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March 9 — Companies relying on treaties to avoid double taxation and ensure governments are taxing them fairly could face difficulties after courts in India and Germany made opposite rulings on whether a bilateral tax treaty would override domestic law.
Although bilateral tax agreements between two or more countries aim to provide clarity for governments and taxpayers about which jurisdiction holds taxing rights, a German court ruled that tax authorities can override a tax treaty with domestic law. An Indian court, meanwhile, said domestic law cannot override tax treaties.
Germany's Federal Constitutional Court ruled domestic legislators can enact laws that contravene international treaties to which Germany is a party. The court said the first sentence of Article 59 sec. 2 of Germany's constitution (Grundgesetz) gives German legislators the right to enact statutes “even if they contravene international treaties,” the court wrote in a Dec. 15, 2015, decision released Feb. 12.
“This ruling sets a precedent for future decisions,” Michael Hoheisel, a tax consultant at Kleeberg & Partner GmbH in Munich, told Bloomberg BNA. “It opens the door for any domestic overruling of treaties. Hopefully it is handled with care by the government.”
Businesses and foreign workers with tax ties to Germany should examine whether treaties contain a regulatory risk of not being applied in Germany and consider jurisdiction shopping, practitioners said. German tax academics, however, said the risk of new legislation contravening treaties remains low.
“If the lex posteriori”—the statutory interpretation—“is actually applied in both directions, the timing of legislation will become more important,” Tino Duttine, a partner at Norton Rose Fulbright LLP in Frankfurt, told Bloomberg BNA. “It may become an important factor in tax planning as there may be a possibility to avoid certain restrictive domestic rules by shopping in a jurisdiction with a very new and beneficial treaty.” However, Duttine said, it is not clear from the recent decision whether treaties not covering specific issues addressed by the domestic treaty overrides will actually prevail for those issues as well.
The court handed down its landmark decision in a case related to a double taxation treaty signed between West Germany and Turkey in 1985. That treaty said income from employment earned in Turkey by persons who also have German tax reporting obligations shouldn't be factored into German tax assessments.
But parts of the treaty were challenged in 2003, when Germany amended its tax law and gave tax authorities the ability to assess Turkey-sourced income unless taxpayers could produce evidence that the “state entitled under the treaty to exercise the right of taxation has waived this right or that the taxes assessed by this state on the basis of the income in question have been paid.”
The case rose to Germany's high court after a married couple with earned income in both Germany and Turkey challenged a tax bill that they had received from German authorities on monies that they had earned in Turkey, but for which they couldn't furnish a tax payment receipt or a waiver from the Turkish tax authorities. They maintained that because these requirements weren't in the original tax treaty, legislative changes requiring that they furnish the documents were illegal.
The court disagreed.
The situation couldn't be more different in India, where judges in New Delhi reached the opposite conclusion.
“An interpretive exercise by the Parliament cannot be taken so far as to control the meaning of a word expressly defined in a treaty,” the Delhi High Court said in its Feb. 8 ruling, published Feb. 12. “Parliament, supreme as it may be, is not equipped with the power to amend a treaty.”
In the case, which involved Thai and Dutch digital broadcast companies disputing tax bills, the Delhi court opined that states have the “power to breach” treaties, yet courts lack jurisdiction in such matters “because in the absence of enactment through appropriate legislation in accordance with Article 253 of the Constitution, courts do not possess any power to pronounce on the power of the State to enact a law contrary to its treaty obligations.”
The separation of powers in India's democracy was cited as another hindrance to those in parliament who sought treaty override authority. The judges continued: “Domestic courts are not empowered to legally strike down such action, as they cannot dictate the executive action of the State in the context of an international treaty, unless of course, the Constitution enables them to. That being said, the amendment to a treaty is not on the same footing. The Parliament is simply not equipped with the power to, through domestic law, change the terms of a treaty. A treaty is not drafted by the Parliament; it is an act of the Executive.”
The ruling also affirmed that legislators could not reach outside the scope of bilateral agreements by defining transmission fees generated by the Dutch and Thai claimants as royalties—which are taxable under Indian law. Nor could they seek to tax such fees as business profits because, again, the respective treaties stipulate that such taxation is allowed only when a business has a permanent establishment in India.
Just as the ruling in Germany was considered precedent-setting, practitioners viewed the Delhi High Court decision as equally important—albeit for the opposite reason.
Under this decision, “amendments to domestic legislation won't supersede treaty provisions,” Rajesh H. Gandhi, a partner at Deloitte Haskins & Sells LLP in Mumbai, told Bloomberg BNA.
Gandhi said the ruling will be used to decide cases in which India's tax treaties are involved. He also said he expects future courts will seek alignment with the provisions set out in India's treaties.
Outside the two differing conclusions reached in Germany and India, the picture is more nuanced.
Some EU countries have amended their tax codes to balance treaty obligations with domestic law. For example, extensive changes to Italy's tax code that went into effect Oct. 7, 2015, gave taxpayers the right to choose and apply the most favorable and appropriate provisions included in either Italy's tax code or treaty provisions.
“Absent any official guideline or precedent, it seems reasonable to conclude that the taxpayer is free to choose the most favorable ‘provision' for each taxable transaction or item of income,” Carlo Galli of Clifford Chance in Milan wrote in Bloomberg BNA's Tax Management International Forum. “But treaty provisions normally take priority, regardless of whether they have been enacted before or after domestic law provisions (no treaty override).”
In the U.S., a tax attorney questioned whether certain tax rules—such as Section 2801, the code section that applies to gifts and bequests made by individuals who have given up their U.S. citizenship or their long-term green cards—could be imposed without the Internal Revenue Service violating U.S. treaty obligations.
Section 2801, the thinking went, may come into conflict with U.S. treaties under the “newer in time rule,” a legal principle that resolves questions of supremacy between a previous treaty and a conflicting act of Congress.
Skepticism in the U.S. around trade treaties and their impact on domestic law also became an issue during the Transatlantic Trade and Investment Partnership (TTIP) talks and during congressional procedures to bring the Trans-Pacific Partnership (TPP) to a vote.
Sen. Elizabeth Warren (D-Mass.), for example, warned that some aspects of fast-track trade authority could lead to the creation of trade deals that allow a future president or Congress to subvert existing laws like Dodd-Frank, Bloomberg News reported.
Warren said Republicans could include provisions in a future trade deal that undercut undesirable laws, and then pass those provisions by holding a simple majority vote in the Senate. The fast-track bill would then prevent Democrats from blocking the legislation through a filibuster. Normally, it takes 60 votes to break a filibuster.
Ekkehart Reimer, director of the Institute for Finance and Tax Law at the University of Heidelberg, said the treaty override decision handed down in Germany highlights a disparity between domestic and international laws.
“These two spheres are not fully converging,” Reimer told Bloomberg BNA March 8. “When we look at the recent treaty override decision, we don't see the court saying that Germany is allowed to infringe on international laws. Rather, the judges are saying a violation of international law isn't a violation of the German constitution. The court said these domestic laws remain valid even though they run counter to Germany's international obligations. But parliaments shouldn't take this as encouragement. Domestic laws should still be interpreted in the light of international tax obligations—that remains compulsory.”
Another German tax practitioner, Heribert M. Anzinger, a professor at the Institute of Accounting and Auditing at the University of Ulm, told Bloomberg BNA March 8 that although German accountants interpreted the court decision as a treaty override, the German academic tax world viewed the decision as “more of statement about the reduction of abuse.”
Still, Anzinger said, “the decision is relevant because it gives lawmakers the ability to override treaties. But I don't think this will become something the government will do on a regular basis.”
On the German treaty override ruling, Anzinger suggested taxpayers “should wait to see what happens.” He emphasized, however, that the changing nature of tax treaties will likely obviate parliamentary need to use its newly won treaty override power.
“Tax treaties are changing,” Anzinger said. “In the 2012 treaty between Germany and Liechtenstein, you notice that the treaty doesn't just aim to avoid double taxation but also—and this is in the title, in fact—to end tax avoidance.” In the past, he said, those treaties were focused solely on avoiding double taxation—but that's changing, particularly in light of the OECD's Action Plan on Base Erosion and Profit Shifting.
“Given this evolving landscape, I would posit that Germany won't need to deviate unilaterally from treaties,” Anzinger said. “Companies are concerned, but I don't think they should be preparing themselves for massive changes or treaty overrides.”
Reimer, for his part, said multinational companies with tax ties to Germany should still make use of tax treaties.
“Real, hard treaty overrides will remain the rare exception,” Reimer said. “Tax treaties still prevail over ordinary statutes, even federal statues. It's only in a few instances where legislators explicitly say they want to override a treaty. But in all other cases, the doctrine of lex specialis derogat legi generali”—that specific law overrides general law—“makes clear that domestic laws do not prevail over treaties in ordinary situations.
Unlike in the U.S., Reimer said, tax treaties that Germany signs are self-executing. “Taxpayers do not need to invoke treaty protection explicitly. Taxpayers and tax courts have to consider treaties on their own, even if taxpayers do not apply them explicitly.”
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