TAXATION OF CROSS-BORDER PARTNERSHIPS

Mr. Jesper
Barenfeld at Jönköping
International Business
School, (www.ihh.hj.se),
has recently published his dissertation “Taxation of Cross-Border Partnerships,
Double-Tax Relief in Hybrid and Reverse Hybrid Situations”. (JIBS Dissertation
Series No. 025)

In the
abstract Mr. Barenfeld points out that the heterogeneity of partnership
structures as business vehicles

“constitutes
a challenging factor for countries’ legislation on foreign entity
classification. As these regimes typically disregard the tax treatment of
foreign entities for domestic tax purposes, cross-border partnerships often
face the risk of being treated as taxable persons in one country but as
transparent in another. This is referred to as asymmetrical situations.

As shown
in this thesis, international double taxation 
arising in  asymmetrical
situations fits badly in countries’ regimes for double-tax relief. As a result
there is considerable risk that international double taxation arising in asymmetrical
situations is not appropriately relieved. In addition to identifying and
analysing the reasons for these problems, the study presents potential
approaches on how to deal with them de lege ferenda.”

This
declaration, as far as Sweden is concerned, is an understatement, because our
country has a tax regime, based on case law, which gives rise to double tax
problems also in symmetrical partnership structures i.e. also in situations
where the foreign partnership in question is treated as transparent both in the
country where it is situated and in Sweden. 
This, in fact, has lead to the situation that foreign partnerships owned
by Swedish residents have been rendered completely useless as investment
vehicles! This of course represents a very serious problem The tax legislator
in Sweden
should therefore pay very close attention to the suggestions put forward by Mr.
Barenfeld.

Most
satisfactory about this dissertation is the fact that it is written in English,
and indeed in very good English. Although I can understand the meaning I do
however object to the title of the book, because there is no such thing as a
cross-border partnership (or company). More preferable would have been
“Taxation of Cross-border Partnership Activities”. As far as is known this is the
first academic dissertation on international taxation ever that is in English.
And of course this is all the more important with regard to research dealing
with international taxation. 
Also, for a business school which takes pride in presenting itself as
“international” it would be embarrassing to publish scientific materials in
Swedish.

Mr
Barenfeld is to be congratulated for his achievement. The work is of such a
quality that he is strongly urged to compete for the Mitchell B. Carol Prize,
hosted every year by the International Fiscal Association for academic research
on e.g. international taxation. The award is 5000 Euros and is open to
participants below the age of 35,
a condition which I believe Jesper fullfills!

This
article is not intended to present a 
complete review of  the more than
300 pages produced by Mr. Barenfeld but will be limited to a few remarks on
issues which have occupied my own interest in the past and on which I have also
published my views, (albeit in Swedish.) The topics I will address comprise a
couple of treaty interpretation matters, the definition of the term “foreign
legal entity” (utländsk juridisk person) and some comments to the Alecta case.

Tax treaty interpretation

-
Intention and context.

In a
dissertation of this kind it is of course not possible for its author to give a
comprehensive coverage of such a broad 
subject as treaty interpretation. Considering the specific nature of the
interpretation of tax treaties it would nevertheless  have been appropriate to mention something
about the special interpretation article included in every tax treaty, normally
article 3.2.,  which declares that any
term not defined in the treaty shall, when applied by a Contracting State,
“unless the context otherwise requires, have the meaning that it has at that
time under the law of that State”. 

Being a
part of a treaty text it naturally also falls under the interpretation rules of
the Vienna Convention’s rules of treaty interpretation. And, which I believe is
unique, Sweden
can boast of having supreme court authority on the interpretation of this rule
of tax treaty interpretation!

One must
bear in mind that tax treaties, in contrast to most other types of
international agreements, are closely related to the domestic legislation of
the Contracting States, in this case their tax legislations. If therefore a
term in a tax treaty has the same meaning under both of the Contracting States’
internal laws then this meaning will naturally and automatically also be the ordinary
meaning of the term in the treaty, which 
according to the Vienna Tax Convention’s rules of treaty interpretation
is the primary and basic point of departure for 
all treaty interpretation purposes. In these cases therefore, where the
domestic law meanings of the Contracting States converge, there will be no
interpretation problem whatsoever. The meaning of the term will be clear and
there will be no double taxation or double exemption from tax. The problem with
interpreting tax treaties therefore only starts when the relevant term of the
treaty has different meanings under the domestic tax laws of the Contracting
Sates. The meaning of the term must then be interpreted under the rules of the
Vienna Convention  which in addition to
the ordinary meaning test also prescribes a number of additional criterias to
be taken into account most important of which are that the terms must be
interpreted in their context and and that one must keep in mind the object and
purpose of the treaty.

But how
does the interpretation rule in article 3.2 of 
tax treaties fit into the picture in these cases? As a matter of fact,
quite badly. The reason herefor  is the
simple fact that, if the two Contracting States apply there own domestic
meanings as prescribed by article 3.2., this will always lead to an
unsatisfactory result i.e. double taxation or double exemption. It is in fact
an irony that tax treaties include an interpretation rule which always leads to
an unsatisfactory result! But as far as Sweden is concerned, and which
already has been mentioned, the Supreme Administrative Court of Sweden (SAC)
has in fact given an interpretation of the interpretation rule in article 3.2.
which more or less solves this problem.

This
follows from the landmark case RÅ 1987 ref. 162 in which the Court made
a declaration which can be called the holy scripture of their tax treaty
interpretation approach.. This is what the Court said:

“When one of the Contracting States
applies the treaty according to this rule, every term of the treaty, that has
not been given a specific interpretation, shall be given the meaning
corresponding to the meaning of that term under the current tax law of that
State. This reference to domestic law allows for taking into account not
only  the tax legislation prevailing at
the time of the conclusion of the treaty but also of such changes of the
legislation that can have occurred up to the point in time of  the application of the treaty. The articl,
however, includes an important reservation. Domestic tax rules shall be applied
only unless the context otherwise requires. The meaning of this restriction
according to the Court can be summed up as follows. If a treaty term, as
applied in a specific rule, does not provide a straight answer, one shall, by
taking into account the terminology of the treaty in general, its structure and
system, its function, origin and historical background and any other such
circumstances that reveal the intention of the contracting parties, and if such
an investigation does not give an answer hereto, then one shall seek guidance
in the domestic legislation of the Contracting States”.

The internal law meaning shall thus be taken into
account only as a very last resort after one has made a thorough
investigation of the meaning of the specific term or expression in its context
in order to determine the intention of the parties. The intention of the
parties is consequently the “hidden treasure” which should be sought for,
and this search shall be conducted by all possible means. This
consequently  and very satisfactorily
leaves very little room for the use of domestic law meanings.

The judgement
makes no reference to the Vienna Convention’s interpretation rules but the
similarities between the SAC’s declaration and the basic rules of article 31 of
this Convention are striking. Although there is no specific mention in the
Vienna Convention of the intention of the parties Mr. Barenfeld argues
convincingly that the object and purpose of a treaty is indeed a reference to
the intention of the contracting parties (page 41).

The basic and
overriding intentions of the Contracting States to a tax treaty are to avoid
double taxation   double non-taxation and
evasion of taxes. But these intentions must also be reflected in the specific
articles under investigation. Considering again the specific nature of tax
treaties it is however not always possible to determine the intention of the
contracting parties in the text itself. This applies in particular to the
articles under chapter III and IV (OECD Model Convention) regarding the
taxation of income and capital where the Contracting States on a reciprocal
basis and according to very technical rules allocate taxing rights. It is
simply not possible to determine  any
specific intention demonstrated by the Contracting States directly in these
distributive rules. With regard however to most of the other articles for
instance those that deal with specific definitions e.g. articles 1-4, the
methods of elimination of double taxation (23 A-B) and the special provisions
about non-discrimination (24), the mutual agreement procedure (25) and exchange
of information (26), it is however much easier to discern the underlying
purpose and object of the contracting parties. In these cases therefore the
interpreter should adopt an imaginative and purposive attitude striving to
widen as much as possible the application of these articles in order to respect
and adapt to the underlying intentions of the contracting parties. Indeed this
also applies to such specific articles as subject-to-tax clauses and limitation
of benefits rules where the intentions of the parties are usually very clear.

-
Interpretation of tax treaties concluded before the adoption of revised
commentaries to the OECD Model.

Someone has
said that the OECD Model Tax Convention is like the bible. The text never
changes, only its commentaries. This indeed has formed the basis for a lively
international academic discussion of the extent to which modified OECD
Model Tax Treaty Commentaries may be applied to the interpretation of treaties
concluded before the modification.

Mr.
Barenfeld has joined the crowd of scholars such as Michael Lang, Mattias Dahlberg and
Maria Hilling that hold that modifications of the commentaries are in general
not to be applied to tax treaties concluded before the adoption of the new and
modified commentaries. Mr. Barenfeld, directly quoting paragraph 35 of the
Introduction of the Model, is of course well aware that this attitude runs
contrary to the OECD’s own opinion in this matter. Indeed the OECD has devoted
almost a full page in the Introduction to this effect.

“Before
analysing this viewpoint,” Mr. Barenfeld adds (page 54), “it must be underlined
that it is a recommendation by the OECD to its member countries. The OECD is
not a lawmaking body and consequently can not decide the legal relevance own
its own materials”.

This
statement requires some words to be said about the OECD. This is an
organisation who’s members are the governments of the participating
states and these governments are all represented in the Committee of Fiscal
Affairs which continuously keep hammering out new explanations to its Model Tax
Treaty. These governments, which is very important to keep in mind, are at the
same time exactly the same “persons” or parties that make tax treaties on
behalf of their countries. This forges a strong link between the treaties
concluded by these governments and the explanations in the commentaries of
their joint treaty model whenever this is used as the basis of the treaties
themselves. One could suggest that what is said in the commentaries of the
Model Convention comes directly “from the horse’s mouth” of the treaty partners
revealing their intentions to be respected in the interpretation process of
their bilateral treaties.

Important
to note is also the fact that the OECD whenever its Model Tax Convention is
modified specifically recommends (paragraph I.3.) “that their tax
administrations follow the Commentaries on the Articles of the Model Tax
Convention, as modified from time to time (emphasis added), when
applying and interpretating the provisions of their bilateral tax conventions
that are based on these Articles”. This clearly indicates an open mind to using
the new commentaries also to earlier treaties.

Mr.
Barenfeld, quoting Mattias
Dahlberg, 
distinguishes between situations where the change is only a
clarification of the commentary and cases where the change is an addition to it
without being a clarification. According to Dahlberg, the commentaries constitute
a basis of the interpretation in the first, but not in the second situation.
Mr. Barenfeld recommends “utmost caution when approaching such a distinction as
it is exceptionally difficult, not to say impossible, to establish what is a
mere clarification of what was already there and what is in fact a change of
the material content.”  Indeed the brunt
of all modifications made to the Commentaries over the years represent
additions to the text. The reason they were not presented from the start is in
most cases that the specific topic addressed were not considered at that time
or that they were simply not considered necessary. A good example hereof, it is
suggested, are the modifications made to the commentaries a couple of years ago
with regard to the treatment of partnerships. With this in mind many additions
to the Commentaries should be seen as clarifications thereof.

On page 55
Mr. Barenfeld makes a point supporting the OECD’s ambulatory approach or its
inclination to apply its modifications to the Commentaries also to earlier
treaties by concluding that “both parties, at the time of ratification,
accepted an interpretation according to the commentaries also in regard to
future changes. Or to put it differently, that future changes constitute the
common intention of the parties.” This declaration which has derived no
explanation by Mr. Barenfeld, indeed dovetails the declaration in the official
recommendation of the OECD that one should follow the Commentaries of The Model
Convention, “as modified from time to time”. Or in other words, also future
modifications.

Another
objection, and his most important one, raised by Mr. Barenfeld, and taking
support from Michael Lang,  with regard
to the ambulatory approach allowing an application of commentaries adopted
later than the treaty itself, is one of constitutionality (page 56). In
his own words: “It must be recalled that double tax conventions are not only
binding for the treaty states but also for a third party, i.e. the tax payer.
Using Sweden
as an example, the constitution provides that taxation of these persons must
follow from law. The legislative body is the Swedish Parliament. Furthermore,
the Swedish Government must not enter into international conventions, such as
double tax treaties, without them being accepted by Parliament if the
convention requires that a law is changed or repealed or that a new law has
been founded. The relevant authority in this respect is consequently the
Swedish Parliament. With this in mind it is hardly reasonable that changes made
to the commentaries by the OECD would meet such constitutional requirements.”

These
statements are completely true insofar as they concern the actual treaty text.
By ratification these bilateral treaties become part of the Swedish domestic
legislation, according to our monistic law-making principle. But as already
determined above by Mr. Barenfeld himself, the OECD is indeed not a lawmaking
body and its commentaries to its Model 
have no legal relevance or binding force. They are only a set of
recommendations to the interpreter indicating how the contracting parties, i.e.
the governments, suggest that the treaty text should be understood.  And for this very reason the commentaries, no
matter when they were introduced or modified, can never raise any
constitutional concerns.

But, as we
all know from experience, the Commentaries to the Model Treaty certainly have
relevance for the interpretation process but only because they are
intellectually convincing and make sense. And also, as aforementioned, because
they have been published after very 
close and joint scrutiny by a very authoritative source, i.e. the
persons who at the same time are those that have made the relevant bilateral
treaty under interpretation!

It is nor
quite clear why Mr. Barenfeld is so reluctant to the ambulatory approach of
using modified Commentaries also to old treaties, but by his reference to the
position of the tax payer, it seems that his hesitation stems from a
consideration for legal certainty. Or, in other words, the taxpayer must be
able to rely on the treaty as it was once concluded. This seemingly suggests
that the modifications of the treaty are always to the detriment of the tax
payer. But one should of course also remember that the modification just as
likely may be to the benefit of the tax payer. In this case everybody would
agree that it would be a great shame not to apply the modification. Moreover,
one is never guaranteed “eternal life” in tax matters. There is for instance
nothing preventing the SAC from changing their mind if they so choose!

At the same
time, and this is something upon which everybody agrees, it is very complicated
always having to determine at what point a specific modification of the
Commentaries took place with regard to the relevant treaty under
interpretation. Considering moreover that the Contracting parties as revealed
in the recommendations of Model Treaty authors have no reservations about
allowing application of modified Commentaries to treaties concluded before
these modifications, a useful compromise of the problem would be to adopt a
method whereby the modified Commentaries shall be accepted for interpretation
purposes only with regard to investments made and income derived after the
adoption of the modifications. The validity of new Commentaries should thus be
referred not to when they were adopted but to the point in time when the income
was derived. In this way the problem of certainty for the tax payer is always
accommodated. (This is an idea I raised already a couple of years ago, see
IUR-INFO 4/02.)

An additional
method, albeit quite impractical, to solve the problem of modification of the
Commentaries would be for the Contracting parties to terminate their treaties
and immediately upon the modifications to let them re-enter into force. In that
way there would never be any bilateral treaties that are older than the last
modification of the Commentaries!

- In dubio pro fiscus or in dubio mitius (pro tax payer)?

On page 44
Mr. Barenfeld has discussed a quite novel point of  treaty interpretation suggesting that in a
situation where there are two different but equally appropriate solutions of
the interpretation process under the Vienna Convention rules one should adopt
that, which gives the most favourable result for the tax payer.

This of course is an appealing attitude with roots in such maxims as in dubio
mitius under penal law etc. and, according to Mr. Barenfeld, resting also on
the principle that treaties can only limit, but not extend, a state’s right to
tax income according to its domestic rules. This last mentioned principle is
however not relevant in this context as it refers not to two (or more) equally
valid interpretations of the treaty but to the relative scope of taxation
between domestic law and the treaty.

But there
are also other reservations to be made against a “pro tax payer” choice of
interpretation. First of all one must remember that not even under tax treaties
is there a final guarantee that double taxation will be relieved. The treaty in
that sense is not a perfect instrument. The point of departure of all treaty
application is double taxation. Relief from double taxation is not a human
right and it not guaranteed not even 
under a treaty for the avoidance of double taxation. This attitude also
becomes apparent by the fact that tax treaties include a specific article
furnishing the tax payer with the possibility of taking his case to a
settlement by the competent authorities (article 25) if he is not satisfied
with the result of the application of the treaty by the courts.

Definition
of the term “foreign legal entity.

Under
section 8.8.3.1. Mr Barenfeld has joined the discussion generated by Nils Mattsson in his
article in Skattenytt no 3, 2000 
regarding the definition of the term “foreign legal entity”.  This inspired myself to an article on
the same topic in IUR-Information, no 4/5 2002 with the long title
“Skattskyldighet I Sverige för inkomst som förvärvas av svenska och utländska
handelsbolag samt svenska och utländska europeiska internationella
intressegrupperingar (EEIG)”.

More specifically
the problems arising with the present definition of the term “foreign legal
entity” (utländsk juridisk person), stems, inter alia, from the requirement
that such an entity shall be an ‘association’. 
“In search of a more suitable provision”, Mr. Barenfeld continues (page
268), “Mattsson has suggested that this expression be replaced with the Swedish
word for ‘alliance’ (sammanslutning)” Mr. Barenfeld, however, rejects this
suggestion contending ,” that  a problem
with this alternative … is that it suggests that the foreign entity  shall be a grouping of persons. It will
therefore give rise to uncertainties with respect to entities that are run by
only one member. It can also be questioned whether it comprises bodies that do
not have any members at all, such as foundations. Furthermore, Sundgren argues
that there is no difference in principle between this expression and the word
‘association’, and therefore this would not give the desired clarification. For
this reason he suggests that the Swedish classification regime should include

                     any person that is not
an individual or a Swedish legal person (…)

Sundgren
consequently uses the fact that the classification legislation shall be
applicable to any person other than an individual. In this respect the approach
is commendable. There is arguably no difficulty in establishing whether a
person is an individual”….. “A difficulty with Sundgren’s approach, however, is
how to understand the word person. Sundgren suggests that the definition
established in the OECD MTC shall serve as guidance. The OECD MTC is, however,
not authoritative for the interpretation of Swedish internal law, and does
therefore not provide for clarity and legal certainty in this context.”

Subsequently
Mr. Barenfeld suggests as an alternative (page 269), in order to facilitate the
approach of including all bodies other than individuals an expression that is
as broad as possible, the term ‘verksamhetsform’.

I am quite
happy with this suggestion and also with Mr Barenfeld’s idea that to clarify
the suggested expression further, it is suitable to supplement it with a
non-exclusive list, exemplifying a number of entity types including for example
partnerships, companies, societies, associations, foundations trusts and estates.

But I still
maintain my idea of seeking guidance from the OECD MTC insisting that anything
that is good enough for the Model Treaty godfathers is good enough for me!

However,
what is most important is that we together can persuade the legislator to do
something about the shortcomings of the present legislation in this field.

The Alecta (advance ruling) case

This SAC,
case RÅ 2001 ref. 21, analysed under paragraph 6 of Mr. Barenfeld’s
dissertation, has, as already mentioned, had the disastrous effect that Swedish
resident partners of foreign partnerships are denied a credit for foreign taxes
attributable to the activities of the partnership irrespective of where the
partnership is situated and irrespective also of whether it is
symmetrical or asymmetrical. This case gave rise to a tsunami of criticism from
the international tax community in Sweden,
most notably from Mr. Yngve Hallin, who in the post-war era was Sweden’s chief
tax treaty negotiator for such a long time that everybody gave up counting the
years. He is now eighty plus and in splendid intellectual form. Mr. Barenfeld’s
analysis which is delivered in very understated language nevertheless
represents a welcome and effective final “intellectual execution” of the
outcome. Especially frustrating for an old time member of IFA like myself,  having taken part of all the efforts made by
that organisation regarding the international tax problems of  partnerships, see Cahiers de Droit Fiscal
International Vol 80 a.
1995, which subsequently inspired the OECD 
to include a very long modification of 
the Commentaries to its Model Tax Treaty in 2000, is the fact that this
has been completely ignored in the judgement. To be perfectly frank this case
represents an irreparable embarrassment to the 
SAC.

Even more
distressing, not to say scandalous, is the fact however that nothing was done
to counteract the effects of the case. In 2002, shortly after I published my
own review of the case, I personally contacted the management of the Alecta
company imploring them to apply for a competent authority ruling under the
treaty with the US.
Obviously disgusted with the ruling and, as it seemed, planning for an
alternative tax structure, the company declined this suggestion. I then got in
touch with the National Tax Board, which is also the Swedish competent
authority under our tax treaties, and suggested to them that they under article
25 subparagraph 3 “should endeavour to resolve by mutual agreement” the problem
that had arisen due to the SAC ruling. The somewhat contradictory reply from
the Board was that this article applied to more general agreements and that the
problem was of such a universal nature that it was not suited for a bilateral
agreement under the mutual agreement procedure (sic.) I then urged the US competent
authority to try to reach a settlement under article 25 but they also declined
the suggestion pointing out that they could take action only upon a specific
request from a taxpayer. They noted however that “if any double tax results
from the Swedish court decision, it would be on the Swedish side, since it
appears they are not recognizing the pass through entity and disallowing the
tax credit for taxes paid to the U.S.”

It has now
been four years since the publication of the Alecta case, and still no reaction
from the legislator. Just recently the Swedish foreign tax credit legislation
was in fact modified to allow for credit of underlying  taxes paid by foreign CFC-companies – a move
that one would have thought should have inspired the legislator to allow a
credit also for foreign partnership taxes – but this opportunity was also lost.
An unconfirmed source has recently declared that the Swedish finance department
has taken note of the problem regarding foreign partnerships and that “some
progress has been made”.

Stockholm 2 March 2005.

Peter Sundgren