Treaty shopping and the OECD Model Tax C
1
ROBERT GORDON UNIVERSITY
Dept. of law
BSM151 - Full Time: Comparative International Tax Law
CITL Coursework 2013
Scotia a small oil & gas producing state, has a number of DTR Conventions which follow the form
of the OECD Model. Its convention with its neighbor Anglia is particularly advantageous reflecting
the good relationship with this neighboring state. However Scotia has become concerned about the
way some individuals and corporations from beyond its boundaries are using its convention with
Anglia.
Despite heavy flows of money through the treaty route, there appears to be little advantage to either
Scotia or Anglia.
1. Consider why this might be the situation.
2. Discuss the formal steps and legal techniques Scotia might take, to reduce what it sees as
an abuse of its treaty network using specific examples from the international experience,
current and past.
3. What particular issues might be relevant to the situation in relation to UKCS and oil & gas
production.
Words:5623
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“When there is an income tax, the just man will pay more and the unjust less on the same
amount of income.” Plato
This essay tries to summarize and analyze the issues of treaty shopping, which is one of the
major problems that countries face today while trying to save their volatile budgets1. It is
being suggested that the imaginable (but very realistic) Scotia and Anglia may have to
accept different approaches to tackle the problem, none of these approaches sufficient
alone to solve the problem. In the last part of this essay a similar issue about the unstable
amount of revenue coming from the UKCS is observed. The whole European fiscal system
is jeopardised today and scholars are ‘called to arms’ to invent new and reintroduce old
solutions for these tough problems.
1. The purpose of a tax treaty
Nowadays people and corporations operate more globally than ever before. This fact
brings real challenges to modern revenue authorities in order for each country to tax the
persons (where ‘persons’ is defined as individuals, companies or other entities) generating
income (or corporate profits), both, home and abroad. Reasonable and economically
justified taxation means not being taxed twice on the same income (corporate profits). The
legal mechanism used to avoid this undesirable effect of person's international economic
activity is finding a compromise between countries by negotiating a bilateral or more
rarely multilateral tax treaties 2 which are governed by public international law (usually the
rules of the Vienna Convention on the Law of Treaties apply). 3 The balance between
stimulating higher economic activity and granting fair taxation is hard to be achieved. The
main purpose of an international double tax treaty is not only to protect the governments'
taxing rights and to protect against attempts to avoid or evade tax liability. It is also the
1
This essay is written in the times of the EU budget crisis, one of the most current developments of which
was the outburst of the "Offshore-leaks" scandal in the media, which recently lead to resignation of the
French finance minister, followed by the call for "eradication of tax havens by governments" of the French
President Fr. Hollande, echoed by the BBC http://www.bbc.co.uk/news/world-europe-22094194
2
There are more than 2,500 Double Taxation Treaties world-wide and the UK has the largest network of
treaties, covering over 100 countries. The UK seeks to encourage and maintain an international consensus on
cross-border economic activity and to promote international trade. To this end the UK plays an important role
in the Organisation for Economic Co-operation and Development (OECD)
http://www.hmrc.gov.uk/taxtreaties/dta.htm
3
W Craig, ‘Taxation Theory and the UK System’, Revenue Law Essentials (2nd ed., Dundee University
Press, Dundee 2010)
3
legal tool for contracting the ways for avoiding, or at least minimizing as much as possible,
double taxation by using some of the known and approved methods - tax exemption, tax
credit or tax deduction4. In order for the international trade to be stimulated, a good tax
treaty is meant to remove this major obstacle for exchanging goods and services across
different countries5.
International taxation rules are developed on a global scale primarily by international
organizations such as UN, EU, the IMF and the OECD. The important role of taxation for
the economy is a constant theme on the political programs of governments after the
outbreak of the Global Financial Crisis in 2008 and the following Public Debt Crisis in
Europe which still continues full steam6. Amending and adjusting the revenue system has
become a more frequent practice for countries searching for adequate reaction to the new
challenging occidental fiscal reality.
2. The OECD Model Convention in general
The OECD Model7 and the UN Model8 Conventions are the most powerful legal tools in
the hands of the governments to create, improve and uniform tax treaties. For most of the
developed countries, and we assume that Scotia and Anglia are also such countries, the
OECD Model is a strong base for drawing up tax treaties. The UN Model, on the other
hand, is designed to serve the same purpose for the similar needs of developing countries.
Every such model treaty, though, shall be enriched with each county's specific legal tax
characteristics to acquire its final appearance.
The OECD Model and its in-depth ‘article-by-article’ Commentary designed for ‘precise
interpretation’ purposes inspire almost all tax treaties among developed counties except the
US, that uses a different, but in the same time very similar to the OECD Model convention
(the US Model Tax Convention). The usage of the OECD Model is preferred
internationally for a couple of reasons:
A Miller and L Oats, ‘5.3 The Double Tax Problem’, Principles of international Taxation, (3rd edition,
Bloomsbury Professional Ltd., Haywards Heath 2012).
Tax deduction is a method which excludes any foreign taxes paid from the tax base in the country or
residence; Tax exemption is a method of non taxation of income derived from another country; Tax credit is
method by which the income is first taxed in full in the home country and than the income tax paid abroad is
deducted.
5
RL Doerberg, Overriding tax treaties: The U.S. Perspective, (9 Emory Int'l L. Rev. 71 1995)
6
e.g. the current Cyprus' talks with the EU, ECB and IMF aimed at securing another bailout for Cyprus after
the bailouts for Greece, Spain, Ireland and Italy.
7
OECD Model Convention on the Prevention of Double Taxation
8
United Nations Model Double Taxation Convention Between Developed and Developing Countries
4
4
the interpretation of the Model is well-established in its Commentary and
respectively clear of vagueness;
it includes main parameters of financial reasoning in a tax treaty as well as general
legal framework, established by leading world experts and further updated and
developed since 1963;
it brings predictability for international businesses and individuals of how ‘double
taxation’ is treated and understood in every different country they operate.
The main feature of the OECD model is the fact that is brings a high level of certainty in
terms of a country's legal tax order to companies and individuals, which aids and
stimulates trade across national boundaries. If two jurisdictions use a DTR Convention
based on the OECD Model, than a person who resides in one of them will have a certain
lucidity of what to expect in terms of local revenue requirements in case he/she decides to
settle down in the other jurisdiction. Not only are the main principles of ‘avoidance of
double taxation’ going to be generally comprehensible for any such person, but also their
interpretation. The possibility for relief of 'double taxation', in hypotheses not envisaged by
the treaty by contacting the two tax authorities involved, to find a common solution,
represents another strong argument for using the OECD Model.9
3. The problem of ‘treaty shopping’
Regardless of all positive features of the OECD Model it still has not found a perfect
solution for all double taxation problems. The fact that we have two neighbouring
countries which have concluded a particularly advantageous DTR convention based on the
OECD Model reflecting the good relationship between them does not mean that there is
not a ‘dark side of the Moon’. Good relationships may attract attention, greed and envy. In
terms of international taxation this 'dark side of the Moon' for a good DTR Convention is
called ‘treaty shopping’.
The term ‘treaty shopping’ originates from the US legal doctrine. It derives from another
term - ‘forum shopping’ which indicates a situation in which a litigant may search for a
more convenient jurisdiction for his case to be judged with a view to a possibility for a
A Miller and L Oats, ‘7.13 Double Tax Treaties’, Principles of international Taxation, (3rd edition,
Bloomsbury Professional Ltd., Haywards Heath 2012)
9
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more advantageous decision. 10 A short description of the term ‘treaty shopping’ has been
given by Rosenbloom, 11 who states that it represents “the practice of some investors of
‘borrowing’ a tax treaty by forming an entity (usually a corporation) in a country having a
favourable tax treaty with the country of source – that is, the country where the investment
is to be made and the income in question is to be earned”12. In short, it is the situation of
being ‘shopped’ by a person for a convenient tax treaty to benefit from its provisions,
either by establishment of a corporate entity or using an existent one, and usually
accompanied by application of different sophisticated schemes to reduce or fully avoid
taxation. Tax treaties are designed to only benefit persons who reside in a country which is
a party to the treaty. That is why, according to the OECD, treaty shopping is an undesirable
phenomenon which is subject to strong efforts for prevention by the tax authorities of each
of the countries affected. 13
As a totally opposite view, the (1988) UN Treaty Shopping Report promotes the idea that
in some instances treaty shopping may even be beneficial. Many underdeveloped states try
to attract investments by introduction of taxation based on low or no withholding taxes on
income even in case that the beneficial owner is based in another country. This is why
treaty shopping may be considered as a normal practice in such jurisdictions. The UN
report further explains that, if the main idea behind a tax treaty is to introduce “freer flows
of international trade and investment, it may be generally arguable that it does not matter if
the desirable result is achieved by the direct use of tax treaties or by their indirect use” 14
(e.g. treaty shopping). For many developing states treaty shopping might be regarded as an
opportunity to draw investments. As an example for this position, in the case Union of
India v. Azadi Bachao Andolan, the Supreme Court of India has held that treaty shopping
is "a necessary evil in a developing economy" and in general is a tolerable practice under
the Indian tax treaty network.15 Nevertheless, in the long term, treaty shopping is generally
10
H Becker and F Würm, Treaty Shopping: An Emerging Tax Issue and its Present Status in
Various Countries (Kluwer, Deventer 1988)
11
Mr. David Rosenbloom used to serve as an international tax advisor at the US Treasury Dept. (1977-1981)
12
HD Rosenbloom, Derivative Benefits: Emerging US Treaty Policy, (Essays on International Taxation,
Kluwer, Deventer 1993)
13
Reuven S Avi-Yonah and Christiana H Panayi, Rethinking treaty-shopping lessons for the European union,
(2010) Public Law and legal theory working paper series Working Paper No. 182
14
UN, Department of International Economic and Social Affairs, Contributions to International Cooperation in Tax Matters: Treaty Shopping, Thin Capitalization, Cooperation between Tax Authorities,
Resolving International Tax Disputes (UN: New York, 1988), at 7.
15
Union of India v. Azadi Bachao Andolan, [2003] 6 ITLR 233. It is interesting that the Chinese position is
fully opposite - it says that treaty shopping is a totally unacceptable practise and represents a tax treaty abuse.
For further comments, see Yang, H., “New Developments in the General Anti-Abuse Rules and the Impact
on International Tax Planning” Asia-Pacific Tax Bulletin (May/June 2009) p. 176.
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believed to have more negative than positive effects on a country's economy and as a
‘plague’ to be dealt with.16
The term ‘treaty shopping’ does not appear by direct reference in the OECD Model and its
description and legal interpretation is not directly and widely discussed in the OECD
Model Commentary. Even though, it might be said that the OECD Model addresses the
problem of ‘treaty shopping’ indirectly - by searching to eliminate its effects through
applying specific provisions for its prevention and by defining the purpose of the tax
treaties as “…is to promote, by eliminating international double taxation, exchanges of
goods and services, and the movement of capital and persons. It is also a purpose of tax
conventions to prevent tax avoidance and evasion.” 17. An example for such and other
indirect reference would be the Commentary on Article 1 which concerns the possible
application of the limitation-of-benefits (LOB) clauses which are meant to tackle the issue
of treaty shopping in a ‘comprehensive way’. 18
3.1. General forms of treaty shopping
There are multiple forms of treaty shopping, but the main two may be defined as these
identified inexplicitly under Para 9, Para 11 and Para 20 of Article 1 of the OECD
Commentary as such (1) including usage of conduit legal entities and/or base companies
19
and (2) such not including usage of conduit structures and tax havens. 20
Treaty shopping through usage of conduit legal entities, though, is the most frequent type
of abuse and therefore the most fundamental form of treaty shopping 21 which is why this
short essay will be concentrated only on that certain ‘conduit’ type of treaty shopping and
its prevention.
16
Jinyan Li, Beneficial ownership in tax treaties, (University of York, Osgoode Law School, Research paper
series, 4/2012)
17
(2010) OECD Commentary to Article 1, paragraph 7
18
(2010) OECD Commentary to Article 1, paragraph 20
19
Simone M. Haug, The United States Policy of Stringent Anti-Treaty-Shopping Provisions: A Comparative
Analysis, (1996, Vand. J. Transnat'l L., p. 191): ‘A base company is a company through which certain
activities are carried out on behalf of related companies in high-tax countries. A base company seeks to
minimize tax in the country of residence-the country in which the investor actually resides, while the main
function of the conduit company is to serve as a pass-through entity that redistributes the income it receives
from a related company in one country to its shareholders in another country.’
20
Christiana H. J. I. Panayi, ‘Chapter 2: Tax treaties and treaty shopping’, Double Taxation, Tax Treaties,
Treaty Shopping and the European Community, (Wolters Kluwer Law & Business, 2007) Such treaty
shopping without conduit as described in the OECD Commentary would be e.g. ’an individual who has in a
Contracting State both his permanent home and all his economic interests, including a substantial
shareholding in a company of that State, and who, essentially in order to sell the shares and escape taxation in
that State on the capital gains from the alienation (by virtue of paragraph 5 of Article 13), transfers his
permanent home to the other Contracting State, where such gains are subject to little or no tax.’
21
Ibid.
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Regardless of the fact that treaty shopping may encompass a huge spectrum of ‘conduit’
structures, two main forms of treaty shopping through such ‘conduit’ legal entities might
be observed according to the (2010) OECD Commentary - these are two general recipes
that a person who is a resident in one jurisdiction could use in order to benefits from tax
treaty arrangements between two other jurisdictions. The forms are being identified by the
legal doctrine as: (1) the method of direct conduit structure and (2) the method of the
stepping stone conduit structure.
The method of direct conduit structure is based on establishing a legal entity in a
jurisdiction to take advantage of its beneficial DTR Convention with another country. A
basic example (provided that there are multiple different scenarios existing) might be
described as follows: jurisdictions X and Y (just like Scotia and Anglia) have concluded an
advantageous DTR Convention which guarantees individuals and legal entities established
in their tax legal systems with preferential tax treatment of minimal or no levy on income
(or corporate profits) gained in the other tax jurisdiction. A company incorporated in
jurisdiction Z (let’s say a tax haven jurisdiction) wants to invest substantial amount in
jurisdiction X and expects to gain profits which should be levied with an extortionate 30%
of withholding tax, because it does not have a DTR Convention with jurisdiction X. In the
same time jurisdiction Z has an advantageous tax treaty with jurisdiction Y. So, in order to
avoid the 30 % withholding tax the company resident of jurisdiction Z establishes a branch
(a ‘conduit’ entity) in jurisdiction Y. This ‘conduit’ entity is treated as a resident in
jurisdiction Y according to the tax treaty between X and Y which is why the investment in
jurisdiction X could be made through it. In order for the parent company in jurisdiction Z
to be able to benefit from that situation, the income derived from the ‘conduit’ legal entity
in jurisdiction Y shall either be fully exempt of taxation according to the other tax treaty
between Y and Z (more improbable) or simply according to the national laws of Y which
may provide a low or zero rate of withholding tax on profits gained by a branch of a
foreign company. In that case the ‘conduit’ entity established in jurisdiction Y will be
entitled to be allocated a full tax exemption or at least tax optimized net profit to its parent
company in jurisdiction Z which, in that way, gains substantial benefits from the X - Y tax
treaty. 22
A Miller and L Oats, ‘16.1 Treaty shopping’, Principles of international Taxation, (3rd edition,
Bloomsbury Professional Ltd., Haywards Heath 2012)
22
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The method of the stepping stone conduit structure is similar to the method of direct
conduit, but while the latter uses a tax exemption in the connecting jurisdiction, the former
reduces the tax due in that jurisdiction by counterbalancing the expenses. The difference
between both methods may be defined using the following basic example: A legal entity in
jurisdiction X, a high-tax jurisdiction is a subject to full high taxation on its corporate
profits derived in jurisdiction Y. In the same time jurisdiction Y allows deductions on
corporate expense and the company decides to balance its total net corporate profit by
making substantial ‘ostensible’ expenses to a connected legal entity in a third low tax
jurisdiction (let’s say jurisdiction Z). In that way the corporate profits gained in jurisdiction
X are transmitted to jurisdiction Z fully free or substantially reduced of taxation, because
of the advantageous DTR Convention between the high tax jurisdictions, X and Y, and the
tax base balancing performed through the conduit legal entity in jurisdiction Y”.23
A corporation that uses the method of stepping stone benefits, because: “(1) the
stepping stone company can deduct all of its expenses against its receipts; (2) the stepping
stone country does not impose a significant withholding tax on the outbound payments;
and (3) the stepping stone company's receipts must be received free of host-country
withholding tax (or subject to significantly reduced withholding tax) by virtue of an
existing tax treaty.” 24
There are many more complex variations of treaty shopping structures including some
which take advantage of both ‘direct’ and ’stepping stone’ conduit methods in order for
funds to be transferred fully free of taxation or taxation optimized between multiple
‘channel’ jurisdictions. In the process different ‘conduit’ companies may be created (e.g.
holding companies, subsidiaries, etc.) 25 The income which is a subject to treaty shopping
may take many different forms during the transfers (e.g. corporate profit, dividend,
interest, etc.). That is why Anglia and Scotia may wish to carefully plan, examine and
decide on the possible methods for prevention of treaty shopping according to the specific
situation they are facing.
23
Opt. Cit. Simone M. Haug, page 205
Ibid.
25
Ibid.
24
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3.2. Methods for prevention of treaty shopping
There are two global approaches that can be used by countries in the situation of Anglia
and Scotia to tackle treaty shopping: (1) the US limitation of benefits 26 approach (which
basically introduces specific anti-treaty shopping provisions in each DTR Convention
concluded) and (2) the OECD Model approach (which firstly encouraged mainly
introduction of domestic anti-treaty shopping tax legislation and more recently also
included anti-treaty shopping provisions in its Model convention) 27 - an example for a
more recent attempt for establishing national rules is the UK HMRC's proposal of
introduction of a special domestic legislation chapter to the UK Finance Act 2012
dedicated to ’Tax Treaties Anti Avoidance’ generally based on denial of treaty benefits in
case of a scheme directly or indirectly constructed for the purposes of gaining treaty
benefits. This reasonable UK HMRC proposal though has not been adopted yet into a valid
UK legislation and remains inactivated. 28
The first treaty shopping prevention methods are as old as the 1977 OECD Model, namely,
the beneficial ownership and the limitation on residence. These two simplified provisions
had been further upgraded by extra measures represented by the 1986 OECD Conduit
Companies Report which followed the main idea that only companies having connections
close enough in terms of ownership and/or economic activity with the jurisdiction of
residence shall be able to benefit from a particular tax treaty. Consequently extended and
improved versions of prevention methods had been approved and incorporated in the
current OECD Model and its Commentary. These anti-treaty shopping provisions still do
not offer a universal solution to solving the treaty shopping problem. Thus, they form only
a base framework of possible approaches for prevention of treaty shopping. The OECD
commentary states that a combination of different measures may have to be used by the
contracting jurisdictions in order for various avoidance schemes to be prevented.29
However, the approaches derived by the OECD theory and practice are to be summarized
as: (1) the beneficial ownership approach, (2) the look-through approach, (3) the channel
26
the LOB are clauses designed to identify the persons allowed to benefit from the treaty (i.e. the benefits of
the treaty are limited to such persons) and not to focus on specific scenarios where conduits might be
involved. It is basically a more detailed approach based on the ‘channel approach’ which is discussed below
27
Opt. cit. Christiana H. J. I. Panayi, page 43
28
Opt. cit A. Miller and L. Oats, p. 483
29
Opt. cit. Christiana H. J. I. Panayi, page 44
10
approach, (4) the limitation on residence approach, (5) the exclusion approach and (6) the
subject-to-tax approach.
3.2.1. The beneficial ownership approach
The ‘beneficial ownership’ provision is the most popular instrument for limiting the
benefits of the reduction of withholding taxes on interests, dividends and royalties given to
the beneficiary according to a tax treaty. It is basically included in almost every OECD
based tax treaty and generally restrains the expansion of treaty benefits to legal structures
(such as conduit entities) which are not ‘beneficial owners’ of the particular income, even
though it is formally attributed to them under the tax treaty (and in that way prevents treaty
shopping). Although, a legal definition of the term is not to be found in any DTR
convention some understanding on the term can be derived by Art. 3(2) of the OECD
Model, but a consensus on its firm legal meaning is hard to be achieved. This mist had
begun to be unveiled by case law like the Indofood30 UK Court of Appeal's decision,
followed by cases such as Real Madrid31, Bank of Scotland32 and Prevost Car case.33 All
these cases concentrate on the question of whether a conduit legal entity established in a
country that is a party to a tax treaty (the United Kingdom in Bank of Scotland the
Netherlands in Indofood and Prevost car case and the Republic of Hungary in Real
Madrid) can be interpreted as a beneficiary according to the relevant DTR Convention. All
the judgments are based on different ideas of the judges on how ‘beneficial ownership’ is
to be interpreted.
The most important UK judgment on ‘beneficial ownership’ is Indofood, mainly because it
is the first that manages to somehow define the term for ’beneficial owner’. Although the
factual content of the case is long and complicated, in general, it focuses on to the main
question whether a conduit legal entity, established especially for the purposes of a
particular deal, may be interpreted as a beneficial owner of an interest payment to be
received by it, and further transmitted through it, according to a double tax treaty. The
essence of the decision is that the UK Court of Appeal denied accepting that a conduit
entity can be interpreted as a ‘beneficial owner’. The judges' decision had been highly
30
Indofood International Finance Ltd v. JP Morgan Chase Bank NA London Branch, [2006] EWCA Civ
158;
31
Real Madrid F.C. v. Oficina Nacional de Inspeccion (18 July 2006), Westlaw Aranzadi JUR\2006\204307
32
Conseil d’Etat, 29 December 2006, Ministre de L’Economi, des Finances et de L’Industrie v. Societe Bank
of Scotland, no.283314. See 9 1 TLR 1.
33
Prévost Car Inc. v. Canada, 2008 3080 (TCC), aff’d by FCA, 2009 DTC 5053.
11
influenced by the following part of the OECD Commentary and its interpretation by
Professor P. Baker 34:
“Where an item of income is received by a resident of a Contracting State acting
in the capacity of agent or nominee it would be inconsistent with the object and
purpose of the Convention for the State of source to grant relief or exemption
merely on account of the status of the immediate recipient of the income as a
resident of the other Contracting State. The immediate recipient of the income
in this situation qualifies as a resident but no potential double taxation arises
as a consequence of that status since the recipient is not treated as the owner
of the income for tax purposes in the State of residence. It would be equally
inconsistent with the object and purpose of the Convention for the State of
source to grant relief or exemption where a resident of a Contracting State,
… simply acts as a conduit for another person who in fact receives the benefit
of the income concerned. For these reasons, the [Conduit Companies Report]
concludes that a conduit company cannot normally be regarded as the beneficial
owner if, though the formal owner, it has, as a practical matter, very narrow
powers which render it, in relation to the income concerned, a mere fiduciary
or administrator acting on account of the interested parties.” 35
The judges held that “the concept of beneficial ownership is incompatible with that of the
formal owner who does not have the full privilege to directly benefit from the income”. 36
The key part saying that beneficial owner shall be interpreted as “the actual owner of the
interest who truly has the full right to enjoy directly the benefits of that interest income”
can not be found in the Commentary. It actually comes from a letter written by the
Indonesian tax authority in response to the question of the UK Court of Appeal if the
former is ready to interpret the conduit legal entity on the case as beneficial owner of the
interest. Another reason for this decision to be so important is the fact that for the first time
judges agreed that the term ‘beneficial ownership’ shall be marked with having an
‘international fiscal meaning’.37
3.2.2. The ‘look-through’ approach
The look-through approach simply denies treaty benefits to legal entities that are direct or
indirect ownership of persons who do not reside in one of the contracting countries.
34
Philip Baker, Beneficial Owner: After Indofood, (2007, Grays Inn Tax Chamber Review, Vol. VI, No. 1, p.
15)
35
Indofood., Para. 42. The Court noted that Philip Baker suggests that the term should be accorded an
international fiscal meaning not derived from the domestic laws of contracting states.
36
Ibid., Para. 42.
37
Opt. cit. Jinyan Li, ‘3. Judicial interpretation’
12
The weakness of this approach is the fact that is does not take into account the legal status
of the respective legal entity and that is why it is held by most commentators as too
restrictive. In order for this approach to work a current info of the identity of the
shareholders should be provided. A typical clause for prevention of treaty shopping using
the ‘look-through’ approach would be:
“A company that is a resident of a Contracting State shall not
be entitled to relief from taxation under this Convention with
respect to any item of income, gains or profits if it is owned or
controlled directly or through one or more companies,
wherever resident, by persons who are not residents of a
Contracting State.” 38
This provision is often modified by the parties in order to account for bona fide businesses,
because of its radical approach. It is meant to be used primarily in treaties with one of the
parties being a low or no-tax jurisdiction, where a the risk of establishment of conduit legal
entities is bigger.39
3.2.3. The ‘channel’ approach
Highly recommended by the OECD, the ‘channel’ approach, also known as ‘base erosion’
is aimed at dealing with conduit legal entities with their tax base reduced in order for third
state residents to benefit (e.g. parent companies or connected legal entities). The reduction
is most likely to be made by payments of interest, royalties or emission of obligations (or
any other tax deductible form). This approach activates a provision for refusal of a country
where the conduit is established to allow tax treaty benefits in case that more than for
example 50 % of the conduit company's income is transferred to third countries as tax
deductions.
A typical example for a channel provision is, again, to be found in the OECD
Commentary:
“ Where income arising in a Contracting State is received by a company
that is a resident of the other Contracting State and one or more persons
who are not residents of that other Contracting State
a) have directly or indirectly or through one or more companies, wherever
38
39
(2010) OECD Commentary to Article 1, paragraph 13
Opt. A. Miller, L. Oats, p 494
13
resident, a substantial interest in such company, in the form of a
participation
or otherwise, or
b) exercise directly or indirectly, alone or together, the management or
control of such company any provision of this Convention conferring an
exemption from, or a reduction of, tax shall not apply if more than 50 per
cent of such income is used to satisfy claims by such persons (including
interest, royalties, development, advertising, initial and travel expenses, and
depreciation of any kind of business assets including those on immaterial
goods and processes).”40
It must be indicated that no matter that the channel approach is extremely good for fighting
conduit legal entities, it may also affect bona fide business operations which is why an
inclusion of a bona fide provision is recommended. 41
3.2.4. The ‘limitation of residence’ approach
If a conduit company is considered to be a resident of a country - party to the tax treaty
according to its domestic laws, it usually is able to benefit from the tax treaty. That is why
counties may adopt a ‘limitation of residence’ clause, by which the term ‘residence’ is
limited in the tax convention or in the domestic law. The limitation usually encompasses
persons who are obliged to pay taxes because of residence, domicile, place of management
etc. The approach is represented in Article 4 of the OECD Model.42
The effectiveness of that provision is a subject of argument, because it is believed that it
may be too widely interpreted and “exclude from the scope of the Convention all residents
of countries adopting a territorial principle in their taxation”. 43 That is why is “it has to be
interpreted in the light of its object and purpose, which is to exclude persons who are not
subjected to comprehensive taxation (full liability to tax)”.44
40
(2010) OECD Commentary to Article 1, paragraph 17
Opt. A. Miller, L. Oats, p 495
42
Art. 4, OECD Model: "… the term "resident of a Contracting State" means any person who, under the laws
of that State, is liable to tax therein by reason of his domicile, residence, place of management or any other
criterion of a similar nature, and also includes that State and any political subdivision or local authority
thereof. This term, however, does not include any person who is liable to tax in that State in respect only of
income from sources in that State or capital situated therein."
43
(2010) OECD Commentary to Article 4, paragraph 8.3
44
Ibid.
41
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3.2.5. The ‘exclusion’ approach
In order for a conduit legal entity to succeed benefiting from a tax treaty it should be a
subject to low or zero taxation in the country in which it is a resident. This is usually made
possible by making use of not having to pay dividends (direct conduit method) or by
transferring income making use of tax deduction for expenses (stepping stone method) or
by establishment of a specific conduit company which is tax-exempt according to the
treaty. The exclusion method provides that countries may just decide to exclude particular
forms of legal entities and unable them to benefit from the convention. The scope of
exclusion may encompass only some or all types of income, which is why the exclusion
provision offers higher chances for soft-adjustment than the limitation of residence
above45.
3.2.6. The ‘subject-to-tax’ approach
The ‘subject-to-tax’ approach is used to establish a requirement for direct connection
between the need of a payment of income tax by the liable person in his country of
residence and the opportunity for double taxation relief in the country where the income is
derived from (i.e. a conduit can benefit from a treaty only if it is a subject to taxation in its
resident jurisdiction as, well???). The ‘subject-to-tax’ is based on the understanding that
the main aim of a tax convention is to prevent for a tax to be paid twice and not to totally
exclude the income from taxation. Both, the U.N and the OECD 46generally do not
recommend the ‘subject-to-tax’ provision, because it may lead to unjust treatment of legal
entities that are subject of some special domestic rules that allow them not to be taxed (e.g.
charity organizations, pension funds or maybe other entitles that are offered with such
incentive for purposes of boosting the economy). The provision is also incapable of dealing
with stepping-stone conduits and is usually hard to be administered, because tax legislation
45
Opt. cit. Christiana H. J. I. Panayi, p.53, a typical exclusion provision from the Conduit Companies Report:
“No provision of the Convention conferring an exemption from, or reduction of, tax shall apply to income
received or paid by a company as defined under section [ . . . ] of [ . . . ] the Act, or under any similar
provision enacted by [ . . . ] after signature of the Convention.”
46
The (2010) OECD Commentary recommends the following safeguarding provision:
“ Where income arising in a Contracting State is received by a company resident of the other Contracting
State and one or more persons not resident in that other Contracting State
a) have directly or indirectly or through one or more companies, wherever
resident, a substantial interest in such company, in the form of a participation
or otherwise, or
b) exercise directly or indirectly, alone or together, the management or control of
such company,
any provision of this Convention conferring an exemption from, or a reduction of, tax shall apply only to
income that is subject to tax in the last-mentioned State under the ordinary rules of its tax law.”
15
(e.g. tax thresholds, deduction allowances) is too different in each country for the balance
to be easily found.47
3.3. Supplementary tests
Because of the fact that all the approaches above may lead to restrictions on bona fide
48
legal entities, which are not conduits established for tax avoidance purposes, application
of supplementary tests is recommended. Their goal is to tell apart bona fide from conduit
structures. Examples for such test are the business activity test49, a detailed ‘subject to tax
test’, a stock market test50 etc.
4. Challenges on taxation in the UKCS and oil and gas production
Following the privatisation of the British National Oil Company (BNOC) in 1982, and
because of the introduction of the current licensing regime, the UK government relies
mainly on taxation to share the wealth from the petroleum industry. Both state and industry
are interested in securing a ‘fair’ share of the gains. The main issue is defining what is
‘fair’ since each of the parties always wants more. Mutually beneficial agreement can be
achieved only through designing of a competitive tax system which should be capable to
both answer the current industry's needs and attract new investors. If the taxation is too
rough, the willingness of the companies to invest in exploration, extraction and expansion
may be restricted which usually results in investments being made in another tax
jurisdictions with more preferable tax systems or in suspension and manipulation of the
established production, which may become ineffective.51
The UK and UKCS oil and gas taxation regime is based on three types of taxation methods
- Ring Fence Corporation Tax (RFCT) of 28%, Supplementary Charge to Corporation Tax
(SCT) of 32 % and Petroleum Revenue Tax (PRT) of 50% where applicable. The ‘ring
47
Opt. cit., Simone M. Haug, p. 228
Bona Fide companies are having genuine business intentions in contrast to conduits and therefore special
provisions usually apply to maintain the tax benefits for such companies.
49
Under the activity test a company is required to prove that it is engaged in substantial business operations
in the Contracting state of which it is a resident and the relief sought from the other Contracting country is on
a lawfully derived income.
50
The detailed subject-to-tax test compares the taxes saved under the treaty benefits and the taxes paid by the
‘suspected’ conduit legal entity in the state where resides; the stock market test excludes from the list of
‘suspects’ companies listed on a stock exchange since they are highly unlikely to act as conduits.
51
Daniel, Philip Keen, Michael Mcpherson, Charles., Taxation of Petroleum and Minerals: Principles,
Problems and Practice, The [e-book]. Taylor & Francis; 2010, page 89, [cited 2013 Apr 1]. Available from:
MyiLibrary.
48
16
fence’ system allows taxation of oil and gas extraction income without inclusion of losses
generated by the operating company outside ‘the fence’. The supplementary charge is
levied in addition to the RFCT on ‘ring fence’ profits with exclusion of the financial costs.
The PRT is an oil and gas field based tax. The profits from every tax field which is
licensed before 16.03.1993 are levied with a 50% PRT. It does not apply to fields licensed
after this date. After the 23rd of March 2011 the maximum tax levied on (old) fields that
shall pay the PRT may be up to 81% (from 75% before 23rd of March 2011) and the
maximum tax that can be levied on new (with no PRT) fields is up to 62% (from 50%
before 23rd of March 2011). The UK oil and gas offshore industry is the most heavily
taxed industry in the UK.
Currently, the UK government tends to use the taxation regime on oil and gas in a way that
does not provide good cash-flows predictability for the oil companies, because of the
constant significant changes to the system. An example for that is the introduction of the
supplementary charge in 2002, levied first at 10% and doubled in 2006 and increased
more recently (on 23rd of March 2011) at 32%. In response the industry, notwithstanding
having a tacit agreement to rather not try to evade taxation, regularly uses different
perfectly legal internal mechanisms for adjusting its total oil and gas sector tax expenditure
to an average of 8.7 billion pounds per year after 2006.
This trend might be examined in numerous studies and may easily be observed via
statistics:
United Kingdom, Year
2002
Crude oil production,
total (in million tonnes
(toe)
Historical annual
average world market
brent crude oil prices
per barrel, 2012
inflation adjusted
Total revenues from oil
and gas production,
excluding gas levy
(in million pounds)
2003
2004
2005
2006
2007
115,944 106,073 95,374 84,721 76,577 76,832
2008
2009
2010
2011
71,664 68,197 62,963
52,003
$ 32.41 $ 38.78 $ 50.52 $ 69.73 $ 78.66 $ 86.24 $ 103.35 $ 65.91 $ 83.29 $ 113.18
5,370
5,054
4,223
5,115
9,323
8,864
7,408 12,925
6,491
8,786
Sources: http://www.hmrc.gov.uk/statistics/prt/og-stats.pdf, accessed 01.04.2013
Institute of Petroleum IP Statistics 14, www.bls.gov,
BP Statistical Review of World Energy 2012,
17
It is easily visible that the revenue on oil has significantly increased in years 2006 and
2007, boosted mainly by the doubling of the supplementary charge from 10 to 20 %. The
decrease from 2008 is considered to be caused by the high decrease in production and the
higher production costs. A considerable increase is to be observed in revenues for 2009,
mainly because of the record oil and gas prices in 2008, but the tax yield have been
reduced twice 2010 after the oil price dropped again. As a result the production has once
more been decreased. Despite rising expenditure and the continuing falls in production,
yield increased again in 2011 as prices got on an increase trend after 2009. There is
obviously a misbalance between the UK tax policy and the industry - higher profits for the
companies do not necessarily lead to higher revenue.52
Certainty in the taxation system is needed in order for future tax rises not to result in
welfare loss and under-investment. This under-investment may lead to two situations: (1)
the total development of the UKCS falling because of non-optimal production and (2)
investments on single oil-fields going under the optimal line. Loss of welfare and underinvestment, because of uncertain taxation strategies, affects the real economy by
production decisions being distorted (e.g. the tax uncertainty may result in that the resource
is being extracted faster, distorting the oil field optimal production).53
5. The solution
There is no perfect tax system, but in order for the UK government to achieve both better
revenue and good investment pace in the UKCS, the balance should be found. Nowadays,
with the financial and budgetary crisis on hand, this balance is harder to be achieved than
ever before. Only wise measures, taken from both sides, can sustain the development of the
UKCS, especially now when the production, the investment and the revenue are in decline
with the ever stronger global competition, high costs of production in the UKCS and the
high and constantly changing taxes. Development of potential new fields (e.g. West of
Shetlands) should be stimulated by the UK government, because sustainability in the
UKCS is of great national interest. Some good signs for government reaction to the current
situation are already to be observed with the creation of some new incentives for the
52
HM Revenue & Customs: Business taxes, Statistics of Government revenues from UK oil and gas
production, (HM Revenue and Customs 100 Parliament Street, London 2012),
http://www.hmrc.gov.uk/statistics/business-taxes.htm accessed 01.04.2013
53
Opt. cit. Daniel, Philip Keen, Michael Mcpherson, Charles, page 425
18
industry (such as the announced decrease of the CT from 28% currently to 23% from April
2014; the decommissioning costs relief, the 2009 ‘field allowance’ etc.), but this is still not
enough to encourage more production and to attract new investors. Meanwhile, creating
more fine adjustment mechanisms like the supplementary charge to the tax system can
only bring more possibilities to finding the ‘golden’ middle line.
Bibliography
Primary sources
Legislation
Vienna Convention on the Law of Treaties 1969, entered into force on 27 January 1980.
United Nations, Treaty Series, vol. 1155, p. 331
Cases
Union of India v. Azadi Bachao Andolan, [2003] 6 ITLR 233
Indofood International Finance Ltd v. JP Morgan Chase Bank NA London Branch, [2006]
EWCA Civ 158;
Real Madrid F.C. v. Oficina Nacional de Inspeccion [18 July 2006], Westlaw Aranzadi
JUR\2006\204307
Conseil d’Etat, 29 December 2006, Ministre de L’Economi, des Finances et de L’Industrie
v. Societe Bank of Scotland, no.283314. See 9 1 TLR 1.
Prévost Car Inc. v. Canada, 2008 3080 (TCC), aff’d by FCA, 2009 DTC 5053.
Secondary sources
Books
W Craig, Revenue Law Essentials (2nd ed., Dundee University Press, Dundee 2010)
A Miller and L Oats, Principles of international Taxation, (3rd edition, Bloomsbury
Professional Ltd., Haywards Heath 2012)
Christiana H. J. I. Panayi, Double Taxation, Tax Treaties, Treaty Shopping and the
European Community, (Wolters Kluwer Law & Business, 2007)
A. Knechtle, Basic problems in International Fiscal Law (HFL London 1979)
Journal articles
Simone M. Haug, The United States Policy of Stringent Anti-Treaty-Shopping Provisions:
A Comparative Analysis, (1996, Vand. J. Transnat'l L., p. 191)
19
RL Doerberg, Overriding tax treaties: The U.S. Perspective, (9 Emory Int'l L. Rev. 71
1995)
HD Rosenbloom, Derivative Benefits: Emerging US Treaty Policy, (Essays on
International Taxation, Kluwer, Deventer 1993)
H Becker and F Würm, Treaty Shopping: An Emerging Tax Issue and its Present Status in
Various Countries (Kluwer, Deventer 1988)
Reuven S Avi-Yonah and Christiana H Panayi, Rethinking treaty-shopping lessons for the
European union, (2010, Public Law and legal theory working paper series, No. 182)
Jinyan Li, Beneficial ownership in tax treaties, (University of York, Osgoode Law School,
Research paper series, 4/2012)
Philip Baker, Beneficial Owner: After Indofood, (2007, Grays Inn Tax Chamber Review,
Vol. VI, No. 1, p. 15)
Daniel, Philip Keen, Michael Mcpherson, Charles., Taxation of Petroleum and Minerals:
Principles, Problems and Practice, The [e-book]. Taylor & Francis; 2010, page 89, ,
Available from: MyiLibrary. , accessed Apr. 1
2013
Other resources
OECD Model Convention on the Prevention of Double Taxation;
UNITED NATIONS Model Double Taxation Convention between Developed and
Developing Countries;
(2010) OECD Commentary;
UN, Department of International Economic and Social Affairs, Contributions to
International Co-operation in Tax Matters: Treaty Shopping, Thin Capitalization,
Cooperation between Tax Authorities, Resolving International Tax Disputes (UN: New
York, 1988), at 7.
HM Revenue & Customs: Business taxes, Statistics of Government revenues from UK oil
and gas production, (HM Revenue and Customs 100 Parliament Street, London 2012),
http://www.hmrc.gov.uk/statistics/business-taxes.htm , accessed 01.04.2013,
http://www.hmrc.gov.uk/statistics/prt/og-stats.pdf, accessed 01.04.2013;
BBC website http://www.bbc.co.uk/news/world-europe-22094194
HM Revenue & Customs website http://www.hmrc.gov.uk/taxtreaties/dta.htm
OECD website http://www.oecd.org/
Institute of Petroleum IP Statistics 14, www.bls.gov
BP Statistical Review of World Energy 2012,
http://www.bp.com/sectionbodycopy.do?categoryId=7500&contentId=7068481
ROBERT GORDON UNIVERSITY
Dept. of law
BSM151 - Full Time: Comparative International Tax Law
CITL Coursework 2013
Scotia a small oil & gas producing state, has a number of DTR Conventions which follow the form
of the OECD Model. Its convention with its neighbor Anglia is particularly advantageous reflecting
the good relationship with this neighboring state. However Scotia has become concerned about the
way some individuals and corporations from beyond its boundaries are using its convention with
Anglia.
Despite heavy flows of money through the treaty route, there appears to be little advantage to either
Scotia or Anglia.
1. Consider why this might be the situation.
2. Discuss the formal steps and legal techniques Scotia might take, to reduce what it sees as
an abuse of its treaty network using specific examples from the international experience,
current and past.
3. What particular issues might be relevant to the situation in relation to UKCS and oil & gas
production.
Words:5623
2
“When there is an income tax, the just man will pay more and the unjust less on the same
amount of income.” Plato
This essay tries to summarize and analyze the issues of treaty shopping, which is one of the
major problems that countries face today while trying to save their volatile budgets1. It is
being suggested that the imaginable (but very realistic) Scotia and Anglia may have to
accept different approaches to tackle the problem, none of these approaches sufficient
alone to solve the problem. In the last part of this essay a similar issue about the unstable
amount of revenue coming from the UKCS is observed. The whole European fiscal system
is jeopardised today and scholars are ‘called to arms’ to invent new and reintroduce old
solutions for these tough problems.
1. The purpose of a tax treaty
Nowadays people and corporations operate more globally than ever before. This fact
brings real challenges to modern revenue authorities in order for each country to tax the
persons (where ‘persons’ is defined as individuals, companies or other entities) generating
income (or corporate profits), both, home and abroad. Reasonable and economically
justified taxation means not being taxed twice on the same income (corporate profits). The
legal mechanism used to avoid this undesirable effect of person's international economic
activity is finding a compromise between countries by negotiating a bilateral or more
rarely multilateral tax treaties 2 which are governed by public international law (usually the
rules of the Vienna Convention on the Law of Treaties apply). 3 The balance between
stimulating higher economic activity and granting fair taxation is hard to be achieved. The
main purpose of an international double tax treaty is not only to protect the governments'
taxing rights and to protect against attempts to avoid or evade tax liability. It is also the
1
This essay is written in the times of the EU budget crisis, one of the most current developments of which
was the outburst of the "Offshore-leaks" scandal in the media, which recently lead to resignation of the
French finance minister, followed by the call for "eradication of tax havens by governments" of the French
President Fr. Hollande, echoed by the BBC http://www.bbc.co.uk/news/world-europe-22094194
2
There are more than 2,500 Double Taxation Treaties world-wide and the UK has the largest network of
treaties, covering over 100 countries. The UK seeks to encourage and maintain an international consensus on
cross-border economic activity and to promote international trade. To this end the UK plays an important role
in the Organisation for Economic Co-operation and Development (OECD)
http://www.hmrc.gov.uk/taxtreaties/dta.htm
3
W Craig, ‘Taxation Theory and the UK System’, Revenue Law Essentials (2nd ed., Dundee University
Press, Dundee 2010)
3
legal tool for contracting the ways for avoiding, or at least minimizing as much as possible,
double taxation by using some of the known and approved methods - tax exemption, tax
credit or tax deduction4. In order for the international trade to be stimulated, a good tax
treaty is meant to remove this major obstacle for exchanging goods and services across
different countries5.
International taxation rules are developed on a global scale primarily by international
organizations such as UN, EU, the IMF and the OECD. The important role of taxation for
the economy is a constant theme on the political programs of governments after the
outbreak of the Global Financial Crisis in 2008 and the following Public Debt Crisis in
Europe which still continues full steam6. Amending and adjusting the revenue system has
become a more frequent practice for countries searching for adequate reaction to the new
challenging occidental fiscal reality.
2. The OECD Model Convention in general
The OECD Model7 and the UN Model8 Conventions are the most powerful legal tools in
the hands of the governments to create, improve and uniform tax treaties. For most of the
developed countries, and we assume that Scotia and Anglia are also such countries, the
OECD Model is a strong base for drawing up tax treaties. The UN Model, on the other
hand, is designed to serve the same purpose for the similar needs of developing countries.
Every such model treaty, though, shall be enriched with each county's specific legal tax
characteristics to acquire its final appearance.
The OECD Model and its in-depth ‘article-by-article’ Commentary designed for ‘precise
interpretation’ purposes inspire almost all tax treaties among developed counties except the
US, that uses a different, but in the same time very similar to the OECD Model convention
(the US Model Tax Convention). The usage of the OECD Model is preferred
internationally for a couple of reasons:
A Miller and L Oats, ‘5.3 The Double Tax Problem’, Principles of international Taxation, (3rd edition,
Bloomsbury Professional Ltd., Haywards Heath 2012).
Tax deduction is a method which excludes any foreign taxes paid from the tax base in the country or
residence; Tax exemption is a method of non taxation of income derived from another country; Tax credit is
method by which the income is first taxed in full in the home country and than the income tax paid abroad is
deducted.
5
RL Doerberg, Overriding tax treaties: The U.S. Perspective, (9 Emory Int'l L. Rev. 71 1995)
6
e.g. the current Cyprus' talks with the EU, ECB and IMF aimed at securing another bailout for Cyprus after
the bailouts for Greece, Spain, Ireland and Italy.
7
OECD Model Convention on the Prevention of Double Taxation
8
United Nations Model Double Taxation Convention Between Developed and Developing Countries
4
4
the interpretation of the Model is well-established in its Commentary and
respectively clear of vagueness;
it includes main parameters of financial reasoning in a tax treaty as well as general
legal framework, established by leading world experts and further updated and
developed since 1963;
it brings predictability for international businesses and individuals of how ‘double
taxation’ is treated and understood in every different country they operate.
The main feature of the OECD model is the fact that is brings a high level of certainty in
terms of a country's legal tax order to companies and individuals, which aids and
stimulates trade across national boundaries. If two jurisdictions use a DTR Convention
based on the OECD Model, than a person who resides in one of them will have a certain
lucidity of what to expect in terms of local revenue requirements in case he/she decides to
settle down in the other jurisdiction. Not only are the main principles of ‘avoidance of
double taxation’ going to be generally comprehensible for any such person, but also their
interpretation. The possibility for relief of 'double taxation', in hypotheses not envisaged by
the treaty by contacting the two tax authorities involved, to find a common solution,
represents another strong argument for using the OECD Model.9
3. The problem of ‘treaty shopping’
Regardless of all positive features of the OECD Model it still has not found a perfect
solution for all double taxation problems. The fact that we have two neighbouring
countries which have concluded a particularly advantageous DTR convention based on the
OECD Model reflecting the good relationship between them does not mean that there is
not a ‘dark side of the Moon’. Good relationships may attract attention, greed and envy. In
terms of international taxation this 'dark side of the Moon' for a good DTR Convention is
called ‘treaty shopping’.
The term ‘treaty shopping’ originates from the US legal doctrine. It derives from another
term - ‘forum shopping’ which indicates a situation in which a litigant may search for a
more convenient jurisdiction for his case to be judged with a view to a possibility for a
A Miller and L Oats, ‘7.13 Double Tax Treaties’, Principles of international Taxation, (3rd edition,
Bloomsbury Professional Ltd., Haywards Heath 2012)
9
5
more advantageous decision. 10 A short description of the term ‘treaty shopping’ has been
given by Rosenbloom, 11 who states that it represents “the practice of some investors of
‘borrowing’ a tax treaty by forming an entity (usually a corporation) in a country having a
favourable tax treaty with the country of source – that is, the country where the investment
is to be made and the income in question is to be earned”12. In short, it is the situation of
being ‘shopped’ by a person for a convenient tax treaty to benefit from its provisions,
either by establishment of a corporate entity or using an existent one, and usually
accompanied by application of different sophisticated schemes to reduce or fully avoid
taxation. Tax treaties are designed to only benefit persons who reside in a country which is
a party to the treaty. That is why, according to the OECD, treaty shopping is an undesirable
phenomenon which is subject to strong efforts for prevention by the tax authorities of each
of the countries affected. 13
As a totally opposite view, the (1988) UN Treaty Shopping Report promotes the idea that
in some instances treaty shopping may even be beneficial. Many underdeveloped states try
to attract investments by introduction of taxation based on low or no withholding taxes on
income even in case that the beneficial owner is based in another country. This is why
treaty shopping may be considered as a normal practice in such jurisdictions. The UN
report further explains that, if the main idea behind a tax treaty is to introduce “freer flows
of international trade and investment, it may be generally arguable that it does not matter if
the desirable result is achieved by the direct use of tax treaties or by their indirect use” 14
(e.g. treaty shopping). For many developing states treaty shopping might be regarded as an
opportunity to draw investments. As an example for this position, in the case Union of
India v. Azadi Bachao Andolan, the Supreme Court of India has held that treaty shopping
is "a necessary evil in a developing economy" and in general is a tolerable practice under
the Indian tax treaty network.15 Nevertheless, in the long term, treaty shopping is generally
10
H Becker and F Würm, Treaty Shopping: An Emerging Tax Issue and its Present Status in
Various Countries (Kluwer, Deventer 1988)
11
Mr. David Rosenbloom used to serve as an international tax advisor at the US Treasury Dept. (1977-1981)
12
HD Rosenbloom, Derivative Benefits: Emerging US Treaty Policy, (Essays on International Taxation,
Kluwer, Deventer 1993)
13
Reuven S Avi-Yonah and Christiana H Panayi, Rethinking treaty-shopping lessons for the European union,
(2010) Public Law and legal theory working paper series Working Paper No. 182
14
UN, Department of International Economic and Social Affairs, Contributions to International Cooperation in Tax Matters: Treaty Shopping, Thin Capitalization, Cooperation between Tax Authorities,
Resolving International Tax Disputes (UN: New York, 1988), at 7.
15
Union of India v. Azadi Bachao Andolan, [2003] 6 ITLR 233. It is interesting that the Chinese position is
fully opposite - it says that treaty shopping is a totally unacceptable practise and represents a tax treaty abuse.
For further comments, see Yang, H., “New Developments in the General Anti-Abuse Rules and the Impact
on International Tax Planning” Asia-Pacific Tax Bulletin (May/June 2009) p. 176.
6
believed to have more negative than positive effects on a country's economy and as a
‘plague’ to be dealt with.16
The term ‘treaty shopping’ does not appear by direct reference in the OECD Model and its
description and legal interpretation is not directly and widely discussed in the OECD
Model Commentary. Even though, it might be said that the OECD Model addresses the
problem of ‘treaty shopping’ indirectly - by searching to eliminate its effects through
applying specific provisions for its prevention and by defining the purpose of the tax
treaties as “…is to promote, by eliminating international double taxation, exchanges of
goods and services, and the movement of capital and persons. It is also a purpose of tax
conventions to prevent tax avoidance and evasion.” 17. An example for such and other
indirect reference would be the Commentary on Article 1 which concerns the possible
application of the limitation-of-benefits (LOB) clauses which are meant to tackle the issue
of treaty shopping in a ‘comprehensive way’. 18
3.1. General forms of treaty shopping
There are multiple forms of treaty shopping, but the main two may be defined as these
identified inexplicitly under Para 9, Para 11 and Para 20 of Article 1 of the OECD
Commentary as such (1) including usage of conduit legal entities and/or base companies
19
and (2) such not including usage of conduit structures and tax havens. 20
Treaty shopping through usage of conduit legal entities, though, is the most frequent type
of abuse and therefore the most fundamental form of treaty shopping 21 which is why this
short essay will be concentrated only on that certain ‘conduit’ type of treaty shopping and
its prevention.
16
Jinyan Li, Beneficial ownership in tax treaties, (University of York, Osgoode Law School, Research paper
series, 4/2012)
17
(2010) OECD Commentary to Article 1, paragraph 7
18
(2010) OECD Commentary to Article 1, paragraph 20
19
Simone M. Haug, The United States Policy of Stringent Anti-Treaty-Shopping Provisions: A Comparative
Analysis, (1996, Vand. J. Transnat'l L., p. 191): ‘A base company is a company through which certain
activities are carried out on behalf of related companies in high-tax countries. A base company seeks to
minimize tax in the country of residence-the country in which the investor actually resides, while the main
function of the conduit company is to serve as a pass-through entity that redistributes the income it receives
from a related company in one country to its shareholders in another country.’
20
Christiana H. J. I. Panayi, ‘Chapter 2: Tax treaties and treaty shopping’, Double Taxation, Tax Treaties,
Treaty Shopping and the European Community, (Wolters Kluwer Law & Business, 2007) Such treaty
shopping without conduit as described in the OECD Commentary would be e.g. ’an individual who has in a
Contracting State both his permanent home and all his economic interests, including a substantial
shareholding in a company of that State, and who, essentially in order to sell the shares and escape taxation in
that State on the capital gains from the alienation (by virtue of paragraph 5 of Article 13), transfers his
permanent home to the other Contracting State, where such gains are subject to little or no tax.’
21
Ibid.
7
Regardless of the fact that treaty shopping may encompass a huge spectrum of ‘conduit’
structures, two main forms of treaty shopping through such ‘conduit’ legal entities might
be observed according to the (2010) OECD Commentary - these are two general recipes
that a person who is a resident in one jurisdiction could use in order to benefits from tax
treaty arrangements between two other jurisdictions. The forms are being identified by the
legal doctrine as: (1) the method of direct conduit structure and (2) the method of the
stepping stone conduit structure.
The method of direct conduit structure is based on establishing a legal entity in a
jurisdiction to take advantage of its beneficial DTR Convention with another country. A
basic example (provided that there are multiple different scenarios existing) might be
described as follows: jurisdictions X and Y (just like Scotia and Anglia) have concluded an
advantageous DTR Convention which guarantees individuals and legal entities established
in their tax legal systems with preferential tax treatment of minimal or no levy on income
(or corporate profits) gained in the other tax jurisdiction. A company incorporated in
jurisdiction Z (let’s say a tax haven jurisdiction) wants to invest substantial amount in
jurisdiction X and expects to gain profits which should be levied with an extortionate 30%
of withholding tax, because it does not have a DTR Convention with jurisdiction X. In the
same time jurisdiction Z has an advantageous tax treaty with jurisdiction Y. So, in order to
avoid the 30 % withholding tax the company resident of jurisdiction Z establishes a branch
(a ‘conduit’ entity) in jurisdiction Y. This ‘conduit’ entity is treated as a resident in
jurisdiction Y according to the tax treaty between X and Y which is why the investment in
jurisdiction X could be made through it. In order for the parent company in jurisdiction Z
to be able to benefit from that situation, the income derived from the ‘conduit’ legal entity
in jurisdiction Y shall either be fully exempt of taxation according to the other tax treaty
between Y and Z (more improbable) or simply according to the national laws of Y which
may provide a low or zero rate of withholding tax on profits gained by a branch of a
foreign company. In that case the ‘conduit’ entity established in jurisdiction Y will be
entitled to be allocated a full tax exemption or at least tax optimized net profit to its parent
company in jurisdiction Z which, in that way, gains substantial benefits from the X - Y tax
treaty. 22
A Miller and L Oats, ‘16.1 Treaty shopping’, Principles of international Taxation, (3rd edition,
Bloomsbury Professional Ltd., Haywards Heath 2012)
22
8
The method of the stepping stone conduit structure is similar to the method of direct
conduit, but while the latter uses a tax exemption in the connecting jurisdiction, the former
reduces the tax due in that jurisdiction by counterbalancing the expenses. The difference
between both methods may be defined using the following basic example: A legal entity in
jurisdiction X, a high-tax jurisdiction is a subject to full high taxation on its corporate
profits derived in jurisdiction Y. In the same time jurisdiction Y allows deductions on
corporate expense and the company decides to balance its total net corporate profit by
making substantial ‘ostensible’ expenses to a connected legal entity in a third low tax
jurisdiction (let’s say jurisdiction Z). In that way the corporate profits gained in jurisdiction
X are transmitted to jurisdiction Z fully free or substantially reduced of taxation, because
of the advantageous DTR Convention between the high tax jurisdictions, X and Y, and the
tax base balancing performed through the conduit legal entity in jurisdiction Y”.23
A corporation that uses the method of stepping stone benefits, because: “(1) the
stepping stone company can deduct all of its expenses against its receipts; (2) the stepping
stone country does not impose a significant withholding tax on the outbound payments;
and (3) the stepping stone company's receipts must be received free of host-country
withholding tax (or subject to significantly reduced withholding tax) by virtue of an
existing tax treaty.” 24
There are many more complex variations of treaty shopping structures including some
which take advantage of both ‘direct’ and ’stepping stone’ conduit methods in order for
funds to be transferred fully free of taxation or taxation optimized between multiple
‘channel’ jurisdictions. In the process different ‘conduit’ companies may be created (e.g.
holding companies, subsidiaries, etc.) 25 The income which is a subject to treaty shopping
may take many different forms during the transfers (e.g. corporate profit, dividend,
interest, etc.). That is why Anglia and Scotia may wish to carefully plan, examine and
decide on the possible methods for prevention of treaty shopping according to the specific
situation they are facing.
23
Opt. Cit. Simone M. Haug, page 205
Ibid.
25
Ibid.
24
9
3.2. Methods for prevention of treaty shopping
There are two global approaches that can be used by countries in the situation of Anglia
and Scotia to tackle treaty shopping: (1) the US limitation of benefits 26 approach (which
basically introduces specific anti-treaty shopping provisions in each DTR Convention
concluded) and (2) the OECD Model approach (which firstly encouraged mainly
introduction of domestic anti-treaty shopping tax legislation and more recently also
included anti-treaty shopping provisions in its Model convention) 27 - an example for a
more recent attempt for establishing national rules is the UK HMRC's proposal of
introduction of a special domestic legislation chapter to the UK Finance Act 2012
dedicated to ’Tax Treaties Anti Avoidance’ generally based on denial of treaty benefits in
case of a scheme directly or indirectly constructed for the purposes of gaining treaty
benefits. This reasonable UK HMRC proposal though has not been adopted yet into a valid
UK legislation and remains inactivated. 28
The first treaty shopping prevention methods are as old as the 1977 OECD Model, namely,
the beneficial ownership and the limitation on residence. These two simplified provisions
had been further upgraded by extra measures represented by the 1986 OECD Conduit
Companies Report which followed the main idea that only companies having connections
close enough in terms of ownership and/or economic activity with the jurisdiction of
residence shall be able to benefit from a particular tax treaty. Consequently extended and
improved versions of prevention methods had been approved and incorporated in the
current OECD Model and its Commentary. These anti-treaty shopping provisions still do
not offer a universal solution to solving the treaty shopping problem. Thus, they form only
a base framework of possible approaches for prevention of treaty shopping. The OECD
commentary states that a combination of different measures may have to be used by the
contracting jurisdictions in order for various avoidance schemes to be prevented.29
However, the approaches derived by the OECD theory and practice are to be summarized
as: (1) the beneficial ownership approach, (2) the look-through approach, (3) the channel
26
the LOB are clauses designed to identify the persons allowed to benefit from the treaty (i.e. the benefits of
the treaty are limited to such persons) and not to focus on specific scenarios where conduits might be
involved. It is basically a more detailed approach based on the ‘channel approach’ which is discussed below
27
Opt. cit. Christiana H. J. I. Panayi, page 43
28
Opt. cit A. Miller and L. Oats, p. 483
29
Opt. cit. Christiana H. J. I. Panayi, page 44
10
approach, (4) the limitation on residence approach, (5) the exclusion approach and (6) the
subject-to-tax approach.
3.2.1. The beneficial ownership approach
The ‘beneficial ownership’ provision is the most popular instrument for limiting the
benefits of the reduction of withholding taxes on interests, dividends and royalties given to
the beneficiary according to a tax treaty. It is basically included in almost every OECD
based tax treaty and generally restrains the expansion of treaty benefits to legal structures
(such as conduit entities) which are not ‘beneficial owners’ of the particular income, even
though it is formally attributed to them under the tax treaty (and in that way prevents treaty
shopping). Although, a legal definition of the term is not to be found in any DTR
convention some understanding on the term can be derived by Art. 3(2) of the OECD
Model, but a consensus on its firm legal meaning is hard to be achieved. This mist had
begun to be unveiled by case law like the Indofood30 UK Court of Appeal's decision,
followed by cases such as Real Madrid31, Bank of Scotland32 and Prevost Car case.33 All
these cases concentrate on the question of whether a conduit legal entity established in a
country that is a party to a tax treaty (the United Kingdom in Bank of Scotland the
Netherlands in Indofood and Prevost car case and the Republic of Hungary in Real
Madrid) can be interpreted as a beneficiary according to the relevant DTR Convention. All
the judgments are based on different ideas of the judges on how ‘beneficial ownership’ is
to be interpreted.
The most important UK judgment on ‘beneficial ownership’ is Indofood, mainly because it
is the first that manages to somehow define the term for ’beneficial owner’. Although the
factual content of the case is long and complicated, in general, it focuses on to the main
question whether a conduit legal entity, established especially for the purposes of a
particular deal, may be interpreted as a beneficial owner of an interest payment to be
received by it, and further transmitted through it, according to a double tax treaty. The
essence of the decision is that the UK Court of Appeal denied accepting that a conduit
entity can be interpreted as a ‘beneficial owner’. The judges' decision had been highly
30
Indofood International Finance Ltd v. JP Morgan Chase Bank NA London Branch, [2006] EWCA Civ
158;
31
Real Madrid F.C. v. Oficina Nacional de Inspeccion (18 July 2006), Westlaw Aranzadi JUR\2006\204307
32
Conseil d’Etat, 29 December 2006, Ministre de L’Economi, des Finances et de L’Industrie v. Societe Bank
of Scotland, no.283314. See 9 1 TLR 1.
33
Prévost Car Inc. v. Canada, 2008 3080 (TCC), aff’d by FCA, 2009 DTC 5053.
11
influenced by the following part of the OECD Commentary and its interpretation by
Professor P. Baker 34:
“Where an item of income is received by a resident of a Contracting State acting
in the capacity of agent or nominee it would be inconsistent with the object and
purpose of the Convention for the State of source to grant relief or exemption
merely on account of the status of the immediate recipient of the income as a
resident of the other Contracting State. The immediate recipient of the income
in this situation qualifies as a resident but no potential double taxation arises
as a consequence of that status since the recipient is not treated as the owner
of the income for tax purposes in the State of residence. It would be equally
inconsistent with the object and purpose of the Convention for the State of
source to grant relief or exemption where a resident of a Contracting State,
… simply acts as a conduit for another person who in fact receives the benefit
of the income concerned. For these reasons, the [Conduit Companies Report]
concludes that a conduit company cannot normally be regarded as the beneficial
owner if, though the formal owner, it has, as a practical matter, very narrow
powers which render it, in relation to the income concerned, a mere fiduciary
or administrator acting on account of the interested parties.” 35
The judges held that “the concept of beneficial ownership is incompatible with that of the
formal owner who does not have the full privilege to directly benefit from the income”. 36
The key part saying that beneficial owner shall be interpreted as “the actual owner of the
interest who truly has the full right to enjoy directly the benefits of that interest income”
can not be found in the Commentary. It actually comes from a letter written by the
Indonesian tax authority in response to the question of the UK Court of Appeal if the
former is ready to interpret the conduit legal entity on the case as beneficial owner of the
interest. Another reason for this decision to be so important is the fact that for the first time
judges agreed that the term ‘beneficial ownership’ shall be marked with having an
‘international fiscal meaning’.37
3.2.2. The ‘look-through’ approach
The look-through approach simply denies treaty benefits to legal entities that are direct or
indirect ownership of persons who do not reside in one of the contracting countries.
34
Philip Baker, Beneficial Owner: After Indofood, (2007, Grays Inn Tax Chamber Review, Vol. VI, No. 1, p.
15)
35
Indofood., Para. 42. The Court noted that Philip Baker suggests that the term should be accorded an
international fiscal meaning not derived from the domestic laws of contracting states.
36
Ibid., Para. 42.
37
Opt. cit. Jinyan Li, ‘3. Judicial interpretation’
12
The weakness of this approach is the fact that is does not take into account the legal status
of the respective legal entity and that is why it is held by most commentators as too
restrictive. In order for this approach to work a current info of the identity of the
shareholders should be provided. A typical clause for prevention of treaty shopping using
the ‘look-through’ approach would be:
“A company that is a resident of a Contracting State shall not
be entitled to relief from taxation under this Convention with
respect to any item of income, gains or profits if it is owned or
controlled directly or through one or more companies,
wherever resident, by persons who are not residents of a
Contracting State.” 38
This provision is often modified by the parties in order to account for bona fide businesses,
because of its radical approach. It is meant to be used primarily in treaties with one of the
parties being a low or no-tax jurisdiction, where a the risk of establishment of conduit legal
entities is bigger.39
3.2.3. The ‘channel’ approach
Highly recommended by the OECD, the ‘channel’ approach, also known as ‘base erosion’
is aimed at dealing with conduit legal entities with their tax base reduced in order for third
state residents to benefit (e.g. parent companies or connected legal entities). The reduction
is most likely to be made by payments of interest, royalties or emission of obligations (or
any other tax deductible form). This approach activates a provision for refusal of a country
where the conduit is established to allow tax treaty benefits in case that more than for
example 50 % of the conduit company's income is transferred to third countries as tax
deductions.
A typical example for a channel provision is, again, to be found in the OECD
Commentary:
“ Where income arising in a Contracting State is received by a company
that is a resident of the other Contracting State and one or more persons
who are not residents of that other Contracting State
a) have directly or indirectly or through one or more companies, wherever
38
39
(2010) OECD Commentary to Article 1, paragraph 13
Opt. A. Miller, L. Oats, p 494
13
resident, a substantial interest in such company, in the form of a
participation
or otherwise, or
b) exercise directly or indirectly, alone or together, the management or
control of such company any provision of this Convention conferring an
exemption from, or a reduction of, tax shall not apply if more than 50 per
cent of such income is used to satisfy claims by such persons (including
interest, royalties, development, advertising, initial and travel expenses, and
depreciation of any kind of business assets including those on immaterial
goods and processes).”40
It must be indicated that no matter that the channel approach is extremely good for fighting
conduit legal entities, it may also affect bona fide business operations which is why an
inclusion of a bona fide provision is recommended. 41
3.2.4. The ‘limitation of residence’ approach
If a conduit company is considered to be a resident of a country - party to the tax treaty
according to its domestic laws, it usually is able to benefit from the tax treaty. That is why
counties may adopt a ‘limitation of residence’ clause, by which the term ‘residence’ is
limited in the tax convention or in the domestic law. The limitation usually encompasses
persons who are obliged to pay taxes because of residence, domicile, place of management
etc. The approach is represented in Article 4 of the OECD Model.42
The effectiveness of that provision is a subject of argument, because it is believed that it
may be too widely interpreted and “exclude from the scope of the Convention all residents
of countries adopting a territorial principle in their taxation”. 43 That is why is “it has to be
interpreted in the light of its object and purpose, which is to exclude persons who are not
subjected to comprehensive taxation (full liability to tax)”.44
40
(2010) OECD Commentary to Article 1, paragraph 17
Opt. A. Miller, L. Oats, p 495
42
Art. 4, OECD Model: "… the term "resident of a Contracting State" means any person who, under the laws
of that State, is liable to tax therein by reason of his domicile, residence, place of management or any other
criterion of a similar nature, and also includes that State and any political subdivision or local authority
thereof. This term, however, does not include any person who is liable to tax in that State in respect only of
income from sources in that State or capital situated therein."
43
(2010) OECD Commentary to Article 4, paragraph 8.3
44
Ibid.
41
14
3.2.5. The ‘exclusion’ approach
In order for a conduit legal entity to succeed benefiting from a tax treaty it should be a
subject to low or zero taxation in the country in which it is a resident. This is usually made
possible by making use of not having to pay dividends (direct conduit method) or by
transferring income making use of tax deduction for expenses (stepping stone method) or
by establishment of a specific conduit company which is tax-exempt according to the
treaty. The exclusion method provides that countries may just decide to exclude particular
forms of legal entities and unable them to benefit from the convention. The scope of
exclusion may encompass only some or all types of income, which is why the exclusion
provision offers higher chances for soft-adjustment than the limitation of residence
above45.
3.2.6. The ‘subject-to-tax’ approach
The ‘subject-to-tax’ approach is used to establish a requirement for direct connection
between the need of a payment of income tax by the liable person in his country of
residence and the opportunity for double taxation relief in the country where the income is
derived from (i.e. a conduit can benefit from a treaty only if it is a subject to taxation in its
resident jurisdiction as, well???). The ‘subject-to-tax’ is based on the understanding that
the main aim of a tax convention is to prevent for a tax to be paid twice and not to totally
exclude the income from taxation. Both, the U.N and the OECD 46generally do not
recommend the ‘subject-to-tax’ provision, because it may lead to unjust treatment of legal
entities that are subject of some special domestic rules that allow them not to be taxed (e.g.
charity organizations, pension funds or maybe other entitles that are offered with such
incentive for purposes of boosting the economy). The provision is also incapable of dealing
with stepping-stone conduits and is usually hard to be administered, because tax legislation
45
Opt. cit. Christiana H. J. I. Panayi, p.53, a typical exclusion provision from the Conduit Companies Report:
“No provision of the Convention conferring an exemption from, or reduction of, tax shall apply to income
received or paid by a company as defined under section [ . . . ] of [ . . . ] the Act, or under any similar
provision enacted by [ . . . ] after signature of the Convention.”
46
The (2010) OECD Commentary recommends the following safeguarding provision:
“ Where income arising in a Contracting State is received by a company resident of the other Contracting
State and one or more persons not resident in that other Contracting State
a) have directly or indirectly or through one or more companies, wherever
resident, a substantial interest in such company, in the form of a participation
or otherwise, or
b) exercise directly or indirectly, alone or together, the management or control of
such company,
any provision of this Convention conferring an exemption from, or a reduction of, tax shall apply only to
income that is subject to tax in the last-mentioned State under the ordinary rules of its tax law.”
15
(e.g. tax thresholds, deduction allowances) is too different in each country for the balance
to be easily found.47
3.3. Supplementary tests
Because of the fact that all the approaches above may lead to restrictions on bona fide
48
legal entities, which are not conduits established for tax avoidance purposes, application
of supplementary tests is recommended. Their goal is to tell apart bona fide from conduit
structures. Examples for such test are the business activity test49, a detailed ‘subject to tax
test’, a stock market test50 etc.
4. Challenges on taxation in the UKCS and oil and gas production
Following the privatisation of the British National Oil Company (BNOC) in 1982, and
because of the introduction of the current licensing regime, the UK government relies
mainly on taxation to share the wealth from the petroleum industry. Both state and industry
are interested in securing a ‘fair’ share of the gains. The main issue is defining what is
‘fair’ since each of the parties always wants more. Mutually beneficial agreement can be
achieved only through designing of a competitive tax system which should be capable to
both answer the current industry's needs and attract new investors. If the taxation is too
rough, the willingness of the companies to invest in exploration, extraction and expansion
may be restricted which usually results in investments being made in another tax
jurisdictions with more preferable tax systems or in suspension and manipulation of the
established production, which may become ineffective.51
The UK and UKCS oil and gas taxation regime is based on three types of taxation methods
- Ring Fence Corporation Tax (RFCT) of 28%, Supplementary Charge to Corporation Tax
(SCT) of 32 % and Petroleum Revenue Tax (PRT) of 50% where applicable. The ‘ring
47
Opt. cit., Simone M. Haug, p. 228
Bona Fide companies are having genuine business intentions in contrast to conduits and therefore special
provisions usually apply to maintain the tax benefits for such companies.
49
Under the activity test a company is required to prove that it is engaged in substantial business operations
in the Contracting state of which it is a resident and the relief sought from the other Contracting country is on
a lawfully derived income.
50
The detailed subject-to-tax test compares the taxes saved under the treaty benefits and the taxes paid by the
‘suspected’ conduit legal entity in the state where resides; the stock market test excludes from the list of
‘suspects’ companies listed on a stock exchange since they are highly unlikely to act as conduits.
51
Daniel, Philip Keen, Michael Mcpherson, Charles., Taxation of Petroleum and Minerals: Principles,
Problems and Practice, The [e-book]. Taylor & Francis; 2010, page 89, [cited 2013 Apr 1]. Available from:
MyiLibrary.
48
16
fence’ system allows taxation of oil and gas extraction income without inclusion of losses
generated by the operating company outside ‘the fence’. The supplementary charge is
levied in addition to the RFCT on ‘ring fence’ profits with exclusion of the financial costs.
The PRT is an oil and gas field based tax. The profits from every tax field which is
licensed before 16.03.1993 are levied with a 50% PRT. It does not apply to fields licensed
after this date. After the 23rd of March 2011 the maximum tax levied on (old) fields that
shall pay the PRT may be up to 81% (from 75% before 23rd of March 2011) and the
maximum tax that can be levied on new (with no PRT) fields is up to 62% (from 50%
before 23rd of March 2011). The UK oil and gas offshore industry is the most heavily
taxed industry in the UK.
Currently, the UK government tends to use the taxation regime on oil and gas in a way that
does not provide good cash-flows predictability for the oil companies, because of the
constant significant changes to the system. An example for that is the introduction of the
supplementary charge in 2002, levied first at 10% and doubled in 2006 and increased
more recently (on 23rd of March 2011) at 32%. In response the industry, notwithstanding
having a tacit agreement to rather not try to evade taxation, regularly uses different
perfectly legal internal mechanisms for adjusting its total oil and gas sector tax expenditure
to an average of 8.7 billion pounds per year after 2006.
This trend might be examined in numerous studies and may easily be observed via
statistics:
United Kingdom, Year
2002
Crude oil production,
total (in million tonnes
(toe)
Historical annual
average world market
brent crude oil prices
per barrel, 2012
inflation adjusted
Total revenues from oil
and gas production,
excluding gas levy
(in million pounds)
2003
2004
2005
2006
2007
115,944 106,073 95,374 84,721 76,577 76,832
2008
2009
2010
2011
71,664 68,197 62,963
52,003
$ 32.41 $ 38.78 $ 50.52 $ 69.73 $ 78.66 $ 86.24 $ 103.35 $ 65.91 $ 83.29 $ 113.18
5,370
5,054
4,223
5,115
9,323
8,864
7,408 12,925
6,491
8,786
Sources: http://www.hmrc.gov.uk/statistics/prt/og-stats.pdf, accessed 01.04.2013
Institute of Petroleum IP Statistics 14, www.bls.gov,
BP Statistical Review of World Energy 2012,
17
It is easily visible that the revenue on oil has significantly increased in years 2006 and
2007, boosted mainly by the doubling of the supplementary charge from 10 to 20 %. The
decrease from 2008 is considered to be caused by the high decrease in production and the
higher production costs. A considerable increase is to be observed in revenues for 2009,
mainly because of the record oil and gas prices in 2008, but the tax yield have been
reduced twice 2010 after the oil price dropped again. As a result the production has once
more been decreased. Despite rising expenditure and the continuing falls in production,
yield increased again in 2011 as prices got on an increase trend after 2009. There is
obviously a misbalance between the UK tax policy and the industry - higher profits for the
companies do not necessarily lead to higher revenue.52
Certainty in the taxation system is needed in order for future tax rises not to result in
welfare loss and under-investment. This under-investment may lead to two situations: (1)
the total development of the UKCS falling because of non-optimal production and (2)
investments on single oil-fields going under the optimal line. Loss of welfare and underinvestment, because of uncertain taxation strategies, affects the real economy by
production decisions being distorted (e.g. the tax uncertainty may result in that the resource
is being extracted faster, distorting the oil field optimal production).53
5. The solution
There is no perfect tax system, but in order for the UK government to achieve both better
revenue and good investment pace in the UKCS, the balance should be found. Nowadays,
with the financial and budgetary crisis on hand, this balance is harder to be achieved than
ever before. Only wise measures, taken from both sides, can sustain the development of the
UKCS, especially now when the production, the investment and the revenue are in decline
with the ever stronger global competition, high costs of production in the UKCS and the
high and constantly changing taxes. Development of potential new fields (e.g. West of
Shetlands) should be stimulated by the UK government, because sustainability in the
UKCS is of great national interest. Some good signs for government reaction to the current
situation are already to be observed with the creation of some new incentives for the
52
HM Revenue & Customs: Business taxes, Statistics of Government revenues from UK oil and gas
production, (HM Revenue and Customs 100 Parliament Street, London 2012),
http://www.hmrc.gov.uk/statistics/business-taxes.htm accessed 01.04.2013
53
Opt. cit. Daniel, Philip Keen, Michael Mcpherson, Charles, page 425
18
industry (such as the announced decrease of the CT from 28% currently to 23% from April
2014; the decommissioning costs relief, the 2009 ‘field allowance’ etc.), but this is still not
enough to encourage more production and to attract new investors. Meanwhile, creating
more fine adjustment mechanisms like the supplementary charge to the tax system can
only bring more possibilities to finding the ‘golden’ middle line.
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