Source: http://kluwertaxblog.com/2019/03/22/foreseeing-the-impact-of-x-gmbh-case-c-13517-ii-a-reasonable-understanding-of-the-ppt-standard-under-oecd-guidelines-and-us-case-law/?print=print
Timestamp: 2019-04-24 20:06:13+00:00

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This second part deals with the issue indicated in point (1) above, by taking into account the guidelines of the OECD and US case law on the PPT standard. Moreover, this part of the piece attempts to foresee the German Federal Finance Court’s judgement in respect of the abusiveness of the German-Swiss structure X, Y, Z.
The presence of circular cash flows, e.g. the issuing and buying of preferred shares or the assigning of promissory notes; and – the impact of an arrangement or transaction on net cash flows of the parties, e.g. maintaining a centralized cash management accounting system and entering into interest rate and foreign exchange contracts.
Those factors imply that the economic substance and business purpose of (i) an arrangement or (ii) transaction constitute features of “relevant facts and circumstances” of significance for determining whether one of their principal purposes was to obtain treaty benefit(s). This also shows, by analogy, that the active business test under the LOB clause (Article 7(8)-(13) of the MLI) seems to be one of the most important tests for appropriately dealing with abusive treaty shopping.[fn]See B. Kuźniacki, “The Limitation on the Benefits (LOB) Rule in BEPS Action 6/MLI: Ineffective Overreaction of Mind–Numbing Complexity – Part 2”, 46 Intertax (February 2018), sec. 2.1.[/fn] Most importantly, it appears that the factors/features of abuse under the PPT standard in respect abuse of EU law and tax treaties are similar and aim to scrutinize the degree of economic substance of the arrangement (in the CJEU’s case law references are usually made to a company) or transaction. It is therefore not impossible that EU abuse and tax treaty abuse standards will largely converge.
Moreover, it is worth to reiterate that the CJEU in point 84 of its judgement in X GmbH (Case C-135/17) defined the concept of abuse, in the context of the free movement of capital, as any scheme which has as its primary objective or one of its primary objectives the artificial transfer of the profits made by way of activities carried out in the territory of a Member State to third countries with a low tax rate. Consequently, on the one hand, the CJEU seems to lower the threshold of the abuse by stepping down from the sole or essential tax avoidance purpose to primary or one of the primary purposes (the PPT standard). On the other, the CJEU requires the tax authorities to prove that income has been transferred via artificial activities, which could be understood as artificial transactions.
This, in my view, means that the analysed judgment has introduced a kind of two-fold economic substance test. First to determine the artificiality of the entity. Second to determine the artificiality of the transaction. If the first test fails, still the second test may lead to the conclusion that the case is abusive insofar as the transactions between non-artificial entities are artificial (see more at sections 18.6.3 and 18.6.4 of my PhD thesis).
The PPT standard is quite new and not well established under the CJEU case law regarding abuse of EU primary law. Indeed, the Court did not elaborate at all on the understanding on the phrases “principle purpose” and “one of the principal purposes” in X GmbH (Case C-135/17). It is therefore worthwhile to look at the case law of foreign courts which has more experience in that area. Since one can find under US Internal Revenue Code almost 30 provisions that use the phrase “principal purpose” in relation to provisions aiming against tax avoidance, US case law may be useful to determine the meaning of “principle purpose” and “one of the principal purposes” in context of discussed EU-standard of abuse.
The judgment of US Tax Court in Dittler Bros, Inc. v. Commissioner, 72, T.C. 896, 915 (1979), 27 August 1979, is considered to be a landmark judgment in which the term “principal purpose” was given a meaning in tax avoidance scenario. The US Tax Court stated that this term should be construed in accordance with its ordinary meaning, that is “first in rank, authority, importance, or degree”.[fn]Such a rule of statutory construction has been endorsed by the US Supreme Court in Malat v. Riddell, 383 US 569, 571 (1966).[/fn] Accordingly, the judgement in the Dittler case shows that any standard using principal purpose is met only when the purpose to evade or avoid tax exceeds or outranks in importance any other purpose.
In the judgement in Furstenberg v. Commissioner of Internal Revenue (83 T.C. No. 43, 83 T.C. 755, 26 November 1984), US Tax Court stated that although the phrase “one of its principal purposes” has never specifically been interpreted, the definition of “principal purpose” set forth in Dittler Bros, Inc. v. Commissioner is instructive to it. Consequently, the phrase “one of its principal purposes” and “principal purpose” in tax avoidance cases should be understood alike and set the tax avoidance standard which is met only when the purpose to avoid tax exceeds or outranks in importance any other purpose.
Such understanding of the phrases “principal purpose” and “one of the principal purposes” is, in this author’s opinion, relevant to the new PPT standard of abuse under the EU primary and secondary law (and by analogy under tax treaties). Only such interpretative approach may ensure a consistent and reasonable application of this standard.[fn]Concurring: in relation to the PPT under MLI, R. S. Avi-Yonah & G. Mazzoni, “The text below from BEPS, ATAP, and the New Tax Dialogue: ¿A Transatlantic Competition?”, 46 Intertax (November 2018), pp. 895-899.[/fn] Otherwise the EU abuse standard may be lowered too much with the result that, as the OECD under tax treaties in my view incorrectly suggests,[fn]Unless the OECD inconspicuously intended to suggest an application of the PPT in order to prevent the use of tax treaties for tax optimization purposes rather than the abuse of tax treaties for tax avoidance purposes.[/fn] a refusal of tax benefit to a taxpayer would be possible if one of the principal purposes was to obtain that benefit. In other words, the OECD implies that under the PPT standard of abuse it need not be the dominant purpose; it need only have been one of the factors that weighed heavily in the taxpayer’s thinking.[fn]See OECD Model Tax Convention on Income and on Capital: Commentary on Article 29(9), para. 180 (21 November 2017).[/fn] This is an unreasonable way of understanding the PPT standard of abuse which may trigger more uncertainty than foreseeability for taxpayers involved in international business and investment, and therefore must be rejected. Indeed, too much uncertainty and the lack of sufficient degree of foreseeability may negatively affect cross-border commerce, whilst EU law and tax treaties should facilitate them within the scope of their application.[fn]Cf. P. Baker, “The Multilateral Convention to Implement Tax Treaty Related Measures to Prevent Base Erosion and Profit Shifting”, British Tax Review 2017, No. 3, p. 283[/fn] Moreover, too low standard for applying the PPT will prevent the use of tax treaties for tax optimization purposes rather than the abuse of tax treaties for tax avoidance purposes.
“One of the principal purposes” should therefore not be understood literally but contextually and purposively as “the principal purpose”.
Had the German Federal Finance Court followed the above guideline, it would most likely decide that the principal purpose of X (German company) was to avoid taxation in Germany by the use of Y (Swiss CFC), because concluding a debt assignment contract by Y with Z seemingly had the principal purpose to transfer profits from Germany to Switzerland (low tax country) in order to avoid taxation on those profits in Germany. Concluding about the principal purpose is, however, not enough to determine the abuse of EU law under the PPT standard. An artificiality of transaction must be also proven and this is about the economic substance of Y. The facts of the case, as delivered by the German Federal Finance Court, did not carry enough factual information to conclude about the economic substance of Y and artificiality of the transactions between X, Y, and Z. Although a deeper investigation is needed, my intuition tells me that Y did not have enough economic substance and the transactions between X, Y and Z were artificial (again not enough substance) in the sense that they were essentially designed and realized to avoid taxation in Germany.

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