By Aitor Navarro, Assistant Professor, Carlos III University, Madrid
The Spanish Supreme Court, in the case of SGL Carbon Holding (ECLI:ES:TS:2021:3572) issued September 22, addressed the denial of a mutual agreement procedure (MAP) initiation request on the grounds of the existence of tax abuse in a case involving the application of the domestic general anti-avoidance rule (GAAR).
Facts of the case
SGL Carbon is a German multinational group operating in the chemical industry. SGL Carbon Holding, SL, is the subsidiary of the group that was assessed by the Spanish tax authorities.
The assessment referred to a series of relatively complex transactions that were made to locate in the hands of SGL Carbon Holding the shares of several other group subsidiaries (tax residents in Spain, Italy, Brazil, and Malaysia). To acquire such shares, SGL Carbon Holding received an intra-group loan from the ultimate parent of the group SGL Carbon AG, tax resident in Germany.
The tax authorities assessed the case and denied the deductibility of both the financial expenses resulting from the loan and the impairment of the shares in the Malaysian subsidiary, on the grounds of the existence of tax abuse. The domestic GAAR present in article 15 of the General Tax Code was applied to that effect.
The taxpayer requested before the Spanish tax authorities the initiation of the MAP envisaged in article 24 of the tax treaty signed between Germany and Spain (2011) and the MAP present in the EU Arbitration Convention (90/436/CEE). The request was also presented before the German Federal Central Tax Office.
The Spanish authorities denied the request by resorting to Royal Decree 1794/2008, a domestic regulation on MAP that includes a list of grounds to deny MAP access. The list includes cases in which the discussion concerns domestic law and not discrepancies as to how the tax treaty should be applied, as well as cases where the taxpayer tried to avoid taxation in any of the involved jurisdictions.
Specifically, the tax authorities considered that the case revolves around the applicability of a domestic rule, namely the GAAR, instead of the tax treaty itself. Moreover, they leaned on the OECD Commentaries on article 1 (pars. 9.2 et seq. and 22.1), which state that countries are not bound to grant the benefits of a tax treaty when there is an abusive use of their provisions. This remark was linked to the content of article 28(1)(a) of the Germany-Spain tax treaty: “The Convention shall not be construed to prevent a Contracting State from applying the provisions of its domestic law on the prevention of tax evasion or tax avoidance”. Hence, the enforcement of a domestic GAAR does not violate the tax treaty and thus, MAP access must be denied. On the other hand, the tax authorities considered that the 1990 EU Arbitration Convention is not applicable either, as it refers to the adjustment of profits in transfer pricing cases. The authorities stressed that they do not question the valuation of the transactions or their existence, but their rationale instead.
Supreme Court’s upholding of the tax assessment
After an unsuccessful appeal by the taxpayer before the National Court (ECLI:ES:AN:2019:1885), the case reached the Supreme Court, which also decided in favor of the tax authorities. Although all arguments posed by the authorities were considered valid, the Court rendered certain additional remarks. For instance, the Court believes that the risk of double taxation is an unavoidable requirement that must always be present when requesting MAP access, even when the wording of the MAP provisions envisaged in the Germany-Spain tax treaty does not demand so.
The Court also sustained that the applicability of domestic rules such as the Royal Decree 1794/2008 that lists specific grounds to deny MAP access, or the GAAR, are not affected by tax treaties. Therefore, allegedly, a conflict does not arise. Yet at the same time, it is stated that the benefits derived from the Convention, including the access to a MAP, must be rejected when the actions of the taxpayer are abusive or fraudulent. In fact, the Court devotes significant efforts to describe the treatment given in the OECD Commentaries to the compatibility of domestic GAARs and tax treaties. However, it ends its reasoning by stating that the very tax treaty explicitly provides for such compatibility in the aforementioned article 28(1)(a).
Surprisingly, although the Court leans on the Commentaries to support its conclusions, it rejects taxpayers’ arguments based on the OECD Manual on Effective MAP and BEPS Action 14 to sustain that MAP access should be granted, as these texts do not have a binding nature.
Critical remarks on the outcome of the case
The decision is noteworthy for several reasons, although the main takeaway is that the Spanish Supreme Court goes against the international standards and the proper interpretation of tax treaty provisions once again. The SGL Carbon Holding case thus joins the long list of flawed decisions consisting of, among others, the U2 case on artists’ income (article 17 OECD Model Tax Convention), the Roche case on the definition of permanent establishments (article 5), or the Sara Lee Southern Europe case on the enforcement of the associated enterprises (article 9).
As a starting point on the examination of the Court’s reasoning, it is striking to note that the Court does not make a single mention of the wording of the MAP provision of the applicable tax treaty or the wording of the EU Arbitration Convention (90/436/CEE). Otherwise, perhaps it would have been noted that the existence of double taxation is not a requirement to access the MAP remedies envisaged in the said Conventions. Instead, it is enough that the taxpayer “considers that the actions of one or both of the Contracting States result or will result for him in taxation not in accordance with the provisions of this Convention” (article 24.1 of the Germany-Spain tax treaty) or that “an enterprise considers that, in any case to which this Convention applies”, the arm’s length principle has not been observed (article 6.1 of the EU Arbitration Convention).
The examination of the Court as regards the relationship between domestic law and tax treaties must be criticized as well. Even if the disputed provisions form part of domestic law, their enforcement may clearly affect the application of treaty provisions. The case of GAARs is paradigmatic: if abuse exists – according to the parameters set out by the applicable GAAR – the consequence may be the non-applicability of treaty provisions. If the use of the GAAR by the tax authorities is defective, the result may certainly entail taxation not in accordance with the provisions of the Convention. Hence, in such cases, MAP access should be granted.
Moreover, as it is well known, the obligation to initiate a MAP does not entail the reaching of a common understanding on the applicability of the treaty. The negotiations may end up without an agreement. Or, perhaps, both authorities agree that the Spanish domestic GAAR was well applied and that the resulting outcome should be upheld. In any case, the only duty that MAP provisions imposed on the parties is to endeavor – if the objection appears to be justified and the authority that received the request is not itself able to arrive at a satisfactory solution – to resolve the case by mutual agreement with the competent authority of the other state. Hence, the signatory states are bound to open negotiations and provide argumentation to support their stance on the issue at hand.
Such understanding of the MAP in the context of treaty abuse was adopted in the final report on BEPS Action 14, aiming to make dispute resolution mechanisms more effective. Specifically, point 1.2. of the minimum standard states that “Countries should provide MAP access in cases in which there is a disagreement between the taxpayer and the tax authorities making the adjustment as to whether the conditions for the application of a treaty anti-abuse provision have been met or as to whether the application of a domestic law anti-abuse provision conflicts with the provisions of a treaty”. Therefore, the outcome of the Supreme Court decision runs against the minimum standard on BEPS Action 14 that the members of the Inclusive Framework – including Spain – agreed to adopt.
The faulty reasoning of the Supreme Court may be traced back to the – unfortunate – wording of the 2003 OECD Commentaries on article 1, which drastically changed the approach posed by the OECD on GAARs and tax treaties. As stated above, the Court considers that the applicability of domestic law such as the Royal Decree 1794/2008 that lists specific grounds to deny MAP access, or the GAAR, are not affected by tax treaties, and therefore, a conflict does not arise. Such wording resembles that of paragraph 9.2 of the said version of the Commentaries: “anti-avoidance rules are part of the basic domestic rules set by domestic tax laws for determining which facts give rise to a tax liability, they are not addressed in tax treaties and are therefore not affected by them”.
Two aspects must be criticized. First, even though the paragraph refers exclusively to anti-avoidance rules, the Supreme Court uses it to save the applicability of the Royal Decree on MAP, which clearly does not qualify as an anti-avoidance device. Second, to affirm that anti-avoidance rules determine the facts that give rise to a tax liability is conceptually incorrect. Facts must be discovered, not determined. In other words, in a first step, one must discover the facts that actually occurred and, in a second step, apply the existing rules accordingly. Hence, rules do not determine facts. Yet, such flawed understanding of how legal rules operate may only be explained by the need that the OECD had to make GAARs and tax treaties compatible. The deficient reasoning of the Supreme Court in the SGL Carbon Holding case is a concrete manifestation of wrongly built soft law recommendations.
Finally, it is striking to note that, despite the prominent use of the OECD Commentaries, the Supreme Court rejects reviewing arguments posed by the taxpayer based on the Manual on Effective MAP and BEPS Action 14 because such texts do not have binding nature. The truth is that the OECD Commentaries do not have a binding nature either, yet the Supreme Court confers them a privileged status in the SGL Carbon Holding decision. The disregard of taxpayers’ arguments based on such disparity in the treatment of equally non-binding texts that should have the same interpretative value must be criticized.
Key takeaway
In short, the Supreme Court’s SGL Carbon Holding decision grants the tax authorities broad powers to deny MAP access in cases where the discussion revolves around domestic rules in general and the enforcement of the Spanish GAAR in particular.
The outcome of the case is at odds with the compromises acquired by Spain as a member of the Inclusive Framework. Specifically, as stated, the minimum standard on BEPS Action 14 requires countries to provide MAP access in cases in which there is a disagreement as to whether the application of a domestic law anti-abuse provision conflicts with the provisions of a treaty. In fact, to honor such commitment, the Royal Decree 1794/2008 was modified in June 2021 to erase one of the mentioned grounds to deny MAP access, i.e., cases where the taxpayer tried to avoid taxation in any of the involved jurisdictions.
Yet, the other ground the Spanish tax authorities invoked in the SGL Carbon Holding decision, namely when the discussion concerns domestic law and not discrepancies as to how the tax treaty should be applied, remains applicable. It is yet to be seen whether the tax authorities will continue denying MAP access in cases of tax abuse based on such ground.
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