3:1 debt/equity ratio. Alternatively, a subjective arm's length approach may be used to test whether an independent third party would be prepared to lend to a thinly capitalized borrower. Transfer pricing rules In Chapters 10 and 11, we discussed the practice of transfer pricing within multinational enterprises. We saw in those chapters that transfer pricing is a means by which multinational enterprises can reduce their worldwide tax liabilities. Many countries attempt to combat transfer pricing by providing in their domestic law that artificial transfer prices must be substituted by arm's length prices, which would otherwise be adopted by independent third parties entering into similar transactions in similar circumstances. Double tax treaty measures to combat international tax avoidance As well as anti-avoidance provisions in a country's domestic law, DTAs also contain antiavoidance measures. Here, the contracting states agree between themselves that relief offered by the DTA from domestic tax obligations will not apply in certain cases. Of course, these measures vary from DTA to DTA. To some extent, they mirror domestic law provisions. The anti-avoidance provisions in DTAs can be very specific and therefore of very narrow

application, or they can be of very general application. The significant anti-avoidance provisions in DTAs are considered below. Specific anti-abuse provisions Specific anti-abuse rules in DTAs are targeted at special sorts of entities or undertakings, which result in little or no tax being payable in the state of residence of those entities (Country R) under Country R's domestic law; for example, Country R might have a special law that grants tax-free status to certain foreign-owned companies that bring capital into Country R to encourage the development of financial centres there. However, Country S will not want to give tax concessions via the DTA with Country R to anyone from third states that establish the specially designated companies in Country R. In effect, residents of the third state could not only avoid tax otherwise payable to Country S if they invested directly in Country S, but could well pay no tax whatsoever because of the tax-free status of their intermediary investment vehicle in Country R and a zero-tax provision in the Country RCountry S DTA. The LuxembourgNorway DTA (1983) contains a specific anti-abuse provision to counter these types of situations. To deal with so-called Luxembourg 1929 holding companies, which enjoy tax-free status in Luxembourg, Art. 29 of that DTA states that: [t]his Convention shall not apply to holding companies within the meaning of the special Luxembourg legislation (currently the Law of 31 July 1929 and the Grand Ducal Decree of 17 December 1938). Neither shall it apply to income which a resident of Norway derives from such companies nor to shares or other rights in the capital of such companies belonging to such a person. The last sentence is targeted at Norwegian owners of the subject companies who otherwise, under the combined effect of the Luxembourg legislation and the provisions of the DTA, may not pay any tax at all on income derived by the company and redirected to them. Permanent establishment You will recall from Chapter 10 that Art. 7(1) of the OECD model DTA limits the taxation of business profits of a resident of one state (Country R) to that state unless the resident carries on business in the DTA partner's state (Country S) through a permanent establishment there. This requirement is designed to ensure that Country S obtains tax revenue from the product of that activity. Art. 5 of the OECD model DTA defines, and gives examples of, a permanent establishment. A permanent establishment means a fixed place of business through which the business of an enterprise is wholly or partly carried on and includes a place of management, branch, office, factory, workshop, mine, well and quarry, as well as building sites and construction or installation projects which last for more than 12 months. [164] In many cases, it would be relatively easy to circumvent this definition of a permanent establishment by engaging an agent in Country S to carry out the business of the resident of Country R on its behalf. In these circumstances, the resident of Country R would not have a fixed place of business in Country S. Hence, Art. 5(5) of the OECD model DTA extends the

concept of a permanent establishment to counter such tax avoidance use of agents by stipulating that a dependent agent who has, and habitually exercises, an authority to conclude contracts in the name of an enterprise resident in Country R is, in effect, deemed to be a permanent establishment. Furthermore, the Nordic Convention [165] extends the 12-month building site and construction and installation project provision to include assembly projects and planning, supervising, consulting and other auxiliary work activities, which are conducted by personnel connected with a building site, or construction, installation or assembly project. In addition, where two enterprises (Enterprise A and Enterprise B) are connected with the same project, the Nordic Convention also deems that an activity carried on by Enterprise A is carried on by Enterprise B if the activity is substantially similar in character to the activity carried on by Enterprise B. The purpose of this extension of the meaning of a permanent establishment is to ensure that taxpayers do not avoid the 12-month threshold by breaking up a project between associated parties into parts each of which is less than 12 months' duration. Art. 7 of the UN model DTA also contains a force of attraction condition, which is intended to prevent a non-resident that has a permanent establishment in Country S from carrying out transactions, which would otherwise be channelled through the permanent establishment (and therefore be taxable in Country S), through other means in Country S. Such avoidance activities are possible where DTAs are based on the OECD model DTA because income from the transaction would not be attributable to the non-resident's permanent establishment in Country S, as required by Art. 7(1) of the OECD model DTA. However, to counter such avoidance possibilities, the UN model DTA allows Country S to tax as profits of the permanent establishment sales and income from other business activities carried on in Country S that are of the same or a similar kind as those affected through the permanent establishment. Arm's length principle As we have seen under Transfer pricing rules above and in Chapters 10 and 11, the DTA response to transfer pricing by multinational enterprises is in Arts. 7 and 9 of the OECD model DTA. These Articles require the application of arm's length pricing in deterring the allocation of income between different countries with respect to cross-border (i) intra-entity payments for goods and services between a head office and its PEs or between different PEs of the same company (Art. 7), and (ii) intra-group payments for goods and services between different related companies (Art. 9). Beneficial ownership We have seen the standard tax planning technique of treaty shopping by interposing a company between two other companies to obtain a tax advantage. Many DTAs attempt to counter such a structure by requiring that the person who benefits from the tax concession offered by a DTA is the beneficial owner of the privileged receipt. See Chapter 12 for a detailed discussion of the beneficial ownership requirement as an anti-treaty shopping measure. Artiste companies

In Chapter 17 we learned that, to avoid tax in countries where he or she performs (Country S), an entertainer, musician or sportsperson (here referred to generically as an entertainer) often establishes a company in a tax haven or low-tax jurisdiction. These companies contract with impresarios in Country S to provide the personal services of the entertainer. Thus, the artiste company, rather than the entertainer personally, derives the income in respect of the entertainer's performances in Country S. In the absence of a proviso to the contrary, that income is normally not taxed in Country S because the artiste company does not have a permanent establishment or fixed base there and, if the entertainer were an employee of the artiste company (which he or she need not be), the conditions of Art. 15(2) of the OECD model DTA would normally be met to ensure that the entertainer's income from employment, which is exercised in Country S, is not taxable in Country S. Art. 17(2) is therefore an anti-avoidance measure, which is designed to attack such arrangements by providing that income that accrues to a person (which includes a company or other non-human entity) other than the entertainer, in respect of the entertainer's personal activities exercised in Country S may be taxed in Country S. From the practical perspective of ensuring that the tax is actually collected, Country S would normally have some sort of nonresident entertainer withholding tax provision in its domestic law, which requires the local payer of the remuneration to deduct tax at source on payments made for the non-resident's entertainment activities (regardless of to whom the payment is made). US savings clause The US model DTA contains a general provision that allows the United States and its DTA partner to tax their residents and citizens as if the DTA had not come into effect (see Chapter 4). This approach to taxation casts a wider net because US citizens who are not resident in the United States are nevertheless taxable in the United States on their worldwide income. In that context, it is attractive for some non-resident citizens to change their citizenship to avoid their US tax obligations. To counter this, Art. 1(4) of the US model DTA defines the term citizen to include a former citizen or long-term resident whose loss of such status had as one of its principal purposes the avoidance of *United States+ tax Limitation on benefits Most DTAs with the United States contain a limitation on benefits clause, *166+ which is drafted with the aim of denying DTA benefits to residents of one of the contracting states that are merely conduits for residents of a third country. This anti-abuse approach complements the beneficial ownership test. Since it is targeted largely at conduit companies, individuals and government entities usually fall outside its scope. The limitation on benefits approach entails a number of alternative tests to ensure that DTA benefits are extended to only those residents of a contracting state for which the benefits are intended. Each of these tests is outlined briefly below. They are based on the US model DTA, although actual US DTAs seldom follow the model exactly. Look-through approach

The look-through approach pierces the corporate veil by examining the country of residence of the conduit's ultimate shareholders. It is an objective ownership test aimed at excluding conduit companies based on the extent that they are controlled by one or a few foreign owners. Art. 22(2)(c) of the US model DTA stipulates that a company that is resident in Country R qualifies for the DTA's tax concessions if more than 50% of the company's shares are regularly traded on a recognized stock exchange in either Country R or Country S, or at least 50% of the shares of the company in question is owned directly or indirectly by such listed companies. Prima facie, this method appears appropriate for companies that are resident of low- or no-tax jurisdictions. However, the method requires exemptions for bona fide intermediary companies, which undertake legitimate business activities in the DTA partner state, notwithstanding their foreign control, i.e. they are not merely flow through conduit companies. Channel approach This objective approach, which is sometimes also referred to as the base erosion test, denies DTA benefits to a conduit company that is used to channel a substantial part of its income via tax-deductible expenditure to a party that controls it. In other words, the test limits the amount that a conduit company may pay on to non-residents in a tax-deductible form, such as interest or royalties. Art. 22(2)(f) of the US model DTA allows deductions for such expenditure only if: at least 50% of the shares of the conduit company are directly or indirectly owned by individuals, government entities, tax-exempt charities, foundations or employee pension plans, or companies that qualify under the ownership test under the look-through approach above for at least half of the tax year; and less than 50% of the company's gross income is paid or accrued in the form of tax-deductible expenditure directly or indirectly to persons who are not residents of the United States or the DTA partner.

This approach combats stepping stone structures whereby deductible expenses, such as interest, royalties, commissions and service fees are paid by one conduit company to a second company, which is resident in a tax haven or low-tax jurisdiction. Again, a bona fide-type exemption is necessary to ensure that legitimate deductible expenses are not caught under the channel approach. Bona fide or active trade or business test This is a subjective test which allows an intermediary company the benefits of a DTA if it is engaged in the active conduct of a trade or business, the income of which is connected to or incidental to that trade or business (cf. a company that is the mere recipient of passive income), and the trade or business is substantial in relation to the activity in Country S, which

generates the income. [167] Quintessentially, the company must show that its principal purpose, business conduct and asset holdings, which produce the income that benefits from the DTA concessions, are motivated by sound business reasons and not tax avoidance. For these purposes, the business of making or managing investments is not regarded as an active trade or business (unless the activity is a banking, insurance or securities activity that is conducted by a bank, insurance company or registered securities dealer). [168] Exclusion approach This approach refuses DTA benefits to tax-exempt companies or companies that enjoy significant tax privileges in their country of residence. In this sense, such companies are excluded from the scope of the DTA. Subject-to-tax approach This rule requires that companies that obtain DTA benefits in Country S must be subject to tax in Country R on the income in respect of which the DTA concessions are granted. This approach is intended to make sure that the objective of DTAs (viz. to ensure that cross-border income is not subject to juridical double taxation) is achieved, and not that such income is not taxed at all. Of course, a determination must be made here by the DTA partners of the extent to which a company is taxable in Country S to qualify as subject to tax there, particularly when Country S offers tax concessions. Competent authority approval This subjective provision is a last chance option, which allows a company to obtain the benefits under a DTA if the competent authority of the state from which the benefits are claimed permits it. [169] Limitation on benefits clauses are inherently complex. They require extensive definitions. With respect to the provisions cited above, Art. 22 of the US model DTA goes on to define a recognized stock exchange; qualified government entity; [170] substantiality of the trade or business (by reference to facts and circumstances, or the proportional share of the resident's interest in the company's asset values, gross income and payroll expense that are devoted to the trading or business activity); connectivity of income with the trade or business; and incidentality of income with the trade or business. Harmful tax competition To a large extent, international tax avoidance is achieved by channelling income through tax havens. Tax havens are: countries which are able to finance their public services with no or nominal income taxes and that offer themselves as places to be used by non-residents to escape tax in their country of residence. In addition to these features the OECD has identified the following typical confirming features of a tax haven: (i) lack of effective exchange of information, (ii) lack of transparency, and (iii) no requirement for substantial activities.

The term may also be used loosely to describe countries which raise significant revenues from their income tax but whose tax system offers preferential tax features in order to attract investment from other countries. [171] The tenor of this definition conveys a sort of social stigma attaching to tax havens. For countries that do rely (heavily) on income tax to finance public expenditure, tax havens cause harmful tax competition. Harmful tax competition can also refer to countries using incentives in their tax systems to compete with each other to attract economic activity into their country and, thereby, increase their tax revenue. Tax competition has become increasingly prevalent as a consequence of the deregulation and globalization of business alongside the technological revolution of the past decade. The harmful effect of such competition between countries is that capital and resources are diverted away from their most efficient pre-tax allocation, and tax revenue is redistributed between countries in favour of those that offer the preferential regimes. Thus, countries that condone and facilitate tax avoidance by offering special tax regimes or incentives are said to cause harmful tax competition in that they undermine real economic efficiency by distorting the location of business and trade, and erode the tax bases of other (higher tax) countries. These tax preferences often encourage tax avoidance and undermine the global integrity and fairness of taxing international transactions. In this sense, they are regarded as harmful. [172] To counter this so-called race to the bottom, the OECD has embarked upon initiatives that try to eliminate harmful tax competition. Its 1988 OECD report on international tax avoidance and evasion [173] was the first comprehensive and authoritative inter-governmental pronouncement of distain about the abuse of tax treaties. More recently, there has been an increased drive from international bodies (particularly, the OECD and the European Union) and the United States to bring about greater condemnation of cross-border tax avoidance. In 1997, the Economic Affairs and Finance Ministers (ECOFIN) Council of the European Union adopted a Code of Conduct on Business Taxation. [174] The Code addresses business taxation measures that affect in a significant way the location of business activities within the EU Member States. Five criteria determine whether such measures are to be regarded as harmful, viz. a Member State: (1) offers tax advantages only to non-residents or only in relation to transactions undertaken with non-residents; (2) offers tax advantages that are outside its domestic market, so that they do not affect the state's national tax base, e.g. by excluding enterprises that take advantage of the beneficial tax regime from operating in a country's domestic market; (3) offers tax advantages in the absence of any real economic activity or where the taxpayer does not have any substantial economic presence in the state; (4) departs from internationally accepted principles of calculating the profits of a multinational enterprise's activities within the state, e.g. non-application of the OECD transfer pricing guidelines; and

(5) adopts tax measures that lack transparency, e.g. where the application of the tax law is relaxed in individual cases in a non-transparent way.

The Code requires Member States (i) not to introduce new tax measures that are harmful, and (ii) to re-examine existing laws and practices taking into account the principles underlying the code and to make any appropriate adjustments to their laws and practices. In 1998, the OECD Committee on Fiscal Affairs examined harmful tax competition in relation to finance and other service activities, which are highly geographically mobile, cf. more traditional industrial and trading activities. [175] The report identifies harmful tax competition using the criteria adopted by the EU Code of Conduct, but also adds: the lack of effective exchange of information; an artificial definition of the tax base, e.g. narrowing the tax base by allowing deductions for deemed expenses that are not actually incurred; tax exemptions in some residence states for foreign sourced income, i.e. a territorial system of taxation; the negotiability of tax rates or the base that is subject to tax; secrecy provisions; accessibility to a wide DTA network that includes DTAs that contain inadequate anti-abuse provisions; the promotion of a regime as a means of tax minimization; and the encouragement of purely tax-driven operations and arrangements.

The OECD report has a long list of recommendations covering strengthening domestic antiavoidance legislation and practices, and tax treaty measures. These include: the cancellation of harmful tax incentive schemes; implementing broader controlled foreign company rules and their extension to foreign investment funds; restrictions on participation exemptions and foreign sourced income exemptions, which are available to taxpayers who derive income from tax havens or preferential tax regimes; implementing foreign transaction reporting rules; introducing transparent advance ruling practices; adherence to the OECD's transfer pricing guidelines;

 allowing access to banking information for tax assessment purposes; employing more extensive exchange of information procedures (including the OECD Multilateral Convention for Mutual Assistance in Tax Matters); [176] better use of restrictions on entitlement to treaty benefits; amendments to the OECD commentary to clarify the compatibility of domestic anti-abuse measures with the OECD model DTA; the termination, and future avoidance, of tax treaties with tax haven countries; coordination of enforcement regimes, e.g. joint audits and training programmes; and tax recovery assistance.

In addition, the Committee proposed that the OECD: establish a forum on harmful tax competition to develop and promote principles for the implementation of the Committee's recommendations and to implement guidelines on how to deal with harmful preferential tax regimes; compile a list of unacceptable tax havens; get countries with links to tax havens as dependencies to ensure that they do not encourage harmful tax competition; develop and promote principles of good tax administration; and promote the Committee's recommendations in non-member countries.

It should be noted that the OECD report was not unanimously endorsed by all of its members. In particular, Luxembourg and Switzerland objected on the grounds that, inter alia: by excluding industrial and commercial activities and restricting the anti-abuse measures to financial activities (which are significant activities of both countries' economies), the OECD approach is partial and unbalanced; the recommendations do not respect the bank secrecy, which is not necessarily a source of harmful tax competition; and the Report did not accept the model of co-existence, wherein withholding taxes constitute an alternative to exchange of information.

Even more recently, the OECD has released a report on the identification and elimination of harmful tax practices. *177+ The OECD Forum essentially used shaming tactics to identify

cases of potentially harmful tax competition in the OECD member states and in 35 tax haven jurisdictions. After modification in 2001, which emphasized fiscal transparency and exchange of information, the Forum's guidelines required that harmful preferential tax regimes end by April 2003 (although a limited grandfathering provision extended that date to the end of 2005). Tax havens were required to eliminate by 2006 those tax practices that result in a lack of transparency and interfere with a proper and effective exchange of information. At the end of July 2007, only three countries (Andorra, Liechtenstein and Monaco) remained on the OECD's list of uncooperative tax havens. The other countries, which were initially identified as uncooperative tax havens, have made commitments to implement programmes to improve their transparencies, and to establish effective exchange of information mechanisms in tax matters. The success of the OECD measures will depend upon the extent to which member countries with harmful preferential tax regimes comply in practice with the OECD's requirements and the extent to which both member and non-member states cooperate with any sanctions that may ultimately be imposed for non-compliance. Conclusion This chapter has provided you with an overview of some legal structures commonly adopted by, primarily, multinational entities to avoid tax on international transactions. It has illustrated the use of conduit companies and base companies in treaty shopping activities designed to leave profits in entities resident in low- or zero-tax jurisdictions and thereby reduce the multinational company's total tax on its global profits. We considered the means by which DTAs, in particular, are used to counter such tax avoidance schemes in an international context. Those measures included, inter alia, the use of Art. 9 (Associated enterprises) of the OECD model DTA to combat transfer pricing arrangements, the expanded definition of permanent establishment in Art. 5(5) of the OECD model DTA, the force of attraction rule in Art. 7 of the UN model DTA, the beneficial ownership requirements in Arts. 10, 11 and 12 of the OECD model DTA, the capturing of artiste companies in Art. 17(2) of the OECD model DTA and the extensive limitation on benefits rules provided in Art. 22 of the US model DTA. We concluded with a comment about international cooperation measures designed to combat harmful tax competition undertaken by some countries to the detriment of the tax bases of other countries. The key concepts introduced in this chapter were: international tax avoidance; conduit company; base company;

 hybrid entities; treaty shopping; abuse of law; substance and form; GAAR; controlled foreign company; thin capitalization; limitation of benefits; and harmful tax competition.

Review questions and case studies 1. A company (not being a bank), which is a resident of Hong Kong, wishes to make a loan at the prevailing market rate of interest to an unrelated manufacturing company in Venezuela. Based on the following assumptions, how should the loan arrangement be structured to minimize withholding taxes deducted at source? Which country loses out on tax it would otherwise collect in the absence of this arrangement? (a) The Venezuelan domestic withholding tax rate on interest sourced in Venezuela and paid to non-residents is 32.3%. (b) Hong Kong has DTAs with Belgium and Thailand, where the relevant source state tax on interest payments is limited to 10%. (c) Venezuela has a DTA with Belgium under which the source state tax on interest payments is limited to 10%. (d) Under Dutch domestic law no withholding tax is imposed on interest payments arising in the Netherlands and made to non-residents of the Netherlands. (e) Spain has a DTA with Venezuela under which the source state tax on interest payments is limited to 10%. (f) The Hong Kong company has subsidiary companies resident in Belgium, the Netherlands, Spain and Thailand. (g) The EU Interest and Royalties Directive prohibits a Member State from which interest is paid to a resident of another Member State from imposing tax on the interest payment. (h) Venezuela has a DTA with the Netherlands under which the source state tax on interest payments is limited to 5%.

2. Kaas Corporation NV (Kaasco), a company resident in Belgium, faces a corporate tax rate of 27%. It wholly owns an operating subsidiary company (Jinjaco), which is resident in Uganda. Kaasco acquires tobacco with a market value of UGS 800 million from Jinjaco for only UGS 400 million. (a) What is the tax saving that arises from this transaction? (b) What country bears the loss of tax revenue? (c) Should the transaction be challenged? If so, what is the authority for doing so? (d) What are the effects (if any) on Jinjaco of a successful challenge? (e) What are the effects (if any) on Kaasco of a successful challenge? (f) Are your answers to (a)(e) different if the transaction was the other way around, i.e. Jinjaco acquired the goods from Kaasco?

3. Assume that Muscat Ltd, a company resident in Oman, has a profitable subsidiary, a 100% owned manufacturing company, which is resident in Zambia (Subco). Subco's equity on 1 January 2007 is ZMK 200 million. All of Subco's after-tax profits are repatriated to Oman. Assume that the applicable rate of corporate income tax in Oman is 12%. The rate of corporate income tax in Zambia is 35%. Subco accurately estimates that its taxable profit for the 2007 year of income will be ZMK 180 million. To avoid Zambian income tax on this estimated profit, on 15 December 2007 Muscat Ltd advances ZMK 900 million to Subco for 1 year at an interest rate of 20% p.a. Subco must pay all of the annual interest up-front, i.e. on the day that the loan is granted to it. (a) What are the tax effects of the granting of the loan by Muscat Ltd to Subco? (b) Can the Zambian tax authority challenge this arrangement? If so, on what ground(s)? (c) Would your answer be any different if Subco's equity on 1 January 2007 was ZMK 500 million and the thin capitalization safe harbour debt/equity ratio under Zambia's domestic tax legislation is 2:1?

4. Jean-Paul Jasper (JPJ) acquired shares of Mineral Resources Ltd. (MR), a Canadian public company. The shares were transferred to Cayman Inc. (CIC), a newly incorporated Cayman Islands company, wholly owned by JPJ. MR discovered a major deposit of nickel, copper and cobalt in Canada, in which several mining companies were interested. As a result, MR's share price increased substantially. In 2006, CIC exchanged the shares in MR for shares in BR Limited (BRL), leaving CIC holding less than 10% of the share capital of MR. CIC sold some of its BRL shares, realizing a gain of

approximately CAD 100 million to fund its new mining operations in Africa. CIC then changed its residence to Luxembourg, which was allegedly a preferable jurisdiction from which to conduct its mining business in Africa. In 2007, BRL offered to purchase all the shares of MR, which was approved by the MR shareholders. CIC made a capital gain of CAD 500 million on the sale of the rest of its MR shares. CIC claimed an exemption from Canadian tax on the resulting capital gain of CAD 500 million under Art. 13 of the CanadaLuxembourg DTA (1999). In terms of that DTA: (a) Is the CAD 100 million gain made by CIC in 2006 exempt from tax in Canada and Luxembourg? (b) Is CIC exempt from Canadian income tax in respect of the capital gain of CAD 500 million arising on the sale of its shares in MR? Can the Canadian tax authority tax the capital gain on the grounds that CIC engaged in tax avoidance?

5. Hans Andersen is a Danish resident trading in textiles, which he buys in China and sells in Western Europe and the United States. Until 2002, he carried on business as a sole trader. In 2002 he incorporated a limited liability company in Switzerland for his trading activities. He owned the entire share capital of the Swiss company until 2005 when he sold one third of the capital to a Chinese national, who is a tax resident of the United States. Hans is employed by the Swiss company and, in practice, carried on business as he did before the creation of the Swiss company, negotiating with suppliers and customers and travelling 6 months each year on business. The textiles he buys in China are usually sent by the supplier to the buyer directly, while the invoice of the supplier is sent to the Swiss company. Then the Swiss company makes out an invoice for the buyer, which includes the company's commission. The company does not have its own office in Switzerland, but it uses the service of another Swiss company, which offered office help. Accounting, auditing and other administrative activities are carried out by a Swiss auditing company. The Swiss company processes around 30 invoices each month. The Danish tax authority contends that Hans is liable to taxation in Denmark on the company's profit, calculated by reference to Hans's activities. It considers that there is no autonomous place of business or staff in Switzerland, besides the office help provided by the other Swiss company. In addition, the tax authority asserts that there is no link to Switzerland as there is no trade with Swiss customers. The tax authority therefore does not see any entrepreneurial reasons for incorporating the Swiss company, but only fiscal ones, viz. to avoid Danish income tax. Hans argues that the Swiss company is not a mere letterbox company. He admits that the invoicing business requires little activity, but this is no reason to disregard the Swiss company, which in reality exists. Are the profits of the Swiss company subject to Danish tax in Hans's hands?

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153. Ward, D.A., Abuse of tax treaties, in Alpert, H.H. and K. van Raad, Essays on International Taxation, Series on International Taxation, No. 15, Deventer/Boston: Kluwer, 1993, p. 397. 154. See also the example under Beneficial ownership in Chapter 12. 155. Larking, B. (ed.), International Tax Glossary, Amsterdam: International Bureau of Fiscal Documentation, 2001, 4th ed., p. 367. 156. Id., p. 181. Sometimes a distinction is made between a regular hybrid (described above) and a reverse hybrid. A reverse hybrid means simply that, from the perspective of one jurisdiction, the entity is non-transparent, while from the perspective of the other jurisdiction, it is transparent, i.e. a reverse hybrid is the mirror image of a regular hybrid. Which type of hybrid the entity is therefore depends on whether the classification is being made from the viewpoint of the jurisdiction treating the entity as transparent (a regular hybrid) or nontransparent (a reverse hybrid); ibid, pp. 181-182. 157. Such entities are sometimes referred to as pass-though or flow-through entities. 158. Larking, B. (ed.), International Tax Glossary, Amsterdam: International Bureau of Fiscal Documentation, 2001, 4th ed., p. 182. 159. Civil law jurisdictions are countries where the law is based primarily on statutory principles, rather than on precedence based judicial decisions. Civil law codes are generally derived from the Napoleonic Code of 1804 and are applied in most European and Latin American countries. 160. Since 1987, the Dutch general anti-avoidance provision has been rendered nugatory by a ministerial decree because the fraus legis judicial doctrine is considered quite adequate to deal with tax avoidance arrangements: see Vanistendael, F., Judicial interpretation and the role of anti-abuse provisions in tax law, in Cooper, G. S., Tax Avoidance and the Rule of Law, Amsterdam: International Bureau of Fiscal Documentation, 1997, pp. 131, 139. 161. OECD Committee on Fiscal Affairs, Issues in International Taxation No. 1: International Tax Avoidance and Evasion Four Related Studies, Paris: OECD, 1987, p. 30. 162. The condition in Art. 15(2)(b) of the KuwaitPoland DTA (1996) (which would otherwise deny Poland the right to tax the PLN 100,000 at all) is not met because the remuneration is paid by a company that is a resident of Poland. 163. The difference may be mitigated if the recipient's country of residence fully or partially exempts dividend receipts from income tax.

164. See Chapter 9. 165. Convention Between the Nordic Countries for the Avoidance of Double Taxation with Respect to Taxes on Income and on Capital (1996). This is a multilateral DTA, which was signed by Denmark, the Faroe Islands, Finland, Iceland, Norway and Sweden; see Chapter 3. 166. Hungary currently being a notable exception for practical tax planning purposes. 167. Art. 22(3)(a) US model DTA. 168. Art. 22(3)(b) US model DTA. 169. Art. 22(4) US model DTA. 170. Defined in Art. 3 (General definitions). 171. Larking, B. (ed.), International Tax Glossary, Amsterdam: International Bureau of Fiscal Documentation, 2001, 4th ed., p. 347. 172. An alternative view is that measures to counter harmful tax competition assist in maintaining the level of taxes in countries that need high rates to support inherent structural economic and public sector inefficiencies. 173. OECD Committee on Fiscal Affairs, Issues in International Taxation No. 1: International Tax Avoidance and Evasion Four Related Studies, Paris: OECD, 1987. 174. Resolution of the Council and Representatives of the Governments of the Member States, meeting with the Council of 1 December 1997 on a Code of Conduct for Business Taxation in Conclusions of the ECOFIN Council Meeting on 1 December 1997 concerning Tax Policy, Annex 1, Official Journal, C 002, 6 January 1998, p. 1. 175. OECD Committee on Fiscal Affairs, Harmful Tax Competition: an Emerging Global Issue, Paris: OECD, 1998. 176. See under Exchange of information in Chapter 20. 177. OECD, Towards Global Tax Co-operation: Progress in Identifying and Eliminating Harmful Tax Practices, Paris: OECD, 2000. Citation: K. Holmes, International Tax Policy and Double Tax Treaties, Online Books IBFD (accessed 22 Oct. 2012).

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