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By Grant Hanessian, Esq., and Michiel Kloes, Esq.
Baker & McKenzie LLPNew York, NY, and Palo Alto, CA/Amsterdam
When investing abroad, one should take into account not only the tax benefits offered by income tax treaties but also the protections offered by bilateral investment treaties (BITs). These protections are often overlooked when structures for foreign investments are created until the value of existing investments is threatened by hostile government action. However, as is shown by a recent ExxonMobil case, one would be mistaken not to take the protection of BITs into account when structuring investments in countries with a political climate with a higher risk profile.
After the expropriation of ExxonMobil's assets in Venezuela, ExxonMobil was able to obtain a freeze on $12 billion of Venezuela's state-owned oil company's assets after claiming the protection of the Netherlands–Venezuela BIT.1 The arbitration is still pending, but this clearly shows that BIT protection should be strongly considered when structuring future (or restructuring existing) foreign investments.
What Is a Bilateral Investment Treaty?
A BIT is a treaty between two states establishing the terms and conditions for the protection of investors of one state and their investments in the other state. BITs may be seen as "free insurance" since BIT protection can often be achieved at minimal cost, for example, by interposing a holding company in a jurisdiction that has a favorable BIT with the country in which the investment is made.
BITs generally include substantive guarantees regarding the treatment of investors, which should be fair, equitable, non-discriminatory, and not less favorable than the treatment of domestic investors or investors from other states. Furthermore, BITs may provide protection from expropriation; a BIT is a commitment of a Contracting State to observe any obligation it has assumed with regard to investments in its territory by investors of the other Contracting State.
The investor directly benefits from these commitments as they establish direct rights of the investor vis-a`-vis the host state, which can be enforced against the host state and reduce the impact of political or legal changes and risks.
The Netherlands is a favorable holding jurisdiction and has a large number of investor-friendly BITs that offer direct access to international arbitration as opposed to requiring proceedings in a local court to be exhausted first. Furthermore, the Netherlands' BITs generally offer protection for indirect investments made by a Netherlands company through local subsidiaries. Obviously, in order to determine whether a Netherlands BIT is indeed the best BIT for protection of a particular investment, it is critical to review the terms and conditions of the Netherlands BIT and the other BITs under consideration.
International arbitration is mostly allowed under BITs under the auspices of the International Centre for the Settlement of Investment Disputes (ICSID) or under the rules of the United Nations Commission on International Trade Law (UNCITRAL). The ICSID is an autonomous international organization based in Washington, D.C., with close links to the World Bank, and was founded in 1966 pursuant to the ICSID Convention.
What Kind of Protection Is Offered?
BITs may offer the following protections:
Fair and Equitable Treatment and the Obligation to Provide Full Protection and Security
The host state has the obligation to treat foreign investments in a manner that is just, non-discriminatory, and conducive to fostering the promotion of foreign investment.
No Arbitrary or Discriminatory Treatment
A measure could be considered arbitrary if it involves a willful disregard of due process of law or an act that shocks, or at least surprises, a sense of juridical propriety. A measure could be considered discriminatory if the intent of the measure is to discriminate or if the measure has a discriminatory effect.
No Expropriation without Compensation
The host state is not allowed to expropriate, nationalize, or take similar measures against investors from the other state unless the expropriation is: (1) in the public interest; (2) not discriminatory; and (3) done for compensation. Such compensation must be equivalent to the fair market value of the investment.
The state action or inaction amounting to an expropriation can take any form. Notably, expropriations can occur gradually through a series of measures eventually resulting in expropriation. The key is the extent to which the measures taken have deprived the owner of the normal control of its property.
National Treatment and Most Favored Nation Treatment
BITs often require the host state to treat investors from the other state at least as favorably as national investors ("National Treatment") and to treat investors from the other state no less favorably than other foreign investors ("Most Favored Nation Treatment").
BITs also include a commitment by the host state to observe any other commitments it has made with regard to investments in its territory by investors from the other state ("Umbrella Clause").
What Investments Are Protected by a Bilateral Investment Treaty?
The investments protected by a BIT depend on the definition of "investment" in the particular BIT. If intellectual property is covered by the definition, it is subject to the general guarantees offered to investors under the BIT, including protection in case of expropriation, national treatment, and most favored nation treatment. The BIT provides a legal basis to investors for action against the host state if it fails to protect the intellectual property.
In order to invoke the protection of a BIT in the host state, an investor must be a "national" of the other signatory state. For the purposes of investment arbitration, a locally incorporated subsidiary is generally regarded as having the nationality of its parent company. Consequently, protection by a Netherlands BIT can often be realized by interposing a Netherlands holding company.
Tax Consequences of Having a Netherlands Holding Company
In general, having a Netherlands holding company will not create a Netherlands tax exposure because of: (1) the participation exemption, which provides for full exemption from Netherlands corporate income tax on income realized through qualifying subsidiaries; and (2) an exemption from Netherlands dividend withholding tax for dividends paid to qualifying parent companies or dividends paid by a Dutch Cooperative. Having a Netherlands holding company may even decrease the aggregate taxes paid in a corporate structure if the Netherlands income tax treaty with the country of residence of the subsidiary is more beneficial than the shareholder's tax treaty with that country.
The participation exemption, together with the wide income tax treaty network, makes the Netherlands one of the premier jurisdictions in which to establish a holding company. If the participation exemption applies, capital gains and dividends are fully exempt from corporate income tax. The income from a participation of at least 5% in the share capital of a company qualifies for the participation exemption if: (1) the participation is not held as portfolio investment; or (2) the participation is subject to a tax of at least 10% according to Netherlands standards; or (3) less than 50% of the fair market value of the participation's direct and indirect assets consists of passive assets. There is no minimum holding period to qualify for the participation exemption.
Exemption from Dividend Withholding Tax
Provided certain requirements are satisfied, a U.S. shareholder of a Netherlands company may qualify for an exemption from Netherlands dividend withholding tax under the Netherlands–U.S. Income Tax Treaty. A European shareholder may qualify for an exemption under the EU Parent–Subsidiary directive as implemented in Netherlands tax law. If the shareholder does not qualify for the exemption, it may be possible to avoid the dividend withholding tax by using a Dutch Cooperative, which is an entity that is exempt from Netherlands dividend withholding tax.
The Netherlands has an income tax treaty network of 90 treaties, which generally provide for lower withholding tax rates on dividends, royalties, and interest.
When structuring investments into countries with a political climate that may have a higher risk profile, one should take the protections offered by BITs into account. BITs generally include substantive guarantees regarding the treatment of investors and provide protection from expropriation.
The Netherlands has a large number of investor-friendly BITs that offer protection for investment made by a Netherlands company through a local subsidiary and direct access to international arbitration without being obliged to exhaust proceedings in a local court first. Furthermore, with its wide treaty network and exemptions from Netherlands tax, the Netherlands is a favorable jurisdiction in which to have a holding company. Thus, a Dutch holding company may provide "free insurance" by way of the protection offered by the Netherlands BIT with the country in which the investment is made.
This commentary also will appear in the March 2011 issue of BNA's Tax Management International Journal. For more information, in BNA's Tax Management Portfolios, see Katz, Plambeck, and Ring, 908 T.M., U.S. Income Taxation of Foreign Corporations, Cole, Kawano, and Schlaman, 940 T.M., U.S. Income Tax Treaties — U.S. Competent Authority Functions and Procedures, and in Tax Practice Series, see ¶7130, Foreign Persons — Effectively Connected Income, and ¶7160, U.S. Income Tax Treaties.
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