In this article, some of the recent important foreign Supreme Court decisions on cross border taxation are covered. In view of increasing globalisation, movement of Capital, Technology and Personnel, various issues arising in taxation of Cross Border Transactions are increasingly becoming similar. The various issues discussed in these Foreign Supreme Courts’ decisions have a global resonance due to common terminology used in Model Tax Conventions and various Double Tax Avoidance Agreements. These decisions represent useful accretion to the jurisprudence on the respective topics/issues. The compilers hope that these decisions would be useful in guiding taxpayers, tax advisors, Revenue Officials and the Judiciary when similar issues come up for consideration in the Indian context.
1. France – Treaty between France and India – French Administrative Supreme Court rules on tax sparing/ matching credit provisions
In a decision (No. 366680, SA Natixis) given on 25th February 2015, the French Administrative Supreme Court (Conseil d’Etat) ruled on the tax sparing/matching credit provisions of the France – India Income and Capital Tax Treaty (1992) (the Treaty). The Court ruled that, for a French resident receiving interest from India to benefit from a tax sparing/matching credit, such interest must either have been subject to taxation in India or exempted by virtue of the laws of India referred to in article 25(3)(c)(i) or article 25(3)(c)(ii) of the Treaty.
(a) Facts. The French-resident bank SA Natixis (formerly SA Natexis Banques Populaires) received interest income from residents of India in 1998 and 1999. This interest income was exempt from tax in India. The tax authorities granted a tax credit for this income. However, considering that the tax credit was not calculated in accordance with the Treaty provisions, the French bank filed a claim. The first-instance Tribunal (Tribunal administratif) rejected its claim.
Confirming the judgment from the first-instance Tribunal, the administrative court of appeal (Cour administrative d’appel) ruled that the tax sparing/matching credit provided for by the Treaty regarding interest shall be granted only where such interest income was subject to tax in India. Where the interest income was not subject to any tax in India, it shall not entitle the French resident to a tax sparing/ matching credit, except where an Indian tax might have been payable but was not levied on the basis of one of the laws of India referred to in article 25(3)(c)(i) or article 25(3) (c)(ii) of the Treaty.
Thus, the administrative court of appeal found that the French bank was not entitled to any tax sparing/matching credit as the French bank:
– neither proved that the Indian-source interest income was subject to Indian tax;
– nor proved that the Indian-source interest income was exempt from Indian tax by virtue of one of the laws of India referred to in the Treaty.
Thus, the court first applied the interpretation given by the French Administrative Supreme Court regarding matching credit provisions contained in the Brazil-France Tax Treaty and then took into account the exception provided for in the Treaty.
(b) Issue. Whether interest income that was fully exempt from tax in India entitle its French recipient to a tax sparing/ matching credit under article 25 of the Treaty?
(c) Decision. The French Administrative Supreme Court ruled that:
– in general, a French resident receiving interest from India may benefit from a tax credit only where such interest was subject to taxation in India; and
– as an exception, a French resident receiving interest from India that was exempt from Indian tax may still benefit from a tax credit where a Indian tax would have been payable but for a full exemption granted under one of the laws of India referred to in article 25 of the Treaty.
The French Administrative Supreme Court then noted that the French bank:
– neither proved that the Indian-source interest income was subject to Indian tax;
– nor proved that the Indian-source interest income was exempt from Indian tax under one of the laws of India referred to in article 25 of the Treaty, and specify the law in question.
The French Administrative Supreme Court therefore concluded that the bank, which bore the burden of proof, was not entitled to any tax sparing/matching credit, and dismissed its claim.
2. Japanese Supreme Court decision – Bermuda LPS is not a corporation
On 17th July 2015, the Japanese Supreme Court disallowed an application by the tax authorities to appeal a Tokyo High Court decision, in which a limited partnership (LPS) registered in Bermuda was held not to be a corporation for Japanese tax law purposes.
(a) Facts. The taxpayer (Tokyo Star Holdings LP) is an LPS based on Bermuda law (Partnership Act 1902 and Limited Partnership Act 1883). The taxpayer is also an exempted partnership (EPS) based on Bermuda law (Exempted Partnerships Act 1992), which is not subject to tax on income in Bermuda.
A Delaware LLC and two Cayman corporations entered into several silent/sleeping partnership agreements with the former as silent/sleeping partners (tokumei kumiaiin) and the latter as business operators (eigyousha). The Cayman corporations as eigyousha had branches in Japan and were in the business of collecting claims.
The Delaware LLC then sold the interests in the silent/ sleeping partnerships to an Irish corporation. The taxpayer and the Irish corporation (as tokumei kumiaiin) subsequently entered into a swap contract under which the business profits of the eigyousha were distributed to the tokumei kumiaiin and, in turn, to the taxpayer.
The Japanese tax authorities argued that the distribution received by the taxpayer from the tokumei kumiai constituted domestic source income under article 138(11) of the Japanese Corporate Tax Act (CTA ). The taxpayer argued that since, as a Bermuda LPS, it was not a corporation within the meaning of the CTA , it was not a taxable entity.
(b) Issue. The first issue was whether the taxpayer was a corporation for Japanese tax law purposes. If not, the second issue was whether the taxpayer was a “non-judicial association, etc.” (jinkaku no nai shadan tou) within the meaning of article 3 of the CTA , which provides that such an association is treated as a corporation.
(c) Decision. The Tokyo District Court, in its decision of 30th August 2012, case number Heisei 23 (2011) gyou-u No. 123, reported in Kinyû Shôji Hanrei 1405-30, ruled that the taxpayer was neither a corporation nor a “non-judicial association, etc.”, and that taxation of the taxpayer was not void but illegal.
The tax authorities appealed, but the Tokyo High Court, in its decision of 5th February 2014, case number Heisei 24 (2012) gyou-ko No. 345, reported in Kinyû Shôji Hanrei 1450-10, upheld the Tokyo District Court’s decision.
The Supreme Court did not allow the tax authorities’ further appeal of the respondent, whereupon the matter was finalised.
With respect to the first issue, article 36(1) of the Japanese Civil Code provides that “…, no establishment of a foreign juridical person shall be approved; provided, however, that, this shall not apply to any foreign juridical person which is approved pursuant to the provisions of a law or treaty.” The courts held that whether a business entity is considered a “foreign corporation” (a foreign judicial person under the Civil Code) is determined with reference to the relevant foreign law governing the corporate legal personality of the business entity in question. In this case, the courts held that Bermuda law did not provide the taxpayer with a corporate legal personality, so that the taxpayer was not a “foreign judicial person” under civil law; therefore, the taxpayer was also not a “foreign corporation” under the CTA.
For the second issue, the courts held that a “non-judicial association, etc.” (jinkaku no nai shadan tou) under the CTA was equivalent to an “association without capacity to hold rights” (kenri nouryoku naki shadan) under civil law, which had been defined by the Supreme Court decision of 15th October 1964, case number Shouwa 35 (1960) o No. 1029, reported in Minshû 18-8-1671. In the 1964 Supreme Court case, it was stated that an “association without capacity to hold rights” must have (1) an organisation as a body, (2) a decision by majority, (3) continuation of the body despite the change of the members, and (4) a defined rule concerning representation, operation of a general meeting, management of properties, etc. In this case, the courts held that the requirements of (1), (2) and (4) were not satisfied; therefore, the taxpayer was not a “non-judicial association, etc.” and was not subject to Japanese corporate tax.
In conclusion, the tax authorities erred in taxing the Bermuda LPS; instead, the partners of the LPS (being corporate entities) should have been subject to tax.
Note: The Supreme Court, in its decision of 17th July 2015 ruled that a Delaware LPS was a corporation. In that case, the Supreme Court applied a “second stage of determination” where the attribution of rights and duties was concerned. Although the attribution of rights and duties was argued by the tax authorities in this Bermuda LPS case, the Tokyo District Court and High Court explicitly rejected this in arriving at their decisions on 30th August 2012 and 5th February 2014, respectively. Since the Supreme Court, in disallowing the appeal, did not mention the second stage of determination, it is reasonable to assume that the Supreme Court would have found that the Bermuda LPS was not a corporation, even if the second stage of determination in the Delaware LPS case had been applied.
3. Argentina – Supreme Court decision on application of substance-over-form principle and CFC rules
On 24th February 2015, the Supreme Court gave its decision in the case Malteria Pampa S.A. concerning the application of the substance-over-form principle (realidad económica) and controlled foreign company (CFC) rules. Specifically, the Court dealt with the difference between a foreign subsidiary and foreign permanent establishment (PE) of a resident company, and the timing of income taxation. Details of the case are summarised below:
(a) Facts. Malteria Pampa, a resident company, had a wholly-owned subsidiary based in Uruguay. The tax authority reassessed the company’s tax returns for 2000 and 2001 to include the profits derived by the non-resident subsidiary. The subsidiary had not paid any dividend; however, the tax administration applied the substance-over-form principle in order to disregard its legal form and to treat it as a foreign PE of the resident company. The tax authority based its position on the resident company’s control of the non-resident subsidiary in the form of capital ownership, voting power and company board appointment power.
(b) Legal Background. The CFC regime generally applies when a foreign subsidiary is a resident of a blacklisted jurisdiction and the passive income derived by that subsidiary is more than 50% of its total income.
The Income Tax Law (Ley de Impuesto a las Ganancias, LIG) contains detailed provisions distinguishing between a subsidiary and a PE by providing for a different tax treatment, i.e. article 69 of the LIG lists different taxable entities, explicitly stating PEs as taxable entities different from the subsidiaries. Articles 18, 128, 133, 148 of the LIG set out the timing for taxation of income accrued by PEs and subsidiaries, regulating situations where CFC rules apply.
(c) Decision. The Court upheld the taxpayer’s position based on the application of the provisions of the LIG, rejecting the application of the substance-over-form principle. In particular, it underlined the relevance of the legal form and confirmed that income derived by a foreign subsidiary may be taxed in the hands of a resident only when dividends are paid, unless CFC rules are applicable.
4 Finland Supreme Administrative Court – Profits of foreign PEs included when calculating FTC although no tax was actually paid abroad
The Supreme Administrative Court of Finland (Korkein hallinto-oikeus, KHO) gave its decision on 31st October 2014 in the case of KHO:2014:159.
(a) Facts. A company resident in Finland (FI Co) exercised its business activities in Finland and through permanent establishments (PEs) abroad, including PEs in Estonia (EE
PE) and the United Kingdom (UK PE). The PE profits, in general, were included in the taxable income of FI Co.
In addition, the PE profits were taxed in the country where they were located. However, UK PE did not have any taxable profits due to the losses from previous tax years which were set off against the profits. EE PE, on the other hand, did not pay any tax due to the Estonian tax system which does not tax undistributed profits.
(b) Legal Background. Under Law on Elimination of International Double Taxation (Laki kansainvälisen kaksinkertaisen verotuksen poistamisesta), double taxation is eliminated by crediting the tax paid on the foreign income in the source country. The foreign tax credit (FTC) is limited to the amount of Finnish tax payable on the foreign-source income.
(c) Issue. The issue was whether or not the PE profits from
EE PE and UK PE should be taken into account when calculating the maximum credit for the tax paid abroad.
(d) Decision. The Supreme Administrative Court held that the PE profits of EE PE and UK PE are to be included in the profits of FI Co when calculating the maximum credit for the taxes paid abroad. The Court pointed out that, when calculating the base for the FTC, it is not required that tax has actually been paid for such income. What is essential is that the income is taxable in Finland and in its source country. The fact that the moment of taxation has been deferred, as in the case of EE PE, has no relevance.
5. Norway – Supreme Court allows use of “secret comparables” in TP assessment
The Supreme Court of Norway (Norges Høyesterett) gave its decision on 27 March 2015 in the case of Total E&P Norge AS vs. Petroleum Tax Office (case 2014/498, reference number HR-2015-00699-A)
(a) Facts. Between 2002 and 2007, the taxpayer Total E&P Norge AS (NO Parent) sold gas to 3 foreign related companies. The tax authorities regarded that the sales prices were not at arm’s length based on a comparison between the sales by NO Parent and similar transactions executed by third-party taxpayers (the Third-party Sales). The tax authorities refused to disclose details of the
Third-party Sales due to confidentiality rules. NO Parent appealed on the assessment.
(b) Issue. The issue was whether the tax authorities could base their assessment on comparables which are not fully disclosed to the taxpayer.
(c) Decision. The Court rejected the appeal and ruled that the tax assessment could be based on “secret comparables”. The use of secret comparables was deemed necessary to ensure an effective control of the transactions. Even though NO Parent was not given access to all the Third-party Sales used as comparables, NO Parent obtained enough information to have an adequate opportunity to defend its own position and to safeguard effective judicial control by the courts, as stated in the OECD Transfer Pricing Guidelines.
6. France – Administrative Supreme Court rules that individual with French income only is resident of France
In a decision given on 17th June 2015 (No. 371412), the Administrative Supreme Court (Conseil d’Etat) ruled that an individual living outside France, but whose only income is a French-source pension has the centre of his economic interests in France. Such an individual is thus a resident of France under domestic law.
(a) Facts. Mr. Georges B. is a French pensioner who lived in Cambodia from 1996 to 2007, working there as a volunteer for non-governmental organisations. His only income during these years was a French pension paid to a French bank account.
The pension was subject to withholding tax applicable to pensions paid to non-resident individuals. As the withholding tax was higher than the income tax that he would have paid as a resident, Mr. Georges B. claimed a tax refund. The tax authorities, however, considered that Mr. Georges B. could not be regarded as a resident of France and that the withholding tax was applicable to his case. The Court of First Instance (tribunal administratif) as well as the Administrative Court of Appeals (cour administrative d’appel) confirmed the tax authorities’ position. The Administrative Court of Appeals considered that the mere payment of a French pension to Mr Georges B. was not sufficient to retain the centre of his economic interests in France insofar as:
– the payment of the pension to a French bank account was merely a technical method chosen by the taxpayer himself;
– parts of the pension were transferred to Cambodia to cover the needs of Mr. Georges B. and his new family there;
– Mr. Georges B. administered his French bank account from Cambodia; and
– the pension was not a remuneration derived from an economic activity carried out in France.
(b) Issue. Under article 4 B(1) of the General Tax Code (Code général des impôts, CGI), resident individuals are persons who:
– have their home or principal abode in France; or
– perform employment or independent services in France (unless such activity is only ancillary); or
– have the centre of their economic interests in France.
In this case, the issue was whether an individual living and working outside France but whose only income is a French-source pension has the centre of his economic interests in France.
(c) Decision. The Administrative Supreme Court ruled that the elements on which the lower courts based their judgments did not prove that the centre of the economic interests of Mr. Georges B. shifted out of France. As his only income was French-sourced, Mr. Georges B. still had the centre of his economic interests in France between 1996 and 2007. Thus, Mr. Georges B. was a resident of France under domestic law.
The French Administrative Supreme Court thus confirmed that the centre of the economic interests of an individual must be assessed mainly with regard to his income, irrespective of the exercise of an economic activity.
Note: Cambodia and France did not conclude a tax treaty.
Consequently, only domestic law was applicable.
7. Netherlands Supreme Court – business motive test also applies to external acquisitions
On 5th June 2015, the Netherlands Supreme Court (Hoge Raad der Nederlanden) (the Court) gave its decision in the case of X1 BV and X2 BV v. the tax administration.
(a) Facts. Two Dutch resident companies (X1 BV and X2 BV) were part of a South African Media group. In 2007, the listed parent company of the group issued shares. Thereafter, the parent company lent part of the proceeds from the share issue to its subsidiary, which was a South African resident holding company. This holding company subsequently contributed the funds to a holding company located in Mauritius. The Mauritius-based holding company then lent the funds to the financing company of the group, which was also resident in Mauritius.
In 2007, the two Dutch resident companies acquired several participations. Those acquisitions were partially financed by funds received from the Mauritian finance company. Those funds originated from the issue of shares by the parent company of the group.
Due to the financing structure, the Dutch resident companies took on a related party debt for financing the acquisition of the participations.
Reasoning that both the acquisitions and the loans were based on commercial reasons, the companies claimed a deduction of interest paid to the Mauritius finance company.
(b) Issue. The issue was whether the interest on the related party debt was deductible.
(c) Decision. The Court began by observing that article 10a of the Corporate Income Tax Act (CITA) limits the deduction of interest on funds borrowed from another group company. This restriction, inter alia, applies in the case of funds borrowed for the acquisition of shares in a company. Thereafter, the Court emphasised that it is for the taxpayer to prove that a decision to borrow funds from a related party to finance acquisitions of participations is predominantly motivated by commercial reasons.
However, in this context the Court decided that not only the taxpayer’s motives are decisive, but that the reasons of all parties involved in a transaction must be taken into account for the determination of whether the business purpose test is met.
Consequently, an interest deduction cannot be justified with the argument that there was no alternative than to accept a loan offer from a related party.
Thereafter, the Court repeated its consistent case law that a parent company can freely decide to fund its subsidiaries with debt or equity. This rule implies that the Dutch legislator has to accept a direct funding through a low-taxed group finance company.
The Court rejected the taxpayer’s argument that both the loan and the acquisitions were predominantly based on commercial reasons. In this context, the Court held that a reference to case law based on the abuse of law doctrine was irrelevant in the case at hand, because this case law is not relevant for the application of the Dutch base erosion rules.
The Court also rejected the reasoning of the taxpayers which was based on legislative history. The taxpayers indicated that the obtaining of a related party debt was based on commercial reasons because debt arose from the issuance of shares. Furthermore, the proceeds from the share issue were not received from the finance company to obtain a specific acquisition but only to obtain acquisitions in general. The Court judged that the moment when a taxpayer decides to purchase a specific acquisition is not decisive for the determination of whether a borrowed loan from a third party is based on commercial reasons.
Due to the fact that it was not shown that all transactions involved in the transaction were based on commercial reasons, the Court denied the interest deduction. In addition, the case was referred to another lower court to determine if funds provided by the Mauritius company to the financing company of the group determined whether the construction was based on commercial reasons.
Note: The importance of the case is that the Court has clarified that a re-routing outside the Netherlands must be based on business motives to claim an interest deduction. In addition, the Court, however, decided that the interest deduction restriction of article 10a CITA does not always apply when an acquisition is financed with an intra-group loan based on tax motives, if the taxpayer shows that business motives exist.
8. Japanese Supreme Court decision – Delaware LPS is a corporation
The Japanese Supreme Court held in its decision dated 17th July 2015, case number Heisei 25 (2013) gyou-hi No.166, that a Delaware limited partnership (LPS) is, for Japanese tax purposes, a corporation.
(a) Facts. The plaintiffs (Japanese resident individuals) participated in a LPS pursuant to the Delaware Revised Uniform Limited Partnership Act (hereafter, DRULPA). The LPS invested in the leasing of used collective housing in the US states of California and Florida, which incurred losses. The plaintiffs filed their individual income tax returns treating the LPS as transparent and taking the losses arising into account when reporting their taxable income as per article 26 of the Income-tax Act (ITA).
The Japanese tax authorities, however, argued that the LPS was in fact a corporation (and opaque) and therefore the losses did not belong to partners, but to the corporation.
(b) Issue. The issue was whether the Delaware LPS was a corporation.
(c) Decision. The Supreme Court overturned the Nagoya High Court’s decision on 24th January 2013 (case number Heisei 24 (2012) No. 8) which had ruled in favour of the taxpayers.
Instead, the Supreme Court held that article 2(1)(7) of the ITA defines a “foreign corporation” as “a corporation that is not a domestic corporation”, but does not go on to define a “corporation”. Therefore, whether or not a foreign entity is a “corporation” (houjin) is based on whether it would be considered a “corporation” in Japanese law.
There are two stages to this. Firstly, it is scrutinised whether the wordings or mechanics of the incorporating law explicitly (meihakuni) gives, without question, legal status to the entity as a corporation or explicitly does not give it. If it is neither, then, at the second stage, it is scrutinised whether the entity is a subject to which rights and duties attribute.
In this case, at the first stage, DRULPA uses the wordings of “separate legal entity”, but it is not clear whether a “legal entity” in Delaware constitutes a “corporation” in Japan.
Additionally, the General Corporation Law of the State of Delaware uses “a body corporate” to mean a “corporation” in Delaware. Therefore it is not explicitly clear whether a “separate legal entity” in Delaware has the same legal status as a “corporation” in Japan.
At the second stage of determination, it is clear that the LPS is a subject to which rights and duties attribute. The partners of the LPS only have abstract rights on whole assets of the LPS, they do not have concrete interests on the respective goods or rights belonging to the LPS.
Therefore, the losses in the leasing business did not belong to Japanese partners. Stating that an LPS in the USA was generally treated as transparent, it remains to be seen by the Nagoya High Court if the taxpayers had “justifiable grounds” in understating their income. Article 65(4) of the Act on General Rules for National Taxes provides that additional tax for understatement will not be charged if a taxpayer has justifiably understated his taxable income.
9. Italy – Supreme Court rules on application of transfer pricing rules to interest-free loans between related companies
The Italian Supreme Court (Corte di Cassazione) gave its Decision No. 27087 of 19 December 2014 (recently published) on the application of transfer pricing rules to interest-free loans between related companies.
An Italian company granted an interest-free loan to its Luxembourg and US subsidiaries in order to optimise the available resources and maintain the market share. The Italian Tax Authorities (ITA) reassessed and included in the corporate income tax basis of the Italian company interest income calculated at the normal value, on the basis of article 110(7) of Presidential Decree No. 917 of 22nd December 1986. Precisely, the ITA defined the Italian company’s choice to grant an interest-free loan as “abnormal” and claimed that, by obtaining the interest–free loan, the non-resident subsidiaries were in a more favourable position compared to other companies operating in the open market.
The Supreme Court noted that the Italian company’s choice to grant an interest-free loan to its non-resident subsidiaries was aimed at addressing their temporary economic needs and, therefore, it did not constitute an unlawful or elusive conduct. Furthermore, the Supreme Court held that article 110(7) of Presidential Decree No. 917 of 22nd December 1986 does not provide for the absolute presumption that any cross-border transaction with related parties must be onerous, but only provides for the valuation of components of income deriving from onerous cross-border transactions, on the basis of the normal value (article 9(3) of Presidential Decree No. 917 of 22nd December 1986) of the goods transferred, services rendered, and services and goods received.
10. Brazil Supreme Federal Court confirms income tax on accumulated income calculated on accrual basis
On 23rd October 2014, the Supreme Federal Court (Supremo Tribunal Federal, STF) confirmed that the income tax levied on accumulated income received at a later stage as a lump-sum payment (rendimento recebidos acumuladamente) must be calculated on an accrual basis (regime de competência) and not on a cash basis (regime de caixa). The STF gave its position in Appeal 614406 (Recurso Extraordinário 614406), lodged by the tax authorities against a decision given by the lower court in favour of the taxpayer.
Since the STF recognised the “general repercussion” (repercussão geral) of the case (see Note), the decision will have an impact on more than 9,000 similar cases currently examined in lower courts.
(a) Background. The National Institute of Social Security (Instituto Nacional de Seguridade Social, INSS) paid a debt it owed to a taxpayer as a lump-sum payment. Tax authorities calculated the income tax due on a cash basis, i.e. on the basis of the accumulated income (i.e. the lump-sum payment) and according to tax brackets and rates applicable at the moment of the payment. The taxpayer requested the calculation he would have been entitled to if the amounts had been correctly paid by the INSS, that is, on an accrual basis. Accordingly, the income tax due would be calculated on the basis of monthly instalments and according to the tax brackets and rates applicable at each month.
(b) Decision. The STF stated that the income tax must be calculated according to the rules existing at the time the income should have been paid. As a result, income tax must be levied on the amount that was due per month and according to the tax brackets and rates applicable at each respective month. The Court stated that the levy of the income tax on the accumulated income would be contrary to the ability to pay and proportionality principles.
Note: The STF may recognise the “general repercussion” (repercussão geral) in cases of high legal, political, social or economic relevance. Once “general repercussion” is recognized in a case, the decision given by the STF on the matter must be subsequently applied by lower courts in similar cases. The purpose of the “general repercussion” procedure is to reduce the number of appeals lodged at the STF.
11. Belgium – Supreme Court – Principles of good governance and fair trial govern admissibility in court of illegally obtained evidence
