Maybe the taxpayer just used the wrong court? The taxpayer, Starr International Co. appeared to have had smart tax planning. It moved its operation to Switzerland. In part because the Swiss are very pro-business and in part because the Swiss have a good tax treaty with the U.S.
But U.S. District Court Judge Christopher R. Cooper would just didn’t like it. So, Judge Cooper made up a new tax term and theory, “Cramped Conception“.
Not knowing that U.S. law allows one to arrange their affairs to pay the lowest tax (except in the case of a sham transaction without economic substance), Judge Cooper ruled for the IRS.
In tax planning, this is known as the “hazards of litigation”. I have a portion of the Judge opinion below with my author notes in bold print.
5. Starr’s Test Would Result In a Cramped Conception of Treaty Shopping
Starr’s proposed test is not only at odds with Article 22 and the Technical Explanation, but it also depends on an unduly narrow definition of treaty shopping. Starr insists that “treaty shopping is a well-defined legal standard,” which categorically excludes situations that do not involve on-paper third-country residents. Pl.’s Cross-MSJ 2.
But, tellingly, the term is nowhere to be found in the U.S-Swiss Tax Treaty (or any bilateral tax treaty, for that matter). (Author note: The Judge admits that the law is not defined but then, below talks about the 1,000s of articles and other commentaries. I doubt if the Judge read all of the articles).
Rather, as indicated by the commentaries, legislative testimony, and agency guidance cited by the parties, there is a fair amount of imprecision surrounding the phrase. (Again the Judge admits the term treaty shopping is not defined…so he just makes up his own theory of “cramped”).
As used by these authorities, treaty shopping does frequently involve the participation of a third-country resident, but it need not. Rather, its essential characteristic is treaty abuse — manipulating on-paper residency for the purpose of obtaining treaty benefits.
Starr insists that “treaty shopping is a well-defined legal standard,” which categorically excludes situations that do not involve on-paper third-country residents. Pl.’s Cross-MSJ 2.
But, tellingly, the term is nowhere to be found in the U.S-Swiss Tax Treaty (or any bilateral tax treaty, for that matter). (Author note: the Judge admits that no tax law exists).
Rather, as indicated by the commentaries, legislative testimony, and agency guidance cited by the parties, there is a fair amount of imprecision surrounding the phrase. As used by these authorities, treaty shopping does frequently involve the participation of a third-country resident, but it need not. (In this case, a third-country resident did not exist).
Rather, its essential characteristic is treaty abuse — manipulating on-paper residency for the purpose of obtaining treaty benefits.
Rather, its essential characteristic is treaty abuse — manipulating on-paper residency for the purpose of obtaining treaty benefits.(Author note: this is not the facts… the Judge is merely “papering” his opinion with “fake news”.)
For example, the Government cites commentary from the Organisation for Economic Co-operation and Development (“OECD”) on its model tax treaty, which expresses concern regarding “the creation of usually artificial legal constructions, to benefit both from the tax advantages available under certain domestic laws and the reliefs from tax provided for in double taxation conventions.” OECD Committee on Fiscal Affairs, Model Double Taxation Convention on Income and on Capital 47 (1977).11
The commentary explains that such abuse (this Judge loves the word “abuse”; it sounds so righteous) would occur, “for example, if a person (whether or not a resident of a Contracting State), acted through a legal entity created in a State essentially to obtain treaty benefits which would not be available directly to such person.” Id. (emphasis added).
(According to the Europeans and not the Americans) Treaty abuse would also occur, according to the commentary, if an individual “transferred his permanent home [from one Contracting State] to the other Contracting State, where [capital] gains were subject to little or no tax.” Id. (California will love this judge… if I move from California to Washington state, this Judge will rule that I still owe tax in California since Washington has not income tax).
Clearly, these examples do not turn on a third-country participant, and yet the OECD’s more current commentary describes this treaty abuse as “the problem commonly referred to as ‘treaty shopping.’” OECD Committee on Fiscal Affairs, Model Tax Convention on Income and on Capital C(1)-26 (2014).
Similarly, the parties have cited and discussed testimony regarding the U.S.-Swiss Treaty, presented before the Senate Committee on Foreign Relations, from former Deputy Assistant Treasury Secretary Joseph H. Guttentag. See Bilateral Tax Treaties and Protocol: Hearing Before the S. Comm. on Foreign Relations, 105th Cong. 354, at 11 (1997). Mr. Guttentag explains that one major objective of U.S. tax treaty policy is to . . . prevent abuse of the treaty by persons who are not bona fide residents of the treaty partner. This abuse, which is known as “treaty shopping,” can take a number of forms, but its general characteristic is that a resident of a third state that has either no treaty with the United States or a relatively unfavorable one establishes an entity in a treaty partner that has a relatively favorable treaty with the United States.
Id. Guttentag elaborates that, while treaty shopping “general[ly]” involves a third-country resident, it “can take a number of forms,” and it is primarily concerned with treaty abuse “by persons who are not bona fide residents of the treaty partner.” Id. (Author note: Starr was a bonafide resident in Switzerland)
Starr’s definition of treaty shopping, by contrast, would narrow the concept to such an extent that even some persons who are not bona fide residents of a treaty nation — persons who lack a “sufficient nexus” to either contracting state — would be entitled to benefits. Of course, that is likely Starr’s reason for proposing such a standard, since it largely concedes that it was not a bona fide resident of Switzerland or the United States at the relevant time.12
Before proceeding to Starr’s remaining arguments, some qualifications are in order.
First, the Court does not mean to suggest that an entity’s on-paper residency (and that of the individuals it associates with) is irrelevant to its bona fide residency.
Surely, in exercising its discretionary judgment under Article 22(6), it would be reasonable for the Competent Authority to consider Starr’s lack of affiliations with on-paper third-country residents in evaluating the company’s bona fide connections to treaty states.
There is simply no per se Article 22 rule, however, requiring the Competent Authority to reach such a determination.
Second, clearly any bilateral tax treaty is intended to benefit the legitimate residents of the two signatory nations. Accordingly, it would also have been permissible as a matter of policy, but was not required as a matter of law, for the Competent Authority to consider an argument that Starr’s majority-control by U.S. citizens should counsel in favor of awarding it benefits under Article 22(6).13
In any event, the point remains that it is difficult to square Starr’s version of the Article 22(6) standard with Article 22’s text, structure, and accompanying Technical Explanation.
The Court therefore reaffirms that the proper standard for determining benefits under Article 22(6) is “whether the establishment, acquisition, or maintenance of the person seeking [treaty] benefits under the Convention, or the conduct of such person’s operations, has or had as one of its principal purposes the obtaining of [treaty] benefits.” Technical Explanation 72. The Competent Authority clearly applied this standard. A.R. 274. (Can you imagine this Judge ruling against a Subchapter S election because the election was with the “principal purpose of obtaining the [tax} benefits?)