Eucotax Wintercourse 2009 Universitat de Barcelona (Barcellona) The Limits to Tax Planning, Minimizing Taxes and Corporate Social Responsibility

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1 Dipartimento di Scienze giuridiche CERADI Centro di ricerca per il diritto d impresa Eucotax Wintercourse 2009 Universitat de Barcelona (Barcellona) The Limits to Tax Planning, Minimizing Taxes and Corporate Social Responsibility Contributi di sintesi maggio 2009 Luiss Guido Carli. La riproduzione è autorizzata con indicazione della fonte o come altrimenti specificato. Qualora sia richiesta un autorizzazione preliminare per la riproduzione o l impiego di informazioni testuali e multimediali, tale autorizzazione annulla e sostituisce quella generale di cui sopra, indicando esplicitamente ogni altra restrizione 1

2 Il presente lavoro nasce dallo Eucotax Wintercourse, al quale l Università Luiss Guido Carli partecipa sin dal Ha formato oggetto dell ultima edizione del Wintercourse tenutosi presso l Università di Barcellona dal 14 al 23 aprile 2009 il tema de I limiti alla pianificazione fiscale e la responsabilità sociale delle società. Si presentano nel seguente documento i paper finali redatti nel corso dei lavori presso l Università di Barcellona cui hanno contribuito i docenti e gli studenti rappresentanti della Luiss secondo il seguente schema: Gruppo Chairman Co-chairman Studenti General anti-avoidance rules and doctrines Prof. Giuseppe Melis Prof. Daniel Gutmann N. Bammens M. Sadowsky Emilio Galdieri Anti-base erosion rules Prof.ssa Heike Jochum M. Bergund I. Kruger Letizia Gianni Treaty shopping Prof. Michael Lang B. Candete Th. Ecker Rossella Sabia Anti-deferral rules Prof. Charles Gustafson F. Rasi M. Ruttemoller Paola Maria Plantamura Implementation of EC Directives'anti-avoidance rules Prof. Daniel Deak B.Kolozs A. Bellens Roberta Piccinni Disclosure rules Prof. Tulio Rosembuj Prof. Eugenio Ruggiero Jan Bjuvberg Vito Giuseppe Liotine 2

3 ELENCO DEI CONTRIBUTI GENERAL ANTI-AVOIDANCE RULES & DOCTRINES INTRODUCTION GENERAL BACKGROUND ON EUCOTAX AND WINTERCOURSE DEVELOPMENT OF TAX AVOIDANCE / TAX EVASION CONCEPTS CONCEPTS SHAM/SIMULATION Austria Belgium France Germany Hungary Italy Netherlands Spain Sweden United States Conclusions EXISTENCE OF A GAAR Austria Belgium France Germany Hungary Italy Netherlands Spain Sweden United States Conclusion INTERACTION BETWEEN GAAR AND SPECIAL ANTI-AVOIDANCE RULES Austria

4 Belgium Germany Conclusion THE POSSIBLE USE OF OTHER NON-TAX LAW TOOLS TO TACKLE TAX AVOIDANCE States where civil law concepts are used to tackle tax avoidance France The Netherlands Spain Sweden United States States where civil law concepts were used in the past to tackle tax avoidance Italy States where non-tax law concepts are not used to tackle tax avoidance Austria Belgium Germany Hungary Conclusion GENERAL ANTI-AVOIDANCE RULE (GAAR) APPLICABLE TYPE OF TAX CONSTITUTIONAL ISSUES States with constitutional issues Austria Germany Hungary The Netherlands Spain Sweden United States States without constitutional issues Belgium France Italy Conclusion INTERPRETATION Austria

5 Belgium France Germany Hungary Italy Netherlands Spain Sweden United States European Court of Justice Conclusion EFFECTS Austria Belgium France Germany Hungary Italy Netherlands Spain Sweden United States Observations and conclusions BURDEN OF PROOF SPECIFIC PROCEEDINGS INFLUENCE OF EUROPEAN LAW Austria Belgium France Germany Hungary Italy Netherlands Spain Sweden United States

6 Conclusion GAAR AND TAX TREATIES Austria Belgium France Germany Hungary Italy Netherlands Spain Sweden United States Conclusion HARMONIZATION OF GAAR WITHIN THE EU RELATIONSHIP BETWEEN GAAR AND CORPORATE SOCIAL RESPONSIBILITY CASE AUSTRIA BELGIUM FRANCE GERMANY HUNGARY ITALY NETHERLANDS SPAIN SWEDEN USA CONCLUSION CASE AUSTRIA BELGIUM FRANCE GERMANY HUNGARY

7 5.6. ITALY NETHERLANDS SPAIN SWEDEN USA CONCLUSION APPENDICES APPENDIX 1: GENERAL ANTI-ABUSE CONCEPTS APPENDIX 2: GAAR CONCEPTS

8 ANTI BASE EROSION RULES INTRODUCTION LIMITATION ON INTEREST DEDUCTION LIMITATION ON INTEREST DEDUCTION IN GENERAL Policy analysis Debt-Equity Definitions Restrictions against excess interest deductions General Anti-Avoidance Rules Thin-cap rules Specific Statutory Provisions Exceptions to national interest deduction limitation rules Germany: France: Netherlands: Belgium: Spain: Italy: Sweden: Austria: USA: LIMITATION ON INTEREST DEDUCTION AND THE EC FUNDAMENTAL FREEDOMS Introduction the Freedom of Establishment Case Law from the ECJ and Grounds for Justification Domestic Provisions and their Conformity with EC Law Interim Conclusion LIMITATION ON INTEREST DEDUCTION AND THE OECD MC Introduction Countries using general anti avoidance rules Countries applying special provisions on thin capitalization (and countries with a mix of measures)..105 Countries applying interest stripping rules only Interim conclusion

9 EXIT TAXES EXIT TAX FOR INDIVIDUALS Overview of national Regulations Taxation of the capital gains that benefited from a deferred taxation: Taxation of the hidden reserves on substantial participations : Potential conflict of the domestic provisions and the EC fundamental freedoms Background Compatibility of the current national regulations Germany/Austria Restrictive Effect Justification France, USA, Belgium Italy Spain Sweden The Netherlands EXIT TAXATION FROM INDIVIDUALS AND THE PROVISIONS OF THE OECD MC Introduction Country analysis Belgium Sweden Spain Italy Germany Austria The Netherlands U.S.A France Interim conclusion CORPORATE EXIT TAXES Introduction Incorporation states vs. siège réel states Different kinds of exit taxes Exit taxes on asset transfers Exit taxes upon seat relocation Interim conclusion CORPORATE EXIT TAXATION AND EC LAW Relocation of Seat Compatibility with the EC Law of exit taxes of corporations

10 Exit taxation on the transfer of a seat Case law on exit rules from the ECJ Domestic Provisions and their Conformity with EC Law Transfers of Assets EXIT TAXATION FOR COMPANIES AND THE OECD MC CONCLUSION

11 TREATY SHOPPING I. INTRODUCTION LETTER BOX COMPANIES / CONDUITS Rules that address or define companies without substance Substance requirements Residence rules RELATIONSHIP BETWEEN DOMESTIC LAW AND TREATY LAW Domestic law vs. treaty law Treaty override Application of domestic anti-abuse measures TREATY LAW A. RULES BASED ON THE OECD OR U.S. MODEL CONVENTION Limitation on Benefits ( LOB ) Subject to tax Bona fide provisions Beneficial ownership Rent-a-star company Real Estate Companies Residence tiebreaker B. RULES NOT BASED ON A MODEL CONVENTION EC LAW A. ECJ RELEVANT CASES ECJ, 12 September 2006, Cadbury Schweppes ECJ, 21 February 2006 Halifax case B. APPLICATION OF DOMESTIC ANTI-AVOIDANCE RULES TO TREATY SHOPPING SITUATIONS Infringement of EC Law C. LOB CLAUSES E. IMPACT OF EC LAW AND GAAR THE FRENCH EXAMPLE CONCLUSION

12 ANTI-DEFERRAL RULES INTRODUCTION CONTROL REQUIREMENT SHAREHOLDER OWNERSHIP REQUIREMENT TYPE OF INCOME CATEGORIES OF INCOME Passive Attribution Countries Total Income Attribution Countries Other Attribution PROCEDURES FOR INCOME INCLUSION Constructive Dividend Treatment Direct Income Allocation Treatment Other Income Inclusion Rules EFFECTS OF INCOME INCLUSION Foreign Tax Credits Payments of Subsequent Dividends SCOPE OF CFC LEGISLATION EXEMPTIONS TO CFC LEGISLATION DE MINIMUS EXCEPTION HIGH TAXED EXCEPTION SUBSTANTIAL BUSINESS ACTIVITY EXCEPTION COMPATIBILITY WITH TAX TREATIES AND EU LAW PRIORITY BETWEEN DOMESTIC LEGISLATION AND TAX TREATY LAW

13 Arguments in favor of compatibility Arguments in favour of incompatibility OPINIONS OF EACH COUNTRY REGARDING CFC RULES AND TAX TREATIES CONJUNCTION OF CFC LEGISLATION AND TAX TREATIES COMPATIBILITY WITH EC LAW Fundamental freedoms Opinions of each country regarding CFC rules and EC law CORPORATE SOCIAL RESPONSIBILITY CURRENT ISSUES CORPORATE SOCIAL RESPONSIBILITY IN GENERAL CORPORATE SOCIAL RESPONSIBILITY IN TAXATION OUR OPINION ON CORPORATE SOCIAL RESPONSIBILITY CFC IN CONNECTION WITH CORPORATE SOCIAL RESPONSIBILITY Tax competition CFC legislation and its obligation to corporate social responsibility RECOMMENDATIONS CONCLUSION RECOMMENDATIONS

14 IMPLEMENTATION OF EC DIRECTIVES ANTI-AVOIDANCE RULES CORPORATIONS IN THE VARIOUS PARTICIPATING MEMBER STATES AUSTRIA IS RANKED 104: THE NETHERLANDS IS RANKED 51: FRANCE IS RANKED 14: GERMANY IS RANKED 102: SWEDEN IS RANKED 30: SPAIN IS RANKED 140: ITALY IS RANKED 53: CONCLUSION GENERAL ANTI-AVOIDANCE RULES (GAARS) INTRODUCTION AUSTRIA THE AUßENTHEORIE THE INNENTHEORIE FRANCE GERMANY ITALY THE NETHERLANDS SPAIN SWEDEN CONCLUSION ANTI-ABUSE PROVISIONS IN COMMUNITY LAW MERGER DIRECTIVE Implementation Interpretation PARENT-SUBSIDIARY DIRECTIVE Implementation THE INTEREST AND ROYALTY DIRECTIVE Implementation THE INCOME ON SAVINGS DIRECTIVE THE RESPONSIBILITY OF THE STATE INTRODUCTION

15 DISCLOSURE RULES AND TAX AVOIDANCE INTRODUCTION DISCLOSURE RULES AND INVESTIGATION PROCESSES a. Systems Where Investigations are Initiated by the Tax Authorities b. Disclosure Rules for Listed Transactions c. Reportable Transactions Rules in the United States THE CO-OPERATIVE SYSTEM INTERNATIONAL EXCHANGE OF INFORMATION A. CURRENT REGULATION, AGREEMENTS FOR THE DETECTION OF EVASION B. OTHER AGREEMENTS AND EU DIRECTIVES: C. RIGHTS OF THE TAXPAYER D. TAX SECRECY E. USAGE OF INFORMATION FOR PURPOSES OTHER THAN TAXATION F. REASONS TO DENY DISCLOSURE G. EXCEPTIONS TO THE MODEL ON THE NATIONAL LEVEL ADVISOR S ROLES ADVISOR RESPONSIBILITIES NON-CODIFIED RULES a. Netherlands and Sweden b. Italy, France, and Spain CODIFIED RULES Germany, Austria, and the U.S PENALTIES Germany and Austria Netherlands and Sweden Italy, France, and Spain United States Summary TAX PATENTS UNITED STATES VIEW RECENT UPDATE: IN RE BILSKI

16 CRITICISMS OF PATENTS FOR TAX STRATEGIES EU VIEW CONCLUSIONS CORPORATE SOCIAL RESPONSIBILITY

17 EUCOTAX Wintercourse 2009 Barcellona GENERAL ANTI-AVOIDANCE RULES & DOCTRINES 17

18 1. INTRODUCTION 1.1. General Background on EUCOTAX and Wintercourse This general report is the result of the annual 10-day Wintercourse comparative tax law symposium and workshop, created and championed by the European Universities Cooperating on Taxes (EUCOTAX), a program established in 1992 by several wellknown European tax law professors as a platform for students and professors to exchange information on international and domestic tax issues and topics. 1 Specific attention is usually paid to European aspects of tax law. However, this program also benefits from insight on the system and techniques currently present in the United States. The eventual goal of the EUCOTAX Wintercourse program is to have every Member State of the European Union join the program. Therefore, an attempt is made each year to expand the number of participating universities. For the program, held in Barcelona, Spain, 2 the following universities participated: The University of Barcelona, Budapest, Leuven, London, Luiss University Rome, Osnabruck, Paris I Pantheon- Sorbonne, Uppsala, Tilburg, Georgetown University Law Center, and Vienna University of Economics and Business Administration. The general topic and theme of this year s Wintercourse program is Limits to Tax Planning: Minimizing Taxes and Corporate Social Responsibility. Specifically, this general report will focus on the sub-theme topic entitled General Anti-Avoidance Rules and Doctrines, the first of six designated subthemes to be analyzed over the course of the interactive symposium Development of Tax Avoidance / Tax Evasion Concepts "In this world, nothing can be said to be certain except death and taxes." 4 - Benjamin Franklin, The program is also sponsored by PricewaterhouseCoopers. 2 Every year, this EUCOTAX Wintercourse symposium takes place in a different country, on the campus of one of the participating universities. 3 The other 5 sub-themes presented at the Wintercourse program are: anti-base erosion rules, treaty-shopping, anti-deferral rules, implementation of EC Directives anti-avoidance rules, and disclosure rules. 4 Letter from Benjamin Franklin to Jean-Baptiste Leroy (1789), in THE WORKS OF BENJAMIN FRANKLIN (1817). 18

19 It is well accepted within all of the countries participating in the Wintercourse program that one of the certainties in life is the unavoidable requirement to pay tax. However, it is also clearly accepted and understood among these countries that there exists no outright duty to pay any more tax than is lawfully required. As such, taxpayers in these countries are legally allowed to decrease (or even altogether avoid) their taxes by any means permitted under applicable law. The International Fiscal Association, for example, has stated in its 1983 General Report that [a]lmost all countries recognize the right of the taxpayer to arrange his affaires in a way that attracts the minimum tax liability, and therefore to choose the legal forms which are in his view the most suitable for the disposition of his affairs. 5 Similarly, in the United States, the honourable Judge Learned Hand reiterated this idea best in his 1934 opinion in Helvering v Gregory, stating a transaction, otherwise within an exception of the tax law, does not lose its immunity, because it is actuated by a desire to avoid, or, if one choose, to evade, taxation. Any one may so arrange his affairs that his taxes shall be as low as possible; he is not bound to choose that pattern which will best pay the Treasury; there is not even a patriotic duty to increase one s taxes. 6 Such rights of taxpayers to arrange transactions for the purpose of limiting tax liability, however, are not without limits. 7 It is clear that there are times when certain activity can go beyond the realm of appropriate tax planning and venture into the area of impermissible tax avoidance (or even worse, illegal tax evasion). Regular attempts are made by cleaver tax schemers to manipulate the boundaries of enacted legal statutes in order to achieve desired tax results that were never contemplated by the drafters of such laws. In an effort to prevent this behaviour, countries within the European Union, and 5 Uckmar,V., Tax avoidance and tax evasion, Cah.Dr.Fisc.Int.,vol.LXVIIIa,IFA 1983 Venice Congress, Kluwer, 1983, Helvering v. Gregory, 69 F.2d 809, 810 (2d Cir 1934); See also Superior Oil Co. v. Miss., 280 U.S. 390, (1930) (containing Mr. Justice Holmes statement that [t]he only purpose of the [taxpayer] was to escape taxation...the fact that it desired to evade the law, as it is called, is immaterial, because the very meaning of a line in the law is that you intentionally may go as close to it as you can if you do not pass it. ); Comm r v. Newman, 159 F2d 848, (2d Cir.) (dissenting opinion), cert. denied, 331 U.S. 859 (1947) (containing Judge Learned Hand s statement that [o]ver and over again courts have said that there is nothing sinister in so arranging one's affairs as to keep taxes as low as possible. Everybody does so, rich or poor; and all do right, for nobody owes any public duty to pay more than the law demands: taxes are enforced exactions, not voluntary contributions. To demand more in the name of morals is mere cant. ) 7 See Uckmar, supra note 5 ( However, if the sole or predominant motive of a certain transaction was to avoid tax, the form of the transaction may be ignored on the grounds that the taxpayer has abused his right to use such a form. ). 19

20 the United States, have created and developed techniques to supersede the inherent limitations of the countries other specific tax anti-avoidance statutes formal rules and employ more general overarching rules and standards in order to reach the appropriate tax result that was intended to be allowed by the countries governing bodies. Every country represented in this general report harnesses the use of a General Anti-Avoidance Rule (GAAR) to route around and through such clever tax schemes in order to find the true nature of the transactions that have transpired. 8 Although it is clearly acknowledged that each country in this report seems to have its own unique approach to the use of general tax anti-avoidance rules, this general report can serve to provide a useful comparison of the overarching similarities and differences found among the several EU countries and the United States as pertains to the use of GAAR and sham in tax law, in an effort to discern where the countries seem to be in agreement in their approaches and where strong divergences may exist within the laws of this group of participating nation states. Such analysis could offer insight into any subrelationships that may be present among some of these countries. Additionally, such juxtaposition of these countries characteristics can provide an opportunity to single out countries that, for whatever reason, are alone in their radically different approach to a particular aspect/characteristic of GAAR, thus possibly providing some evidence to better understand why such a difference exists (if this is indeed the case), or even possibly providing some incentive for that country to modify its practices and policies to fall more in line with the general thinking/philosophy of the rest of the EU countries. In this general report, a brief analysis will be made of the relative GAAR and sham schemes (should they exist) in the following countries: Austria, Belgium, France, Germany, Hungary, Italy, The Netherlands, Spain, Switzerland, and the United States. This paper will review the countries approaches to the use of general anti-avoidance rules and doctrines in an effort to limit inappropriate income tax planning strategies employed by taxpayers. Part 1 of this paper will provide a brief introduction to EUCOTAX and Wintercourse, following with a short introduction and background on tax avoidance and tax evasion in the participating countries. 8 For the purpose if this paper, a General Anti-Avoidance Rule (or GAAR ) is defined more generally as a principle or technique employed by countries (through their legislatures, administrative agencies, and/or courts) to tackle the growing problem of tax avoidance. 20

21 Part 2 will discuss general anti-abuse concepts, including an analysis of whether the concept of sham (typically associated with tax fraud) exists in each of the countries general/civil laws and/or tax laws and an analysis of each country s GAAR (including whether it is statutory or case-law based, and its relationship with specific tax antiavoidance rules in the countries), and other non-tax tools that may be implemented (such as civil law and private law techniques). Part 3 will discuss in greater detail the GAARs in each country, focusing on the applicable type of tax, constitutional issues, interpretation criteria, effects of the GAAR, burden of proof issues, the presence of procedures special to the GAAR itself, the influence of EU and ECJ law, and the relationship between GAAR and bilateral tax treaties. Also, Part 3 will briefly consider the relationship between the GAAR and corporate social responsibility (CSR). There will then follow two case examples (Parts 4 and 5) that attempt to provide situations where the GAAR and sham concepts will be applied differently to the case facts in each country, in an effort to show a practical application of these rules and principles and their differing effect on the same type of real-life tax situation, depending on the country. The hope and goal of such a comparative analysis is to determine where these participating countries may essentially agree on a particular topic concerning the use of general anti-avoidance rules, and where, in fact, they may fundamentally diverge. Such an analysis should prove useful in allowing the participating reporters to theorize/hypothesis where the core similarities and differences exist among these participating countries tax law systems. This analysis can even possibly allow for opportunities to contemplate and consider where effective legal harmonization efforts may be able to practically take place within the EU as pertains to the use of these general tax anti-avoidance doctrines and related sham concepts. 2. CONCEPTS 2.1. Sham/Simulation As part of the exploration of anti-avoidance rules and doctrines, each national reporter was asked to research the concept of sham or simulation in private law and tax law, and how it is applied their jurisdiction. It is important to understand how these jurisdictions handle and categorize sham transactions as tax avoidance or tax evasion 21

22 and the consequences of such determination as well as the distinction and the categorization of this concept. This section of the report will provide a comparative analysis on the results of these investigations Austria In Austria the term sham transaction describes transactions concluded between two parties who do not really want the transaction to take place in reality. The concept of sham is embedded in both civil law and tax law. 9 Also, one must distinguish between absolute sham transactions and relative sham transactions. While in the first case both parties want to make the transaction for sham reasons, in the second case they want to hide another transaction with the sham transaction. 10 It is worth mentioning that the courts have used both, the sham transaction doctrine and the GAAR to fight avoidance schemes in Austria. 11 The tax law provision entitles the Tax Administration with the ability to recharacterize or void simulated transactions, depending if they are relative or absolute, to impose taxes upon the real transactions without any additional penalties Belgium The doctrine of sham originated under Belgian civil law and describes the situation in which parties enter into an apparent act the effects of which they have agreed to modify or destroy by another act to which only the parties are privy. Currently, the definition that is still accepted by legal scholars and applied by the Supreme Courts is the following: There is sham where parties outwardly enter into an act whose effects they agree to modify or destroy by another contract, which remains secret. Sham thus presupposes two contracts, each contemporaneous with the other, but one of which is intended only to lay a false scent. There exists only one genuine contract, the secret contract See Section 23 BAO; also see ABGB in Sec See Doralt/Ruppe, Steuerrecht, MN 437. Doralt, Werner/Ruppe, Hans Georg Steuerrecht5 Volume 2 (2006). 11 See VwGH , 91/14/ See De Page, H., Traité élémentaire de droit civil belge, II, 3 éd., 1964, no

23 There is no provision in Belgian tax law that defines sham transactions and also no distinction regarding absolute or relative simulation. The tax authorities can and must disregard a feigned legal transaction and impose taxes on the genuine transaction. Since sham implies a conflict between the intentions which parties outwardly express, but which are only apparent ones and conceal the parties real intentions which they keep secret, a sham involves the use of false or fraudulent acts and constitutes a form of tax fraud France The concept of sham in France is entrenched in article 1321 of the Civil Code and the provision distinguishes between relative and absolute simulation. However, the tax authorities will not rely on this civil law provision to tackle tax avoidance. The French authorities will use the general anti-avoidance rule, L64 of the Tax Procedure Book, to deal with simulated transactions. 15 Since tax avoidance is penalized in France, and due to the fact that sham transactions are tackled with the general anti-avoidance rule, penalties will also be imposed upon simulation schemes. It is also worth mentioning that since the enactment of the Financial Law of 2008 the concept of sham is equivalent to the concept of abuse of right that the articulation between the new article L64 and the civil concept of sham contained in article 1341 of the civil Code is not clear Germany A simulation rule is codified in the Civil Code as well as in the General Fiscal Code (=GFC). 16 The tax law concept relies heavily on the civil law concept, which states that simulation occurs if the parties agree to cause the outer appearance of a legal transaction, although they do not want the legal consequences to take place See De Broe, L., International Tax Planning & Prevention of Abuse under Domestic Law, Tax Treaties and EC- Law, Doctoraal Proefschrift, K.U.Leuven, , 60, (nr.34). 14 See De Broe, L., International Tax Planning & Prevention of Abuse under Domestic Law, Tax Treaties and EC- Law, Doctoraal Proefschrift, K.U.Leuven, , 62, (nr. 37). 15 See Art. 1321of the French Civil Code; also see L64 of the Tax Procedure Book. 16 See section 117 German Civil Code (BGB); section 41 General Fiscal Code. 17 See Cf. II. 4. a). 23

24 Moreover, it is not only applicable where there is no legal reality at all, but also in cases of disguised legal realities. If a sham transaction is executed, the simulated transaction is void. Instead the dissimulated transaction becomes effective if it is not void for itself, e.g. because of formal defects. A transaction cannot be qualified as tax avoidance and sham at the same time. The classification as one of them excludes the application of the other Hungary The Hungarian Constitutional Court in its decision on the constitutionality of Subsection 7 of Section 1 19 of the Act on the Rules of Taxation (=ART) has established that a contract is simulated when its form does not correspond with its true substance, i.e. when the will as stated in a contract and the true will of the party, or parties, are divergent. In Hungary there is a civil law and tax law concept for sham transactions. Section 207 of the Civil Code states that simulated (false) contracts are null and void. For tax law purposes, sham transactions are tackled using the general anti-avoidance rule and the tax administration has the capacity to nullify these transactions or impose taxes upon the simulated transaction Italy In the Italian legal system there is civil law 20 and tax law concept for sham transactions. In tax law there also is a provision that regulates concept of subjective simulation, but not the objective concept. 21 For what concerns the legal situation behind the simulation, there are two possible cases: - if the simulation is absolute, there is no legal reality between the parties and therefore the previous legal situation remains unchanged; - if the simulation is relative, another transaction, different from that stated in the 18 See Supreme Tax Court (BFH) BStBl II 1988, 640 (643); 1992, 143 (147). 19 See Subsection (7) Contracts, transactions and other similar operations shall be judged in accordance with their true content. For the purposes of taxation, an invalid contract or any other legal transaction shall be applicable to the extent of the apparent economic results it carries. 20 See Article 1414 of the Civil Code. 21 See Article 37 par. 3 DPR 600/73. 24

25 simulated contract, takes place; this last transaction is called dissimulation. In the second paragraph of article 1415 c.c., the legislator stated that the third parties who had been damaged by the simulation can ask the judge to declare the nullity of the simulated contract, making the actual reality prevail over the fake one stated on the contract. However, the applicability of simulation to tax avoidance cases is unlikable. Simulation is characterized by a difference between what is the legal reality wanted and what is declared. Therefore, it can be considered more a question of tax evasion than of tax avoidance, since in the last there is not a different intention from that declared, but a different scope from the typical one linked to the contract made Netherlands The figure of sham or simulation is in the Netherlands a general law concept and it is therefore applicable in civil law as well as in tax law. In the Netherlands this concept is not codified. 22 The Dutch Supreme Court concluded a schijnhandeling in BNB 1973/ Regarding sham or simulation transaction ( schijnhandelingen ) two simulations can be distinguished. The first is the absolute simulation and the second is the relative simulation. Concerning the first the absolute simulation, there is the illusion of an alteration in the relation between the parties; however this is just an illusion. 24 The alternation is neglected for tax levy, since in fact there is none. Tax levy will occur as if the alternation does not exist. 25 Concerning the latter, the relative simulation, there is an alteration in the relation between parties, however this is something else then what is reality. 26 The real alternation is the fact, tax levy will occur on the basis of reality. 27 Independent of the form of simulation, in these simulations the economic reality is not in line with the chosen legal form See Geppaart 1965, p CH.P.A. Geppaart, Fiscale rechtsvinding, Amsterdam: NV Uitgeverij FED See HR 27 juni 1973, BNB 1973/ See Geppaart 1965, p and Ijzerman 1990, p See Blieck e.a. 2004, p See Geppaart 1965, p and Ijzerman 1990, p See Blieck e.a. 2004, p See Geppaart 1965, p

26 Spain In Spain the concept of sham is regulated by a civil law and a tax law provision. The concept is embedded in article 1276 of the Spanish Civil Code and article 16 of the General Tax Law of However, the tax law concept is based and derived from the one established by civil law. The scope of the private law concept of sham/simulation, as well as the tax law concept, include not only transactions where there is no legal reality between parties absolute simulation but also those transactions where there is a legal reality, albeit one that is different from the one expressed by parties relative simulation. 29 The tax causa simulationis consists of the intentional breach of a tax debt that was legally originated through the realization of the taxable fact. It is a method directed towards tax evasion. 30 In accordance with article 16 of the General Tax Law, the tax administration has the capacity to impose taxes on the simulated transaction, nullify it and penalize 31 these transactions Sweden In Swedish law there is no distinction made between sham/simulation and transactions that have been wrongly characterized. Since the basic principle concerning any transaction with the wrong characterization is that they shall be evaluated based upon their true substance it is of no practical consequence if the transaction is completely fraudulent or simply mischaracterized. 32 In Swedish statute law there is no clear definition of sham or simulation. There is however a definition of sham in the preparatory works for the Swedish Contract Act (Se. avtalslagen). 33 Currently the concept of simulation is derived from general law and no 29 See Article 1276 of the Spanish Civil Code. 30 See T. Rosembuj El fraude de ley, la simulación y el abuso de las formas en el derecho tributario, 2da edicion, Madrid, 1999, p (citing Hensel, Diritto Tributario, p. 317; Blumenstein, Sistema di Diritto delle imposte, p. 27). 31 See article 16 3) of the General Tax Law of See Rosander 2002, p See Förslag till lag om avtal och andra rättshandlingar på förmögenhetsrättens område, lag om avbetalningsköp m m. Angivna den 31 jan 1914 av därtill utsedda kommitterade, p

27 specific tax law concept exists United States In the U.S., courts can invoke the sham transaction doctrine to disallow tax benefits when taxpayers structure transactions in a manner that creates an illusion of economic activity, presenting false or incomplete facts so as to derive tax benefits that are not warranted (given the fact that, in many cases, the economic activity never occurred). As with the substance over form, business purpose, and economic substance doctrines, the beginnings of the sham transaction doctrine are commonly traced to the U.S. Supreme Court opinion in Gregory v. Helvering. 34 There are two categories of sham transactions that have been developed over time by the courts: sham in fact (also known as factual sham ) and sham in substance (also known as economic sham ). A factual sham is one in which the alleged transactions never actually took place. An economic sham is one in which the alleged transactions actually took place, but are nonetheless without economic substance. If the transaction described by the taxpayer never actually occurred, then it should be deemed a factual sham, and all tax benefits related to the transaction should be denied. 35 If it can be determined that the transaction in question actually took place and was not merely a sham in fact, the second layer of analysis to be undertaken is to determine whether the transaction had economic substance and was motivated by an economic purpose other than tax avoidance. 36 Sham, as is defined in this general report, is addressed in the United States through the use of the factual sham concept of the sham transaction doctrine Conclusions From the information above it is noted that the concept of sham is generally regarded as a civil law concept; however, recently certain jurisdictions have embedded this concept into specific tax law provisions. Austria, Germany, Italy and Spain are the four countries that have particular rules within their tax systems that define, regulate fiscal 34 See Jt. Comm. on Tax n, supra note 78, at 186 n Id. at See Lerman v. Commissioner, 939 F.2d at 49. See also Keinan, supra note

28 sham transactions. Their respective tax administrations rely on these provisions to deal with sham schemes that aim to obtain tax benefits. It is worth mentioning that, out of these four countries, Spain s anti-sham provision is the only that explicitly allows the implementation of penalties by the administration, while the remaining countries tax the real underlying transaction or nullify it in case of absolute simulation. In Italy, from a legal point of view, there is no doubt that sham is quite different from tax avoidance. Simulation is characterized by a difference between what is the legal reality wanted and that declared. Therefore, it can be considered more a question of tax evasion than of tax avoidance. On the other hand, in Hungary, sham transactions are tackled using the general anti-avoidance rule because no specific tax law provision exist to handle simulated transactions that seek to achieve tax advantages. For Belgium, sham transactions are generally being considered not as tax avoidance but as a tax evasion. It is important to recall that the tax administration in France has the authority to impose penalties upon sham transactions. The Netherlands, Sweden and the United States of America are three jurisdictions that do not contain any formal provision civil law or tax law to regulate sham transactions. Netherlands relies on a general law concept and Supreme Court rulings to handle these transactions. The United States, as is usual in common law, invokes a courtdeveloped sham transaction doctrine. On the other hand, Sweden does not have any statutory or case-law provisions that define these transactions, although, as previously stated, it is in works for the Swedish Contract Act. It currently uses the concept of sham derived from general law. To sum up, even though there are certain differences in the way these countries tackle sham transactions, they will generally reach very similar conclusions. When confronted with an absolute simulation scheme most jurisdictions will nullify it. On the other hand, if the courts or tax authorities encounter a relative simulation they will uncover the simulated transaction, imposing the adequate taxation without penalties. The only two jurisdictions that have explicitly granted their tax administrations the authorities to impose penalties upon provisions for sham schemes are France and Spain. 28

29 2.2. Existence of a GAAR The principles for tackling tax avoidance and their dogmatic background differ from country to country. Therefore the term general anti-avoidance rule must be interpreted broadly. In the following the term is used for codified rules as well as for case law regarding to the problem of tax avoidance. Hence, a general anti-avoidance rule is to be understood in this evaluation as a general principle or technique which is used to tackle tax avoidance. Thus, even the methods of interpretation and analogy can, depending on the respective national point of view, be covered by this definition. According to this, every country being part of the evaluation has a general anti-avoidance rule Austria In the field of taxation there is a special general anti-avoidance rule in Austrian law to combat this circumvention. 37 This general anti-avoidance rules is described in sec. 22 of the Austrian Federal Fiscal Code (FFC). Sec. 22 BAO is the most important general anti-avoidance rule in the Austrian tax law Belgium In a statute of 22 July 1993 the tax legislature has introduced a general anti- abuse of law provision into the Belgian Income Tax Code (=BITC) effective as of 31 March The scope of which covers the entirety of the BITC and which was soon extended to registration duty. The rule is embodied in article of the BITC (and in similar terms in article 18 2 of the Registration Duties Code) and often called the general anti- abuse provision France The abuse of law (abus de droit) doctrine has been specifically embodied in article L64 of the Tax Procedure Book. The rule concerns the cases of abuse of law by simulation and abuse of law by fraus legis. Nonetheless, both cases are treated equally: The tax administration is authorized to redefine the respective transaction (e.g. a sale) for tax law purposes. Hence, the French sham concept is considered to be part of the tax avoidance scheme but not to be separated from it (as it is the case in most other countries 37 See Tanzer, Gelber Brief des Instituts für Finanzwissenschaft und Steuerrecht , p

30 except for Hungary) Germany The GFC provides a written general anti-avoidance rule in sec. 42 (As it has been amended by Art. 14 JStG 2008, 20 th December 2007). 39 According to the rule tax law cannot be avoided by the abusive usage of legal constructions. It is the purpose of sec. 42 GFC to prevent the avoidance of special tax law provisions and therefore to realize the purpose of the avoided rule although its requirements are not fulfilled. 40 Aside from this general anti- avoidance rule, German law provides a substance over form approach which is considered to be part of the teleological interpretation method. Therefore the scope of the approach is limited by the wording of the respective rule. Analogy is assumed to be prohibited in tax law - nonetheless it was applied in a few decisions and therefore cannot be completely disregarded in this context Hungary General anti-avoidance rules are based on two principles in Hungary: (1) the proper use of rights and (2) the characterization of contracts according to their true nature. Among the general principles the taxability of income from illegal acts must also be mentioned. The concept of the proper use of rights originates in civil law but it is a concept that is exercised in other areas of the law as well. At this moment, the specific circumstances when the proper use of rights principle is applicable in tax law cases as well as specified actions to be taken by tax authorities should these legal principles be breached are stipulated in sec. 2 of the ART. The principle of classification of contracts by their true nature is codified in subsection 7 of sec. 1 ART. It is not the name or form given to a contract by the parties that is the basis for classification but it is the substance that will determine which provisions of contract law will apply. 38 Faes, P. Belgian Income Tax Law, John Wiley & Sons, 1995, p11. nr BGBl. I 3150 (3171). 40 Lang, in: Tipke/Lang, Steuerrecht, sec. 5 para

31 As these principles have a very wide scope, even the Hungarian sham concept is considered to be a special case of proper use of rights and characterization of contracts Italy In Italian tax law, three different concepts are used to tackle tax avoidance. A general anti-avoidance rule which covers only direct taxes is codified in Art. 37-bis DPR 600/1973. In contrast, for VAT the abuse of law doctrine as developed by the European Court of Justice applies (case law). For all other indirect taxes a general anti-avoidance provision is taken from Art. 53 of the Italian Constitution, namely the ability to pay principle Netherlands The Netherlands provide a general anti-avoidance rule, codified in art. 31 General Law concerning State Tax (GLcST) called righteous levy ( richtige heffing ). Nonetheless, the rule is not applied anymore. Instead the Netherlands make use of the judicially developed doctrine of fraus legis to counter avoidance of taxes. 41 Although, the doctrine of avoidance of the law is applicable on all Dutch law, in tax law fraus legis was especially present. In civil law fraus legis results in a sanction as for example invalidity, in tax law the result of fraus legis is that the tax legislation is applicable on the converted facts Spain Before the introduction of the Spanish anti-avoidance rule, Spain referred to the principles of fraus legis and abuse of rights to tackle tax avoidance. By now a codification of a general anti-avoidance rule is provided in art. 15 General Tax law The rule applies to all kind of taxes. Special proceedings for the case of tax avoidance are stipulated in art. 159 General Tax Law: The tax administration has to create a committee of two persons which assesses the facts of the case with binding effect for the authorities Sweden The Anti-Avoidance clause is found in lag (1995:575) mot skatteflykt. The general clause is found in 2 of the legislation. The Anti-avoidance rule is applicable only on 41 Ijzerman 1990, p. 4, Geppaart 1965, p. 192 and Blieck e.a. 2004, p

32 transactions which trigger municipal or governmental income taxation. 42 The reasons behind the limited scope of application are the fact that the investigations and evaluations made before the law was enacted were concentrated to the area of income taxation United States Unlike the statutory law of many other countries, the United States Internal Revenue Code does not lay out a general anti-abuse rule (GAAR). Although the Internal Revenue Code and associated IRS regulations contain anti-abuse rules for certain specific situations, the American general anti-abuse rules remain solely within the realm of common law. It is universally accepted that the 1934 U.S. Supreme Court opinion in Gregory v. Helvering marked the beginning of a steady, albeit somewhat confusing, evolution of judicially created anti-abuse doctrines used by U.S. courts to help limit the tax avoidance scheming of American citizens. In that case, the Court held that tax motivated transactions must have a business purpose to be given effect. The Court also found that an important issue to be determined was whether what was done, apart from the tax motive, was the thing which the statute intended (thus creating a requirement that the courts discern the legislative intent behind drafted tax statutes). In its opinion in Gregory, the U.S. Supreme Court effectively laid the foundation from which the five prevailing tax anti-avoidance common law doctrines originated. Those doctrines are: (1) substance over form; (2) step transaction; (3) sham transaction; (4) business purpose; and (5) economic substance. Interestingly, the doctrines commonly overlap each other and tend to be applied by courts in pairs or even groups when determining whether to deny tax benefits Conclusion All countries provide for a general anti-avoidance rule. While it is codified in Austria, Belgium, France, Germany, Hungary, Spain and Sweden, the GAAR is based on case law both in the United States and in the Netherlands. Italy provides a codified general anti-avoidance rule as well as a judge-made rule on the field of VAT. As e.g. the German anti-avoidance rule is used very restrictively while the judgemade rules of the Netherlands and the United States are applied in a more flexible way, it 42 1 lag (1995:575) mot skatteflykt. 32

33 seems likely that these rules are more effective. This can be reasoned by relying to the circumstance that in case of judge-made rules disagreements between legislator and jurisdiction concerning the scope of the general rules cannot arise. Furthermore, case law seems to be more flexible as it can develop Interaction between GAAR and special anti-avoidance rules Specific anti-avoidance rules or provisions exist in all countries being part of the investigation. Therefore, the problem arises how the relation between these special rules and the general anti avoidance rule can be determined. In most cases, it is assumed that the special rules will prevail and hinder the general anti-avoidance rule to apply anymore (lex specialis derogat lex generalis). An application of the general anti-avoidance rule is still possible when the respective special rule is absent or when the tax result is against the evident intent of the special rule. This approach does at least apply in Germany, Hungary, Italy, the Netherlands, Spain, Sweden and the United States. According to this, the possibility of applying the general anti-avoidance rule depends on the transaction the taxpayer has chosen. In France, special anti avoidance rules often apply first, but their potential application does not prelude the general anti avoidance rules if necessary. There is a lot of discussion on this matter in France. In Austria and Belgium the relation between special and general anti- avoidance rules is discussed. In Germany some particularities do apply as well Austria While many scholars in Austria are of the opinion that the specific anti-avoidance rules can prevail and that they can hinder the applicability of the general anti-avoidance rule, there is also a group which is of the opinion that the application of a specific antiavoidance rule does not prevent the additional application of a general anti-avoidance rule if this is necessary in a particular situation. 44 Although some special anti-avoidance rules exist, many problems in the field of international tax law are solved by the Austrian general anti-avoidance provision. This is because in Austria one does not find a CFC regulation or a thin capitalization rule 43 Ds B 1978:6, p and Rosander, p See Gassner, Austria report, IFA Cahier 2002, Vol. LXXXVIIa, form and substance in tax law, p. 144et seq. 33

34 provided for by the law. Nevertheless, Austria has to deal with this problem. It should be noted that there is still a discussion whether the general anti- avoidance rule is applicable in these fields, whether specific rules are needed additionally or if problems in these fields may be solved by a correct interpretation of the tax provisions provided for by the different laws. So a general answer to the relation between special and general rules cannot be given at the moment Belgium On the basis of the principle lex specialis derogat legi generali one might think that the tax administration is not able to apply the general rule when a specific anti- avoidance rule is applicable. Or on a situation wherefore a specific anti- avoidance rule was designed. It is stated that this is defendable in view of article BITC. The specific antiavoidance rule is more severe than the GAAR in art BITC. Since in art BITC the non- opposability sanction is in fact the ignorance of the act stated by the taxpayer, without any question of requalification as an application condition. Here Faes states that it is hard to see how art adds any content to art BITC. 45 About the specific anti- avoidance provisions in art 46 and 211 BITC a more modified answer is imposed. During the legislative history of art it has been said that the tax authorities cannot recharacterize the fusion, but only can investigate if the sole or main intent was to avoid taxes: art in this sentence is not a reinforcement of art 344 1, it is an addition to the GAAR. It is so that the Belgian GAAR cannot be applied on fusions and divisions as such. 46 What is meant here probably is that art and are applicable in a cumulative way. Whereby, both provisions use a different approach. The specific provision concentrates on the operation itself, whereas the general provision is focused on the legal characterization and more in particular in the situation where fusion and division are combined with one or more acts that from an economic point of views bring about one and the same operation. We can apply an analogue reasoning as to the relationship between art 46 1 and Faes, P.,, Het rechtsmisbruik in Fiscale Zaken Artikel jaar later, Larcier 2008, p. 128 (nr. 214). 46 Part. St. Senaat , 765-2, 34 and Faes, P., Het rechtsmisbruik in Fiscale Zaken Artikel jaar later, Larcier 2008, p. 128 (nr. 217). 34

35 Germany As stipulated by the second sentence of sec. 42 para. 1 GFC, the general antiavoidance rule does not apply if the requirements of more specific anti-avoidance rules are fulfilled (lex specialis derogat legi generali). A particularity has to be mentioned regarding the relation between the German CFC rules and sec. 42 GFC. Contrarily to the above mentioned, in this particular case sec. 42 takes priority. 48 The ( Dublin-Dock- ) jurisdiction reasons this by arguing that the legal consequence of sec. 42 were a differing allocation of the income whereas sec. 7 et seq. Foreign Tax Act would feign a dividend distribution. 49 Hence, if the income were already income of the shareholder but not of the corporation, it would consequently not be possible anymore to feign a dividend distribution Conclusion In most cases, the relation between special and general anti-avoidance rule is mostly determined by using the principle of lex specialis. Nonetheless, there are differences regarding the details. It depends on the particular case and the respective special anti-avoidance rule whether an application of the GAAR is excluded or not. This is a problem which is especially discussed in Austria and Belgium where the situation is very unclear at the moment. In Germany the particular case of the relation between CFC-rules and the GAAR is determined altering from the general principles, so the GAAR can rule out the CFC-rules The possible use of other non-tax law tools to tackle tax avoidance Tax avoidance is generally countered by using a general anti-avoidance rule (GAAR) or a general anti-avoidance principle (GAAP), depending on which one is present in the legal system. However, in certain States the tax administration or the judiciary also make use of concepts that have not been provided by tax law but by private (or civil) law. This is the case, for example, in countries such as France, Hungary, the Netherlands, Spain, Sweden, and the United States of America. 48 Hahn, DStZ 2008, 483 (487); Wassermeyer, in: Flick/Wassermeyer/Baumhoff, AStG sec. 7 Para Vogt, in: Blümich, EStG/KStG/GewStG, sec. 7 AStG para. 9 with further references. 50 Hahn, DStZ 2008, 483 (487). 35

36 There are other countries, like Italy, where civil law concepts were used in the past as a way to contrast tax avoidance but have currently been left aside, in favor of a GAAR. Finally, there are States in which civil law concepts are not used at all as antiavoidance instruments, like in Austria (where tax law and private law are completely separated from one another), Belgium, and Germany States where civil law concepts are used to tackle tax avoidance France The concept of sham is contained in the article 1321 of the French Civil Code. Its articulation with the new definition of abuse of law as written in the article L64 is not clear The Netherlands In the Netherlands the GAAR is a general law concept (fraus legis) and civil law is a starting point for tax law. Hence when using the sham concept one can find the civil law form, fact, which is needed for tax purposes Spain In Spain, civil law concepts used to tackle tax avoidance are fraus legis, abuse de droit and sham. Fraus legis was introduced into Spain s Civil Code (art. 6.4) with the reform of The abuse de droit is established in art. 7.2 of the Civil Code. Sham describes the concept of simulation as it is recognized in civil law, with the only notable difference in the treatment of the sham concept between these two fields of the law being that in tax law the legislator does not identify simulation as a false cause. There is also the tendency to make the substance prevail over the form Sweden In Sweden, while the legal form of a transaction is taken into account, there is a tendency to make its economic substance prevail. And it is probably for this reason that civil law concepts such as sham and the wrong qualification of contracts are not kept 36

37 distinguished: in both cases, what really counts is the economic substance behind the transaction United States A similar approach is taken also in the U.S., where the economic substance of a transaction tends to be regarded as more important than its legal form. 51 However, differently from the States previously seen, the U.S. is a common law country and its antiavoidance instruments are essentially based on case law and judicial developments (substance over form, step transactions, business purpose, economic substance, sham transactions) rather than on tax or civil law statutes States where civil law concepts were used in the past to tackle tax avoidance Italy In Italy there is a very formal approach in the application of law, a characteristic of this legal system that made it somehow difficult to contrast tax avoidance with civil law concepts, given the different scopes of tax law and private law. In the past, use had been made of fraus legis (art of the Italian Civil Code) and the functional interpretation of contracts. However, both putted in jeopardy the certainty of law and were left aside in favour of a GAAR (art. 37-bis DPR 600/1973). Sham is not considered as equivalent to tax avoidance and is therefore of no use in tackling it. The only civil law concepts that are still used are the rules on the interpretation of contracts, as provided by the Italian Civil Code (art and following) States where non-tax law concepts are not used to tackle tax avoidance Without any doubt, the use of civil law concepts together with the presence of a GAAR and a GAAP in the same legal system tends to represent a major defence against the perils of tax avoidance schemes. However, there are some countries where it is preferred to tackle it only with tax instruments. This is the case of Austria, Belgium, Germany and Hungary. 51 Form, however, is sometimes acknowledged over substance, usually in cases where such form aligns properly with the legislature s intent. 37

38 Austria In Austria tax law and civil law are two distinct and autonomous fields, which means that tax avoidance cannot be contrasted with civil law instruments but only with specific tax law instruments Belgium The Belgian Supreme Court has unambiguously rejected the doctrine of fraus legis in income tax matters in its Brepols and Au Vieux Saint- Martin- decisions, and such even if the sole purpose of the taxpayer in accomplishing an operation is to reduce his tax burden Germany In Germany, on the contrary, the civil law sham concept does not apply in tax law as the German GFC provides its own simulation rule (sec. 41 GFC). The idea of fraus legis is incorporated in the general anti-avoidance rule (sec. 42 GFC), as it is dogmatically a case of evasion of the law. The rules of statutory prohibition and legal transaction contrary to public policy (sec. 134 and 138 German Civil Code) do not apply in the context of tax law. The abuse of law doctrine is a general principle and can be used in every field of law, therefore even in tax law. Nevertheless, it is not used (as a doctrine) to handle tax avoidance, as its application is excluded by sec. 42 GFC (Germany s GAAR) Hungary In Hungary tax law is heavily based on civil law and concepts as the proper use of the law, sham and the characterization of contracts are all considered as GAARs. Therefore, a clear distinction between tax law and civil law anti-avoidance measures is not really possible, since the deep correlation of these two branches of the law Conclusion In conclusion, it is interesting to note how the main civil law concepts, taken into 52 De Broe, L., International Tax Planning & Prevention of Abuse under Domestic Law, Tax Treaties and EC-Law, Doctoraal Proefschrift, K.U.Leuven, , 54, (nr. 27). Supreme Court, 22 march 1990, Pas., 1990, I, 853 (Au vieux Saint Martin); Supreme Court, 6 June 1961, Pas., 1961, I, 1082; Garabedian, D., «Forme» et 38

39 consideration by some of these countries, are useful tools to counter tax avoidance tend to be very similar in each country (fraus legis, sham, abuse of law). However it is also curious to note how these legal approaches can differ from one another. An example of this possible difference is the comparison between Austria, where tax law and civil law are two completely distinct fields, and Hungary, where on the contrary tax law is heavily based on civil law. But the difference in approaching tax avoidance may regard the legal system also in its entirety, as is the case of Italy, where a very formal approach is preferred, and the USA, where the substance of a transaction tends to prevail over its legal form. 3. GENERAL ANTI-AVOIDANCE RULE (GAAR) 3.1. Applicable type of tax Except from Belgium, Sweden and Italy, all kind of taxes are covered by one and the same general anti-avoidance rule. Belgium provides separate anti-avoidance rules for all fields of taxation. The Swedish rule does only apply to income taxes. Italy provides three different (general) anti-avoidance rules to cover all type of taxes Constitutional issues Tax avoidance is a very dangerous phenomenon for society. It deprives the tax administration of its rightful tax revenue and subsequently the community as whole of the resources needed to foster its growth and wellbeing. For this reason, modern legal systems are equipped not only with specific anti-avoidance rules but also with general ones (GAARs) or with general principles (GAAPs). But in tackling tax avoidance it is important not to violate those fundamental rights of any human being, generally embodied in the Constitution of each country. Therefore, sometimes issues may arise regarding the relationship between such constitutional principles and the use of GAARs. However, different States have different attitudes toward this relationship and while some of them have explicit constitutional issues, others do not. Part of the first «Substance» en droit fiscal belge, J.D.F., 2003, 200; Garabedian, D., Form and Substance in Tax Law, Belgian 39

40 category are countries like Austria, Germany, Hungary, Spain, Sweden, and the United States of America (USA). Instead, countries without any particular constitutional issue are Belgium, France, the Netherlands and Italy States with constitutional issues The constitutional issues of each country that has them may differ from one another, and even when they appear to be the same, the reasons they arise may be different, often influenced by the historic experiences of the States themselves. It is therefore interesting to see the differences that there may be between those countries, one by one Austria In Austria, even if there are some constitutional issues concerning the freedom of contract and the precise use of terms in tax statutes, the national GAAR (sec. 22 of the Federal Fiscal Code) is considered accepted overall. In this case, it is important to remember that in this State tax law and private law are two completely different fields; therefore a GAAR is of essential importance since civil law instruments cannot be used to tackle tax avoidance Germany In Germany there are constitutional issues concerning the limits to the power of both the legislator and the judge. The actions of the first one are limited by the freedom of contract (art. 2.1 of the German Constitution), the precept of using precise terms in statutes, the equality of taxation (art. 3 of the German Constitution), and the principle of proportionality. On the other hand, judges are limited by the separation of powers principle and by the requirement of a formal parliamentary act on which to base their judgments Hungary In Hungary constitutional issues mainly regard the freedom of contract (art. 9 of the Hungarian Constitution). According to it, public and private interests need to receive equal consideration and the safeguard of the freedom of contract is essential for the Report, Cah. Dr. F. Int., Vol LXXXVIIa, IFA 2002 Oslo Congress, Kluwer, 2002,

41 wellbeing of a market economy. The centrality of such constitutional issue may be a sign of the importance for Hungary to preserve its free market economy, after so many years of Communist regime The Netherlands In the Netherlands, while its GAAR (fraus legis) has always been found constitutional, there may arise some constitutional issues regarding the principle of legality. In fact, as it happens also in other countries, it is quite important that the application of the Dutch GAAR does not contrast with this fundamental principle of any modern State. Nevertheless, no other constitutional issue is present in the Netherlands Spain In Spain there are two constitutional issues: one represented by art. 31 of the Spanish Constitution, which establishes the ability to pay principle ; another by art. 53, which declares that fundamental rights can only be regulated by an act of the Parliament, respectful of their basic content. One of these fundamental rights is the principle of legality, according to which no one can be convicted or sanctioned for actions or omissions that did not constitute a crime, offense or administrative violation, at the moment they were committed Sweden In Sweden the Constitution forbids the use of analogy in tax law and according to some Swedish scholars the national GAAR (art. 2 of Statute 575/1995) is an example of analogy. If this was the case, the Swedish GAAR would be unconstitutional. However, it must be said that this GAAR has been applied for quite some time by now and Swedish judges have never contested its constitutionality United States In the U.S. the main constitutional issues regard due process and the right to a trial by jury. This may be an example of the checks and balance between the legislative, executive, and judiciary powers. 53 In fact, by having a trial and having it in front of a jury, 53 For U.S. constitutional constraints on tax anti-avoidance rules, see BORRIS BITTKER, MCMAHON & ZELENAK, FEDERAL INCOME TAXATION OF INDIVIDUALS 1.03 (Thompson/West) (2008) ( Like all other federal powers, the right of Congress to levy and collect taxes is subject to a wide range of 41

42 the taxpayer has much more chances to demonstrate his/her innocence. But there is also an issue regarding the precise definition of income, which is a very important topic considering the large amount of tax revenue that income taxes provide in modern States. 54 Congress is, however, consistently provided wide latitude in defining, within reason, the concept of income for purposes of taxation. Lower federal courts have also commented (and even sometimes disagreed) on the constitutionality of the judicial anti-abuse doctrines. 55 The Courts, however, have confirmed the constitutionality of the common-law general anti-avoidance doctrines States without constitutional issues Such constitutional issues, as said above, do not seem to arise in every country, as it is the case of Belgium, France, and Italy Belgium In Belgium the Constitutional Court in its decision of November 24, stated that the Belgian GAAR (art of the Belgian Income Tax Code) is in line with art. 170 of the national Constitution, which establishes the principle of legality (i.e. a tax can be imposed only by a statute) France In France there are no constitutional issues. However, since its GAAR (art. L64 of the Code of Tax Procedure) is now applicable to the whole tax system, some issues may arise in the future concerning the constitutionality of its penalties, given the principle of nulla poena sine lege. constitutional limits, including the due process clause, the right to trial by jury in criminal cases, and the prohibition of unreasonable searches and seizures. ). 54 See Eisner v. Macomber, 252 U.S. 189 (1920) (confirming that a constitutional limit exists on Congress definition of what constitutes income ). 55 See, e.g., Coltec Industries v. United States, 62 Fed. Cl. 716, (Fed. Cl. 2004) (U.S. Court of Federal Claims held that the economic substance doctrine was unconstitutional, in that it violated the separation of powers doctrine); Coltec Industries v. United States, 454 F.3d 1340, 1352 (Fed. Cir. 2006) (U.S. Court of Appeals for the Federal Circuit reversed the Court of Federal Claim s decision, finding the economic substance doctrine to be constitutional, based on the doctrines recognition in several Supreme Court and Federal Circuit cases, with no contrary precedent holding the doctrine to be unconstitutional. The court found the doctrine to be similar to other constitutional principles of statutory construction that permit courts to look beyond the language of a statute if legislative intent would be violated.). 42

43 Italy In Italy there is not any constitutional issue either, perhaps with the sole exception of some weak arguments concerning the freedom of contract (art. 41 the Italian Constitution). On the contrary, the Italian Court of Cassation has recently begun to read art. 53 of the Italian Constitution, which provides the ability to pay principle, as a GAAP. If this was the case, there may not be any specific procedures to be followed for transaction not covered by the Italian GAAR (art. 37-bis DPR 600/1973) Conclusion In conclusion, it may be noted how different legal systems react in different ways to the introduction or use of a GAAR. Some of them see the rise of specific constitutional issues, while in others the constitutionality of GAARs is not even put into question. It is also peculiar the case of Italy, where not only there is not any constitutional issue but the Constitution itself is read as an anti-avoidance instrument Interpretation The next paragraphs will discuss the GAAR of the countries that have been subject to the investigation. These paragraphs will first highlight certain interesting points concerning a country (if there are any), and then present the criteria to meet the GAAR. Furthermore, countries will be distinguished based on the criteria of taxpayer intent, legislative intent, and other criteria in order to compare the GAAR Austria Concerning the GAAR it is interesting that the meaning of Sec. 22 FFC in Austria is still in dispute. There are two theories on the meaning of this section or on how Sec. 22 FFC has to be interpreted. The two theories are referred to as the Innentheorie and the Außentheorie. These specific theories describe what consequences, according to their proponents, have to be attributed to a behavior characterized as abuse according to Sec. 22 FFC. The Außentheorie was developed by the German courts, explicitly by the Financial Court of the German Empire. The conditions to meet sec. 22 FFC under the Außentheorie are the following. Firstly, if there are other reasons for the transaction(s) than tax reasons it can not be met. 56 Court of Arbitration, Case 188/2004, 24 November, 2004, B.6 43

44 Secondly, is the unusualness and inappropriateness of the transaction. To meet the conditions of sec. 22 FFC under the Innentheorie one must look at the purpose of the law and whether any tax provision is fulfilled or not. (Sec. 22 FFC is not a material tax provision, the tax authorities may not levy tax on the grounds of Sec. 22 FFC Sec. 22 FFC merely is an interpretation aid) Belgium Interesting to mention is that in Belgium the legislator s intent has to be taken into account only in VAT matters and only since the Halifax case. Art BITC can be applied in the case where the legal characterization chosen by the parties has only been chosen to avoid taxes and where the taxpayer is not able to demonstrate any economic, financial or legitimate need for this chosen characterization. The problem with the Belgian GAAR is that you will have to be able to recharacterize in something. Into a legal characterization that gives similar consequences in that case. So it has to be determined on a case to case base France Interesting is that in the France L64 Tax Procedure Book contains the sham and fraud principle. Sham is met when the real situation is hidden. Fraud is met when the transaction is done exclusively for tax purposes (taxpayer intent) and there must be a conflict with legislative intent (added post-halifax) Germany Concerning the intent of the taxpayer the following is interesting. Whether intent to avoid is required by sec. 42 GFC or not is contentious; indeed, the prevailing opinion is that it is needed. The opposite view argues that tax law would have to be impartial as a rule and there were no reasons for making an exemption in regard to sec. 42 GFC. However, this is not in accordance with the wording of the provision which requires an abuse and not only an incorrect use of legal constructions. Hence, for applying sec. 42 GFC the taxpayer must have the intention to avoid taxation. The dispute is not of particular importance as, even when subjective criteria are required, they will be assumed 44

45 when the objective elements are given; consequently, the results will be typically the same. Furthermore, it is important that the contract is not void otherwise there is a sham. To meet sec. 42 GFC there must be an intent to avoid taxation. Next, there must be a conflict with goal and purpose of the law. Furthermore, the appropriateness of the chosen legal construction is important Hungary Interesting to see is that in Hungary the Proper Use of Rights, characterization of transactions according to their true nature (sham and simulation) and taxability of illegal incomes are all seen as a GAAR according to literature. The non-abuse of rights is only one aspect of the proper use of rights. The proper use of rights would also require one to act in good faith and with honesty and to cooperate with his partner in the legal relationship. The use of rights is against the interests of society when it is against the interests of the treasury, a non-party in the public law contract. The use of rights (e.g. to contract) in this instance is specifically aimed to profit from the non-payment of taxes or other schemes. A ruling of non-proper use of rights, section 2 of the ART, is firmly linked with taxpayer intent, which is in conflict with the interests of society When characterization of transactions according to their true nature (sham and simulation), subsection 7 of section 1 ART, is used, it is not the name nor the form given to a contract by the parties that is the basis for classification but it is the substance that will determine which provisions of contract law will apply. taxed. Taxability of illegal incomes implies nothing more than that illegal income is Italy The conditions concerning art. 37-bis DPR 600/1973 for direct taxes are that the business purpose is not the prevalent reason behind them. Furthermore the circumvention of obligations/prohibitions is a condition and the result is obtaining tax reductions/refunds otherwise not due. 45

46 Netherlands In the Netherlands there is a codified GAAR, righteous levy and a judicially developed GAAR, fraus legis. On July the 29th 1987 the State secretary of Finance announced that per August the 1st 1987 for a period of five years no authorization would be given in order to observe how the judicially developed GAAR fraus legis would develop in tax cases. Since then no authorizations were given for righteous levy therefore, it is not covered in this paper. The conditions to meet fraus legis firstly, that the predominant motive of the composition of transactions is a substantial reduction of tax levy, and secondly, there is a conflict with goal and purpose of the law Spain In Spain the GAAR, art. 15 General tax law 2003, can be applied when the following conditions are met. The transaction must be inadequate and artificial and does not produce any relevant legal or economics effects. Furthermore, there has to be an essential aim of the taxpayer to circumvent tax law Sweden The conditions to meet the GAAR mentioned in lag 2 (1995:575) mot skatteflykt are the following. The transaction, on its own or in combination with another transaction, is part in a procedure which entails a substantial tax-benefit for the taxpayer and the taxpayer, directly or indirectly, has taken part in or contributed to the transaction or chain of transactions. Next to that, the tax benefit, considering the circumstances can be assumed to have constituted the predominant reason for the procedure and a taxation on the basis of the procedure would be contrary to the purpose of the legislation as it is evident in the general composition of the tax legislation and the provisions which are directly applicable or has been circumvented through the procedure United States It is a generally accepted notion that the American legal system is one in which substantive reasoning has historically been used far more widely than formal reasoning when decisions have been made or other legal actions taken. Unlike the statutory law of 46

47 many other countries, the United States Internal Revenue Code does not lay out a general anti-abuse rule (GAAR). Although the Internal Revenue Code and associated IRS regulations contain anti-abuse rules for certain specific situations, the American general anti-abuse rules remain solely within the realm of common law (originating from dominant legal theories of substance over form). However, the principles and theories generating from those common law doctrines are now so interwoven in the fabric of American tax law that they have been portrayed by one scholar as resembling a preamble to the Code, describing the framework within which all statutory provisions are to function. Attempts have been made since 1999 (and are currently ongoing) within United States to codify at least the economic substance doctrine; however such efforts have been, as of yet, unsuccessful. Substance over form is based not on the formal steps taken to achieve a specific tax result, but rather on the actual substance of what transpired. With Step transaction interrelated steps of an integrated transaction should be analyzed as a whole rather than treated separately. Sham transaction can be divided in economic sham and factual sham. Economic sham looks at whether the transaction in question is bona fide and ever actually took place. Factual sham is not a GAAR, see the section about sham. With the Business Purpose Doctrine a transaction is not to be given effect for tax purposes unless it serves a purpose other than tax avoidance. Economic substance looks at the subjective intent of the taxpayer entering into the transaction (business purpose) and the objective economic substance of the transaction (economic substance) European Court of Justice The Conditions to meet abuse of EC law are first, that the predominant aim of the transactions concerned is to obtain a tax advantage through community law and second, that the transactions concerned result in the accrual of a tax advantage the grant of which would be contrary to the goal and purpose of those provisions. 47

48 Conclusion Harmonization would be in the interest of the internal market. Looking only at the conditions to apply the GAAR that have been expounded above, the following can be concluded. Hungary has its own view on what a GAAR is and this view deviates somewhat from the GAAR used in other countries. All nine European countries presented in this paper have a taxpayer intent as a condition to meet their GAAR. In addition, the U.S. has a taxpayer intent in its GAAR to counter avoidance. Moreover, the ECJ has also introduced a taxpayer intent in its conditions to meet abuse of EC law. Concerning legislative intent, it can be concluded that all European countries presented in this paper except for Belgium and Spain have this condition. This condition is also present when applying the GAAR from the U.S. Next to this legislative and taxpayer intent, there are mentioned several other criteria. These are for instance the appropriateness of the chosen legal construction in Germany and the unusualness and inappropriateness in Austria under the Außentheorie. This paper advocates the idea that these sort of conditions contribute to the proof of that the predominant reason of the taxpayer is a tax frustration condition. Interesting to see is that the ECJ Halifax concluded to the taxpayer and the legislative intent. Therefore, this could be a step in the direction of harmonization Effects After the GAAR has been found to be applicable on a transaction or chain of transactions the question arises which practical effect the application of the GAAR will have. In our research we have found the most common action is a re-characterization of the legal action. Another consequence of applying the GAAR is the possibility of administrative or criminal sanctions. In this area we found a difference between the jurisdictions concerning: who could be targeted, the conditions for the sanctions, under which circumstances and which cases, different, if any sanctions could be applied. 48

49 Austria In Austria there is a debate regarding two different theories of how to interpret the GAAR in Sec. 22 FFC, the Außentheorie and the Innentheorie. According to the Außentheorie it is necessary for the Tax Administration to examine whether the construction in question is an appropriate and usual construction and if it is then assessed that the construction is unusual and inappropriate the tax authority can re-characterize it to a fictitious construction the tax authority regards as appropriate and usual. 57 According to the second theory Innentheorie Sec. 22 FFC is not a material tax provision. This means that the tax authority is not allowed to levy taxes on the grounds of Sec. 22 FFC. The proponents of this theory are of the opinion that the construction has to be examined and the question has to be answered whether a tax provision is fulfilled or not. The legislator s intent is very important. This means that purpose of the law is very important and has to be assessed carefully. According to the Innentheorie for the taxation it is definitely not Sec. 22 FFC but any other tax provision that has to be applied to the specific situation. Teleological interpretation of the concerned tax provision is necessary and the result of the teleological interpretation tells the tax authority whether they should tax the construction or not Belgium For the application of the Belgian GAAR once the tax authorities have established that the legal characterization, which the parties have given to their legal act(s), was motivated by tax avoidance purposes and that they have set aside such legal characterization, one must turn to the legislative history to establish the legislator s intent. The ratio legis of the Belgian GAAR is to allow the tax administration to ascertain that the tax is imposed on the normal legal characterization of the operation executed by the parties that restores the tax base. 57 In this process however the authorities do not need to consider facts in favour of the taxpayer which arises from the fictitious situation. This means that facts that occur as a result of the construction chosen by the taxpayer such as higher prices for loans or other economic disadvantages are not considered or deducted when taxing the appropriate and usual construction, see, Reeger/Stoll, Kommentar zur Bundesabgabenordnung, p

50 Tax authorities cannot simply ignore the act and refuse the tax benefits pursued by the taxpayer. Since it is only the legal characterization of the act(s) that is not binding on the tax authorities they cannot deny the existence of the legal act and its legal effects. The Belgian GAAR can therefore only be applied where there is room for more than 1 correct legal characterization of an act under private law. That condition will rarely be met if an operation is accomplished through one single legal act. If there is a chain of transactions the Tax Administration has to assess the legal consequences of the entire operation and not the intermediate acts themselves France According to the French GAAR in art. L64 of the Livre de Procédure Fiscale (LFP) the Tax Administration has the authority to re-characterize a transaction even if the formal elements are effective in law. Concerning the sanctions France applies a strict administrative sanction. The general rule is that the main instigator in penalised by adding the avoided taxes plus an additional 80% to the tax burden. In certain cases the sanction can be lowered to 40 %. This can happen in two cases. First in the case when the taxpayer is not the main instigator of the transaction and second if he is not the main beneficiary. In addition there is a monthly interest of 0.4% in the latter case 59. In addition to the taxpayers directly involved in the transaction it is, according to Fouquet s financial law (loi de finance rectificative pour 2008), possible for a French court to decide that a beneficiary of a tax avoidance transaction can be subject to administrative sanctions. Who or whom exactly can be a beneficiary is currently unclear Germany If sec. 42 GFC applies, the legal consequences of the inappropriate legal construction in regard to tax law are replaced by the legal consequences of an appropriate 58 De Broe, L., International Tax Planning & Prevention of Abuse under Domestic Law, Tax Treaties and EC-Law, Doctoraal Proefschrift, K.U.Leuven, , 201, (nr. 247). 59 Art of the French General Tax Code (Code général des impôts) 50

51 legal construction. 60 If more than one appropriate legal construction exists, the one which is most advantageous for the taxpayer is to be applied. 61 In the case only parts of a transaction are inappropriate only these parts will be affected by the GAAR. In respect to civil law the taxpayer s transaction remains valid. 62 Tax avoidance in itself is not criminal but can coincide with tax evasion which is a criminal offence pursuant to sec. 370 GFC when the taxpayer conceals or fakes the facts of the case Hungary The three different GAARs in Hungary give rise to different legal consequences. In the case where a taxpayer has improperly used his rights the Tax Administration takes into consideration all circumstances in the case. In this process the Tax Administration pays special attention to the situation which would have arisen had the taxpayer used his rights properly. If this operation is not possible the Tax Administration may estimate the tax liability. The most straight forward approach in this process would be to disregard the elements of a transaction which are improper. A risk with this method however is that it may lead to a re-characterization which alters the transaction in such a way that the question arises if the transaction had been undertaken at all without the disregarded elements. A solution to this issue would be to only disregard transactions which have the sole purpose to evade taxes while transactions with only the main purpose to evade taxes would be not be disregarded. Section 108 Act on the Rules of Taxation regulates a special case where it is impossible to determine the tax obligation and stipulates that the taxable base in these cases has to be assessed by estimation. If the legal action is considered to constitute sham/simulation the general principle is that the simulated contract shall be judged in accordance with the contract which it was intended to disguise. This has the effect that if the disguised contract is void so is the simulated contract. 60 Drüen, in: Tipke/Kruse, AO/FGO, sec. 42 AO para. 50; Birk, Steuerrecht, para Drüen, in: Tipke/Kruse, AO/FGO, sec. 42 AO para Koenig, in: Pahlke/Koenig, AO, sec. 42 para Lang, in: Tipke/Lang, Steuerrecht, sec. 5 para

52 The main rule concerning void and voidable contracts is that they both result in a reparation of pre-contractual circumstances. However in certain cases the voidable legal action may already have been partially executed. Parts that have been executed of the now void transaction, however may not be granted tax immunity. 64 The third and final GAAR, the taxability of income from illegal acts, is straight forward in its application and effects: all transactions whether they are legal or illegal are, by virtue of this provision, subject to taxation. An administrative penalty can be levied in three different cases. The first case is when there is an outstanding tax obligation, the second case is when a budgetary subsidy is unlawfully used and the last case is when a tax rebate is excessively claimed Italy In Italy the effects of the GAAR can be found in article 37-bis DPR 600/1973. There are three main effects of an application of the GAAR. First the legal act becomes unenforceable, meaning that any tax advantages derived from the legal act are eliminated. This is done not in order to erase the juridical effects of the avoidance scheme but rather in order to eliminate any economic damage suffered by the state. The second effect concerns the assessment of taxes based on the avoided norms. The taxes which have already been paid based on the tax avoidance scheme will be deducted from the tax assessed based on the avoided norms. The rationale for this order is the unwillingness of the legislator to sanction tax avoidance. In the cases where third parties are affected by the anti-avoidance procedure it is possible for them to request a reimbursement of taxes because of the avoidance acts. not. 65 In the Italian legal system it is not clear if tax avoidance should be sanctioned or It is neither clear whether a hypothetical sanction would be administrative or if tax 64 The second sentence of Subsection 7 of Section 1 of the ART 65 A. SPOTO, Revisione della clausola antielusione. Si devono applicare le sanzioni?, in Il Fisco, 1997, p

53 avoidance could be subject to criminal sanctions. The majority of scholars however are of the opinion that tax avoidance should not be subject to criminal sanctions. 66 In the past the nullity of contracts was not considered to be the best way of combating tax avoidance. However since 2005 the Court of Cassation changed its position stating that tax avoidance transactions should be considered void. It is hard to predict what will be the future developments on this aspect Netherlands Netherlands have two separate GAARs, the righteous levy and fraus legis. Righteous levy is codified in art. 31 General Law concerning State Tax (GLcST), in Dutch Algemene Wet inzake Rijksbelastingen and fraus legis is a judicially developed doctrine. When righteous levy is applied it results in a fiscal re-qualification of the facts. The legal actions are neglected for tax purposes. In the case of fraus legis there are two possible consequences. Firstly, substitution to nil which implies that the legal action(s) is (are) neglected for tax levy and secondly, the legal action(s) are substituted with a legal action for tax purposes, the tax is then assessed based on the new transaction Spain In Spain the legal effects of applying the GAAR can be found in art. 15 of the General Tax Law. The method used is to re-characterize the legal action in accordance with the tax law and in a way which corresponds to the appropriate transaction. There are no sanctions for tax-avoidance, instead the tax is assessed on the recharacterized facts and any tax advantages obtained through the original legal action are eliminated. 66 G. BARTOLINI, Sulla progettata penalizzazione delle condotte elusive, in Il Fisco, 1998, p. 5496; O. CUCUZZA, L art. 37-bis del D.P.R. n. 600/1973 e la riforma del sistema penal-tributario, in Il Fisco, 1998, p. 3715; M. DI SIENA, Brevi considerazioni sulla criminalizzazione dell elusione fiscale, in Il Fisco, 2003, p

54 Sweden In Sweden the legal consequences of the GAAR are found in the 3 of lag (1995:575) mot skatteflykt. According to this provision there are two alternatives for the reassessment. First in the case where no alternative transaction to the avoidance scheme can be found the Court will disregard the transaction. If there on the other hand exists an obvious alternative legal action the assessment shall be made based on this transaction. The reason for choosing this method was its close correlation with the effects of substance over form United States The substance over form doctrine essentially provides that the resulting tax incidence of a particular transaction should be based not on the formal steps taken to achieve a specific tax result, but rather on the actual substance of what transpired. 68 In Gregory v. Helvering, where the U.S. Supreme Court stated that, generally speaking, the incident of taxation depends on the substance rather than form of the transaction. 69 It is also possible for the taxpayer to invoke substance over form in his favour, but the courts are reluctant to allow this possibility The U.S. Tax Court held in Cutts v. Commissioner that [t]he taxpayer too has a right to assert the priority of substance at least in a case where his tax reporting and actions show an honest and consistent respect for the substance of a transaction. 70 If a court determines that the step transaction doctrine should be invoked, it can either choose to change the order of the steps taken or disregard (or compress) the steps altogether; however, the government must be able to logically account for all the steps that it chose to remove. 71 As is the case with the substance over form doctrine, taxpayers 67 Court of Cassation, judgement of Glickman and Calhoun, supra note 83, at See Keinan, supra note 77. (citing Gregory). 70 Cutts v. Comm r, T.C. Summ.Op (U.S. Tax Ct 2004) 71 See Keinan, supra note

55 sometimes may have ability to use the concepts of the step transaction doctrine to provide them with beneficial tax savings. 72 In the case of the sham-doctrine there is a distinction between factual sham and economical sham. If the transaction described by the taxpayer never actually occurred, then it should be deemed a factual sham, and all tax benefits related to the transaction should be denied. 73 If it can be determined that the transaction in question actually took place and was not merely a sham in fact, economical sham, the second layer of analysis to be undertaken is to determine whether the transaction had economic substance and was motivated by an economic purpose other than tax avoidance. 74 If a US court finds that there is a lack of business purpose, it has the power to recharacterize the inappropriate transaction to better reflect the true nature of the situation. It should be noted that such re-characterization is usually done for tax purposes and the economic structure of the transaction may still very well retain its character. The effects of the business purpose doctrine can also be used on the economic substance doctrine. The US makes use of several different administrative penalties, especially with respect to transactions deemed to be tax shelters by the IRS. The U.S. government requires the organizer of a tax shelter to register the transaction and provide certain benefits concerning the associated tax benefits. Penalties (20%) are also issued for underpayment of tax, if such underpayment is attributable to one of the following: (1) Negligence or disregard of rules or regulations; (2) Any substantial understatement of income tax; (3) certain substantial valuation misstatement; (4) Any substantial overstatement of pension liabilities; (5) Any substantial estate or gift tax valuation understatement. 75 In addition, tax advisors in these types of tax shelters are subject to the rules of IRS Circular 230 and could be restricted from practicing before the IRS if these rules are not followed See Keinan, supra note Id. at See Lerman v. Commissioner, 939 F.2d at 49. See also Keinan, supra note See also 26 U.S.C See IRS Circular

56 Observations and conclusions During our research we found several similarities and differences between the legal systems. A first and important observation concerns the legal consequence of an application of the GAAR. The general method used in the examined jurisdictions is a re-characterization for tax purposes. All legal orders in our survey make use of re-characterization. An exceptional case can be found in Hungary where in extreme cases of sham are possible to declare legal actions totally void. In Italy there is some uncertainty as to whether legal actions can be considered void after the ruling of the Court of Cassation from Concerning the sanctions for tax avoidance the general order in the jurisdictions examined is to not attach penalties to tax avoidance. In Hungary, France and the US and in France however tax avoidance can give rise to administrative penalties. In the case of Italy it is currently unclear if there are any administrative penalties. There is an ongoing debate among legal scholars about both administrative and criminal sanctions with respect to tax avoidance. All countries apply criminal sanctions for tax evasion Burden of proof As the assumption of tax avoidance is in favor of the tax authorities and in disfavor of the taxpayer, the burden of proof is normally on the tax administration among these countries to prove that tax avoidance (or evasion) took place. 77 The tax administration typically will have to evaluate and prove that the taxpayer met the criteria of taxpayer intent and legislator intent, as well as the additional criteria which are applied in Austria and Germany ( unusual, and inappropriate characteristic requirements). If this burden is met in Austria and Germany, the taxpayer has the possibility to refer to justifying reasons which exclude the application of the general anti-avoidance 77 Cf. e.g. for Germany Supreme Tax Court (BFH) BStBl. II 87, 756 (758); 90,

57 rule. For these reasons the burden of proof of these justifying reasons is on the taxpayer. If this applies for Italy is discussed but still unclear. 78 Due to the special proceedings in France mentioned above, the burden of proof shifts to the taxpayer if he receives a negative ruling on the Consultative Committee level. In the United States, if the taxpayer attempts to invoke a substance over form or step transaction concept in his or her favor, then in this particular case the burden of proof is on him or her to prove that such doctrines should be employed by the courts Specific proceedings Out of all the jurisdictions involved in this investigation, only three have special proceedings when it comes to handling tax avoidance schemes: France, Italy and Spain. In France, Law n of 8 July 1987 introduced LPF, Arts L64 and L64 B, which allow taxpayers, as well as the tax administration, to submit their case to the Consultative Committee. If the Committee finds that the tax administration failed to follow the procedure set out in Art.L64, the reassessment is invalid. The burden of proof in any subsequent litigation will fall on the party that received a negative opinion from the Committee or, if the case was not referred to the Committee, from the tax administration. The name of this Committee changed with the financial law of 2008 ( loi de finances rectificatives pour 2008 ). Now, the name of this committee is: The Committee for the tax abuse of law (Comité de l abus de droit fiscal) and not like before The Consultative Committee for the repression of the abuse of right (Comité consultative pour la répression des abus de droit). In Italy there are specific proceedings to follow for abuse of law. If art. 37-bis DPR 600/1973 is applied, the tax administration has to communicate to the taxpayer that his transaction is going to be considered as a tax avoidance attempt unless he will not give further clarification that would prove the lawfulness of his behaviour. If the taxpayer does not give any answer in sixty days, then the tax administration will continue in its pursuit of the tax revenue avoided. 78 Drüen, in: Tipke/Kruse, AO/FGO, sec. 42 AO para. 54 with further references. 57

58 If However in Italy, it is a GAAP that has to be applied then the tax administration is not bound by any particular proceeding. Furthermore, Spain has a special procedure that is activated when handling tax avoidance schemes. This procedure is established in article 159 of the General Tax Law of This provision requires that the tax administration, when they believe that there is conflict in the application of a tax law, creates a four-person committee that reviews the transactions. The taxpayer will have the opportunity to present allegations on his/her behalf after being notified of the situation. The committee will provide a report that will be binding upon the Tax Administration Influence of European Law The European Court of Justice has made use of the concepts of abuse of law (e.g. Emsland Stärke) or abuse of rights (Diamantis) and has over the past years expanded these doctrines to tax cases (e.g. Cadbury Schweppes and Halifax cases). In regard to national general anti-avoidance rules the question arises to what extent these decisions have influence on the jurisdiction or even the legislation of the member states of the European Union Austria The Austrian tax authorities also apply Sec. 22 FFC to cross border cases and the Austrian Supreme Administrative Court has always held that this is correct. The Austrian Supreme Administrative Court is of the opinion that the ECJ does not mind the Austrian tax authority applying Sec. 22 FFC to cross border cases to prevent abuse. 79 The ECJ has not yet decided about the applicability of Sec. 22 FFC to cross border cases as it has not been asked for a preliminary ruling. According to some tax experts, the Austrian Supreme Administrative Court should have asked the ECJ whether the Austrian tax authorities are allowed to apply Sec. 22 FFC to tackle a construction set up in different Member States in an important case called Dublin Docks II but in fact it did not do that. Maybe the ECJ will give an answer in the future. 79 See VwGH , 2001/13/

59 Belgium The existence of a European concept of abuse necessarily influences the scope of the Belgian GAAR. 80 The question arose whether there still is room for general national anti- avoidance rules in tax law. The reference to Halifax of the Belgian general antiavoidance rule in VAT matters points out that the courts will have to apply the rule under supervision of the ECJ. Thus, in the wake of Halifax the Belgian legislator has enacted an abuse of rights- rule in the VAT Code thereby almost literally copying the ECJ s conclusion and requiring an essential aim (art. 1(10) Belgian VAT code). As to direct income tax matters, there is still room for art BITC, but the scope will have to be limited. Therefore Vanistendael suggests rewriting the Belgian GAAR in income tax matters so that it can maintain the European interpretation France Conclusions are to be drawn from the Bank of Scotland case: First, Art L64 applies only if there has been reassessment and the procedure in art L64 has been followed. Second, if it is simply a matter of denying treaty benefits there is nonreassessment. Therefore, in such cases the tax administration may invoke the general principle of abuse of law as set out in the Janfin case. To invoke the principle, the tax administration must establish: that there was a planned arrangement and that the exclusive aim of putting the plan into effect was to obtain a tax advantage that the taxpayer could not normally have obtained. Where treaty provisions apply, the beneficial ownership concept (discussed above) reinforces the general abuse of law principle. The impact of the Halifax Decision on the French Abuse of Law is also very important. The question is how compatible are French tax rules with EC Laws? The debate on the compatibility of French tax rules prohibiting abusive practices with European Community law first arose after the ECJ gave its judgment on July 16, 1998 in ICI VS Colmer (Case C-264/96). This judgment prompted a debate among French tax practitioners and scholars as to whether the procédure de répression des abus de droit could be considered as one of the overriding reasons of general interest justifying a restriction on the right deriving from the EC laws. 80 Faes, P., Het rechtsmisbruik in Fiscale Zaken Artikel jaar later, Larcier 2008, nr Vanistendael, F., de Weerslag van recente arresten van het Europees Hof van Justitie op het Belgisch Belastingrecht, Recht in beweging 2007, p

60 Germany Generally, a recharacterization of the taxpayer s activities is not excluded by the circumstance that the transaction took place (partly) in a foreign country. The Supreme Tax Court decided in 1997 that the anti-avoidance rule also applies when the taxpayer is not a resident of Germany but still has domestic income (limited tax liability). 82 Nonetheless, in case a double tax treaty exists attempts of tax avoidance are mostly covered by the German treaty shopping rule, sec. 50d Income Tax Act. Literature partly assumes that an additional application of the general anti-avoidance rule is therefore excluded. The jurisdiction did not decide about this problem until now. However, it seems that a subsidiary application of sec. 42 GFC is accepted Hungary There is no direct effect in Hungarian tax legislation Italy In Italy, the recognition of the doctrine of the abuse of law, as developed by the European Court of Justice, came in two judgements of 2005: n and n The national judges found that the concept of abuse of law should have had a central role in the application of domestic law. While the Italian GAAR (art. 37-bis DPR 600/1973) was not operative yet in the Italian legal system at the time of the facts object of the judgment. This had been the first time that the Court of Cassation expressly supported the direct applicability in the Italian legal system of the principle of abuse (of Community) law as developed by the European Court of Justice. But in 2008, the Court of Cassation pointed out that such principle was deductible from EC law only in the case of VAT Netherlands On an international level, concerning European Community law, it can be concluded from BNB 2004/ that in circumstances it is possible to state fraus legis, although the taxpayer appeals to the European Community freedom of capital movement. In that case an interest deduction on a loan which was before a dividend 82 Supreme Tax Court (BFH) BStBl. II 1998, Supreme Tax Court (BFH) BStBl. II 1998, HR 23 January 2004, BNB 2004/

61 debt was limited. The Supreme Court did not state an abuse of the freedom of capital, but the Supreme Court judged that since the taxpayer wanted to avoid the national legislation and this is unsuccessful the taxpayer cannot appeal to the freedom of capital Spain Spain has also been influenced by the Halifax case and the courts will need to abide by the decision in the application of the general anti-avoidance rule as the abuse of rights concept now permeates the Spanish legal system Sweden The ruling in C-255/02 Halifax does potentially have an effect on Swedish antiavoidance law. Since the Swedish GAAR does not cover VAT, the principle in Halifax might introduce a fraus legis principle concerning VAT. As to this date there are no rulings from the Supreme Administrative Court regarding this matter. There is however a ruling from the Administrative Court of Appeals (Sw. Kammarrätten) from 10 th of May 2007 case no in which the Court found itself unable to apply the principle developed in Halifax with the motivation that directives only have direct effect in favour of the individual. This ruling has been criticized and it has been argued that the Court made the mistake of not realizing that the fraus legis principle is not derived from directive 77/388/EEG but rather a general principle based on the primary legislation. 85 Until a case concerning this principle has been decided by the Supreme Administrative Court however the judicial status of the fraus legis principle concerning VAT is unclear. Should a case reach the Supreme Administrative Court it is in my opinion very likely that the judgement will be that the fraus legis principle will be applied concerning VAT United States Other than somewhat persuasively (as coming from a ruling body of other members of the larger participating global market), rulings of the ECJ and EU do not affect the decisions of U.S. courts in their invocation of U.S. common-law GAAR doctrines. 85 von Bahr, p

62 Conclusion In conclusion, it can be said that EC law is having a growing influence on the legal systems of the EU Member States. Principles such as the abuse of law or the abuse of rights are prompting many interesting discussions among scholars, legislators and judges GAAR and tax treaties While GAARs are formidable instruments to tackle tax avoidance at national level, some problems may arise when the tax avoidance schemes take place in more than one Country. In fact, it is particularly important to understand to what extent national anti-avoidance rules can be applied to double tax treaties Austria One has to differentiate between the two existing theories for the interpretation of Sec. 22 FFC. According to the Außentheorie the tax authority may and should apply Sec. 22 FFC (national provision) to tackle constructions even if a tax treaty has to be applied. This was also confirmed by the Austrian Supreme Administrative Court. According to the Innentheorie Sec. 22 FFC is a national rule and therefore it may not be applied to tackle abuse on the level of tax treaty law. National and international tax law are two separate levels and therefore the national rule should not be applied as this could lead to a weakening of the tax treaty law Belgium In the light of the Belgian tax law, anti-avoidance rules cannot normally be applied, except for treaties that explicitly allow the application of Belgian anti-avoidance provisions or treaties which include a domestic anti-avoidance provision France The debate on the compatibility of French tax rules prohibiting abusive practices with European Community law first arose after the ECJ gave its judgment on July 16, 1998 in ICI VS Colmer (Case C-264/96). This judgment prompted a debate among French tax practitioners and scholars as to whether the procédure de répression des abus 62

63 de droit could be considered as one of the overriding reasons of general interest justifying a restriction on the right deriving from the EC laws Germany Even before the decisions Halifax and Cadburry/Schweppes the Supreme Tax Court decided that the general anti-avoidance rule is regularly not to be used for transaction which took place within the European Union. By relying to Inspire Art 86, which does indeed not deal with the problem of (tax) avoidance (so the reference seems surprisingly) but with the legitimacy of special statutory reporting requirements for foreign companies, the German Supreme Tax Court declared that the establishment of foreign subsidiaries within the European Union cannot be assessed to be generally avoidant, even if the establishment were motivated primarily by fiscal and taxation reasons. 87 According to the Court, an exemption from this rule can only be made, if the foreign company is intended to exist merely temporarily. Even if the reference to Inspire Art is not convincing, the Supreme Tax Court concretized the criteria for applying sec. 42 General Fiscal Code in a similar manner as the European Court of Justice did two years later with Halifax and Cadburry Schweppes Hungary It is an interesting question whether Hungarian domestic anti- avoidance laws can be applied to cases where another sovereign country s tax administration has the primary power to tax. Subsection 5 of Section 2 of the Income Tax Act states that in cases where there is no treaty agreement with another country, domestic laws shall apply. Even when there is a bilateral double taxation treaty the taxation process may become so convoluted that Deak goes as far as saying that the `only thing to be hoped for would be [ ] the treatment of the double taxation problem on a triangular basis Italy In Italy, it is not clear whether domestic anti-avoidance rules (such as art. 37-bis DPR 600/1973) can be adopted in cross-border situations involving the application of a double taxation convention. In this respect, the lack of significant case law and official 86 Case C-167/01, Inspire Art, (2003), E.C.R. I E.g. Supreme Tax Court (BFH) IStR 2004, D. Deak, Hungary in international Tax Planning, p

64 clarifications by the tax administration is noteworthy Netherlands Concerning treaties, the supreme court stated that fraus legis concerning treaties is not possible when there is nothing from which can be concluded that the parties which developed the treaty between themselves had the mutual intention that in certain situations fraus legis can be used by the court, BNB 2003/ It must be noted, furthermore, that there is next to fraus legis the term fraus conventionis, also called fraus tractatus. Kemmeren rightfully argues that the conditions to meet fraus conventionis are the same as the conditions to meet fraus legis. 90 From BNB 1995/ can be concluded that fraus conventionis is also not possible when there is nothing from which can be concluded that the parties which developed the treaty between themselves had the mutual intention that in certain situations fraus conventionis can be used by the court Spain The application of the anti-avoidance rule in defect of protection of double tax treaties, according to scholars, will only be possible when it has been explicitly stated in the treaty. If this option is not established in the treaty, then a new treaty must be enacted, unless the parties involved are willing to engage in friendly negotiations and mutually reach an agreement. According to scholars, domestic anti-avoidance provisions can be applied if the double taxation convention does not contain specific anti-abuse provisions applicable to the case (as normally happens in treaties concluded by the Italian government) Sweden To this date there has been no case in which the GAAR has been applied in a manner that it trumps a double taxation treaty. From a theoretic perspective the GAAR can not extend the right to tax and can not be used to change the right to tax settled when interpreting the tax treaties. 89 HR 6 December 2002, BNB 2003/ Kemmeren 2003, p HR 15 maart 1995, BNB 1995/ Kemmeren 2003, p

65 The case in which a transaction has two parts, one that falls within the internal Swedish legislation and one that makes use of a tax treaty, the part which has utilized Swedish law can be attacked using the GAAR. Since 2008 there is a certain degree of uncertainty concerning the relation between internal anti-avoidance legislation and double taxation treaties. In case no the Supreme Administrative Court had to determine the relation between the Swedish CFC-legislation and the double taxation treaties. In order for the treaties to become applicable in Sweden they have to be incorporated in Swedish law. These incorporation laws do not have a special status in relation to other Swedish laws. This constitutes a problem in the case where two laws are found to be incompatible. In case the Court settled the conflict between the CFC-legislation and the double taxation treaties be applying general law competition principles. Since the CFCregulation had been amended after the treaty in question was incorporated with Swedish law the Court ruled that the CFC-regulation was lex posterior and also that it was lex specialis concerning the transactions in the case. According to these two principles the CFC-regulation was found to take precedence over the treaties. This ruling has been heavily criticized with reference to Sweden having signed the Vienna Convention as well as the principle of pacta sunt servanda. 93 This case indicates that there might be problems with a conflict between the GAAR and a tax treaty. It is important however to bear in mind that there are differences between the CFC-regulation and the GAAR which might lead to a different ruling. Also this is one isolated ruling and thus the position of the Supreme Administrative Court is not clear United States In the United States, the Later in Time doctrine holds that a tax treaty will not be in effect over US courts if there is a later contradictory US Federal statute (and vice versa). Such a concept, somewhat unique to the US, especially as compared to the EU, is many times referred to as a treaty override. 93 Mutén, Treaty Overide i Regeringsrätten, pp. 354 f. 65

66 Conclusion As seen above, the relationship between national GAARs and tax treaties is still not completely clear in most countries. As the comparisons above demonstrate, there currently exist many similarities among the participating countries in their use of GAAR and sham to combat tax avoidance and tax evasion. These similarities in some cases seem to be mostly differentiated at their most basic level by different terminology; however there does seem to exist in many cases some minimum pervasive content which can be extracted and seen across all the countries. However, it should be noted that in some cases, fundamental differences exist, as is the case with the dependence on formal rules in some countries and a focus and reliance on pure case law in others. Such an analysis would possibly shed light on which EU countries are potentially acting in a manner that is problematically different than its European cohorts Harmonization of GAAR within the EU Concerning the delicate issue of harmonization of GAAR within the EU, there seem to be reasons both for such a choice and against it. Reasons for harmonization include the argument that such a choice would increase legal certainty/clarity (helping to promote further this minimum shared content ideal), promoted by the idea that legal certainty is good for EU internal market. Also, harmonization has already been done with VAT (in the Halifax case). However, it should be noted that it is acknowledged that EC Treaty Art. 93 has no competence with direct taxation. Such influence of Halifax could be simply persuasive as a guide to show how harmonization is at least possible in one type of tax (VAT) and could possibly be extended to others, as well. For example, the Halifax decision has seemed to influence the use of legislative intent for direct taxes in France. There are, however, a great many reasons against harmonization. Those reasons include inflexibility/rigidity issues and sovereignty issues. Also, transfer of power would be required from each country, with adoption by unanimity needed by each country under Art. 94 of the EU Treaty. Finally, the clearly stark differences among the EU countries in some areas that will cause a great many compatibility issues, including for 66

67 example the strict formality of UK as compared to the substantive approach applied by many of the other countries Relationship Between GAAR and Corporate Social Responsibility It can be deduced that with the rising awareness and interest in the concept of corporate social responsibility (CSR), an argument can be made that the rising presence of CSR (either inherently found in the managing decision makers of the corporations or the result of outside pressures for such by the economic market) further legitimates the use of overriding general anti-avoidance rules by legislatures, courts and tax administrators to thwart inappropriate tax avoidance situations (in an effort to keep corporations acting in a manner befitting a proper corporate citizen). Such use of GAAR to assist with the spirit of CSR is in keeping with the ideas of equality that are pervasive in the idea/rationalization of the GAAR itself. In addition, the concept of CSR could be implemented in situations where the GAAR in a particular country was followed as exactly required by current law, but the resulting tax advantages might still seem somehow not in keeping with what one would consider responsible corporate behavior (taking into account the effects on the greater population). If such a situation occurs, a corporation could apply its specific definition of CSR and determine whether any affirmative action should be taken the corporation in order to be a good corporate citizen, even if such action is not specifically found to be legally required following proper application of statutory or common law GAAR. The thresholds and boundaries for such invocation of pure CSR decision making are, however, constantly unclear and fluctuating, thus the invocation of pure CSR will depend on the values of the corporations who choose to subscribe to such concepts. 67

68 4. CASE 1 Company A has made a capital gain of 20 by selling shares. We assume that the rules in State A provide for capital gain taxation in this case. We also assume that the law allows capital losses to be set off against capital gains to determine the taxable basis. A now buys shares of company B at a price of 110. Shortly after this, A receives a dividend of 10 from B, which is tax exempt (for example, by virtue of participation exemption rules, etc.). Then A sells the shares in B for a price of 100, thereby deriving a capital loss of 10 which may be set off against the previous capital gain of 20. It is clear that the capital loss does not correspond to an actual loss for A since it paid 110 and received 110 (10 exempt dividend resale price). Assume that all valuation is based on free market value. If company A was located in your country, could the tax authorities apply the GAAR to deny the capital loss deduction? Are there general criteria to characterize this as abuse? The idea in this case is that company A has capital gains and wants to reduce this by generating a loss to offset against this. Certain questions may arise when setting up this type of schemes. May company A take into account the loss made on this transaction to offset it against the original capital gain of 20 made on the very first sale of shares? Example in detail: In January of Fiscal Year N, company A has sold shares which it had in its account since a certain time. The capital gain on the shares is supposed to be taxable for 20 in the Fiscal Year N because it has not yet been taxed. In March of the same Fiscal Year N, A expects that B will distribute a dividend. The market value of the shares in B is 100 but they are sure that they are really going to receive a dividend of 10. So by the end of March they would have a profit of 10. Therefore A is willing to pay 110 for the B shares, since you can add the dividend expectation to the market value. The dividend income is tax exempt in the home state of company A. The market value of the shares in B after the dividend distribution is again 100 because nobody is expecting a dividend any more. From a strict tax perspective the following calculation can be made: A paid 110 to buy the shares but only received 100 when selling them again. Therefore A suffered a loss of 10 from a tax point of view. When taking into account the dividend income, then company A has a neutral transaction. The only economic result was the loss gained which the company can use to reduce its tax burden. When we look at the financial statements of the company, we notice that company A does not really realize a loss because of the received dividend. The existing tax rule is that losses can be offset against the realized gains. 68

69 Figure 1 Figure 2 tax base calculation: Revenue (i.e. capital gains) - Costs (i.e. capital losses) tax base Figure 3 Time 1: Figure 4 Time 2: 69

70 Figure 5 Time 3: Figure 6 accounting profits: 20 capital gain -110 purchase 10 dividend 100 sale 20 profit Figure 7 taxable profits: 20 capital gain -110 purchase 0 no dividend (tax exempt) 100 sale 10 profit 70

71 4.1. Austria The Austrian tax authorities would start here to investigate the situation and decide whether this construction was unusual and inappropriate to reach the economic aim of the construction. It is necessary to emphasize that even though the word unusual may seem to ask for it, according to quotes of the Austrian Supreme Administrative Court, the frequency of the appearance of such a legal construction is not decisive for applying Sec. 22 FFC. 95 This means that a taxpayer cannot justify his behavior by showing that others have used the same construction to evade tax liability as was the case concerning subsidiaries in tax havens. Nevertheless it should be pointed out that the following argument was raised in favor of the taxpayer: as this is a very common method to reduce one s tax burden it should not be regarded as unusual and inappropriate. 96 The problem in this case is that it is not easy for the tax authority that they get to know that the sole purpose of the whole construction was just to gain a tax loss that can be used to reduce the taxable income of the company. Therefore generally speaking this construction will not give raise to any tax issues in Austria. In the case that the tax authority is really able to get some evidence that the main purpose of the transaction was the tax benefit it might be tackled through the application of Sec. 22 FFC as Sec. 22 FFC provides 97 that With abuse of form and structure that are possible under civil law one cannot eliminate or reduce the duty to pay tax. If abuse (para. 1) can be established, the tax has to be charged as it would have been in the case of a legal construction which is appropriate to the economic proceedings, facts and circumstances. As a result the deduction of the loss would be denied as the company abused legal structures to reduce its tax burden. If the taxpayer is able to prove that there was another reason than the tax reason that made him set up the transaction the tax authorities are not allowed to apply Sec. 22 FFC and as a consequence the loss is deductible. 95 VwGH , 2000/13/ Gassner, IFA Cahier 2002, p Sec. 22 FFC, own translation; original wording of Sec. 22 FFC: (1) Durch Mißbrauch von Formen und Gestaltungsmöglichkeiten des bürgerlichen Rechts kann die Abgabenpflicht nicht umgangen oder gemindert werden. (2) Liegt ein Missbrauch (Abs. 1) vor, so sind die Abgaben so zu erheben, wie sie bei einer den wirtschaftlichen Vorgängen angemessenen rechtlichen Gestaltung zu erheben wären. 71

72 According to another theory the only problem that has to be investigated is if the parties really wanted to have the contracts to come true in reality as a consequence the concept of sham (Sec. 23 FFC) may not be applied. As one has according to the Innentheorie to investigate the purpose of a provision and the economic substance of a transaction here it should be checked whether the contracts really took place in reality, which means that there was a change of ownership (risk and benefits). According to the fact that we assume that each transaction was made as a part of the free market no problems should arise with the mentioned example Belgium The tax administration will try to tackle this kind of scheme but it will not use its GAAR for this matter. This transaction falls within the scope of art BITC, but the conditions for the application of the article are not met. Since it has not been made clear in the given case that there is a tax avoidance purpose with the taxpayer, nor that there is a lack of economic, financial or legitimate need. The taxpayer will under any circumstance have the possibility to prove his economic, financial or legitimate need for his way of acting. Tax authorities are most likely to tackle this scheme with art. 49 BITC that states that cost are only deductible when they are made to gain or maintain taxable income in that certain Fiscal Year. Here the tax authorities will say that the loss is not made or the costs of the transaction are not due to gain or maintain taxable income. The Supreme Court even says that the costs must be made for purposes that are connected to the real economic activity of that company. As may be assumed in this case, the buying and selling of shares is not the core activity of the company A France In France this case would be considered as tax avoidance because A reduces his capital gain from 20 to 10. This case is very similar to the famous Janfin case. The facts differ a little. With Janfin, it was about a tax credit exempt and in this case it is about a capital gain exempt. This operation is called in France opération autour du coupon. The only aim of this transaction is to avoid tax, so the condition for the application of the French GAAR is fulfilled and therefore art L- 64 will be applied. 72

73 4.4. Germany Till 2000 there was a special anti- avoidance rule for this type of cases. As this specific anti-avoidance rule was deleted, the German Supreme Administrative Court is of the opinion that the legislator should have thought about closing this loophole. Due to the fact that it did not do that the German GAAR may not be applied to solve the problems arising here according to the Court. However this opinion is discussed. According to the opponents of the position of the German BFH not the single steps but the whole construction would have been considered as abuse. Nevertheless it is at this moment uncertain whether one or more transaction have to be taken into account to consider if it is taxable or not. The criterion of inappropriateness is mentioned in the German GAAR so there may be discussions whether this construction was inappropriate. Here one has to emphasis that inappropriate is a wide term that is not well determined Hungary The described transaction would be disregarded as a sham because the sole purpose of the taxpayer to enter the transaction is to erode the tax base thus avoid paying taxes. This case however will not occur in Hungary because of the accounting principles. From the buying price, a certain amount will be seen as the actual payment and the expected dividend income will already be taken into account as dividend. Therefore at time 2, at the moment of the dividend distribution, the dividend income cannot be offset against the initial capital gain Italy In the Italian legal system there is a specific norm that regulates such cases as the one described in Case 1. According to art. 109 paragraph 3-bis of Legislative Decree n. 917 of , the capital losses on shares, participations, and other financial instruments, are not taken into account until their value amounts the same as the non-taxable part of the dividends perceived in the thirty-six months preceding their realization. 98 Art. 109, par. 3-bis TUIR: Le minusvalenze realizzate ai sensi dell'articolo 101 sulle azioni, quote e strumenti finanziari similari alle azioni che non possiedono i requisiti di cui all'articolo 87 non rilevano fino a concorrenza dell'importo non imponibile dei dividendi, ovvero dei loro acconti, percepiti nei trentasei 73

74 However, if we choose to assume that art. 109 of Legislative Decree n. 917 of 1986 did not exist, in Italy it would be possible to solve this case with the Italian GAAR (art. 37-bis DPR 600/1973), since its three criteria (the lack of business purpose; the circumvention of obligations/prohibitions; the result of obtaining tax reductions/refunds otherwise not due) are met Netherlands In the Netherlands this is not a problem when the shares are of the same kind. If they are not of the same kind it is not possible to deduct the loss of the profit. If we neglect these present Dutch rules which can be applied on this case fraus legis can maybe be used if the two conditions are met of this GAAR. Firstly, there has to be the predominant reason of the taxpayer to realize a tax reduction with his transaction and, secondly, there must be a conflict with the goal and purpose of the law. Concerning the first condition the letterbox contributes to the proof that the predominant reason of the taxpayer could be a tax frustration. Concerning the second condition, we must know the goal and purpose of the law which gives the tax exemption. If there is a conflict, then this condition is met. If both conditions are met fraus legis can be used Spain In Spain, the above scenario would not be tackled by the Tax Administration with the general anti-avoidance rule. The Tax Administration would use a specific statutory provision of the Real Legislative Decree 5/2004 which would prevent such deductions from taking place. mesi precedenti il realizzo. Tale disposizione si applica anche alle differenze negative tra i ricavi dei beni di cui all'articolo 85, comma 1, lettere c) e d), e i relativi costi 74

75 If we assume that this specific rule would not exist the construction would be tackled by the GAAR according to the inappropriateness and the fact that with this construction no other relevant economic or legal result was achieved. As a consequence the deduction of the loss would be denied Sweden All the transactions are valid from a civil law perspective and therefore the Swedish sham-conception cannot be applied. An application of the Swedish GAAR when all transactions take place between unrelated entities, on market terms and at market values is very unlikely. The fact that there is a risk involved with the value of the shares makes it difficult to find that the transaction was undertaken with the purpose to avoid taxes. The rational reason behind paying 110 is that the shares were actually worth 110 and the subsequent sale at 100 is because at that time the market value is 100. If a tax benefit is achieved as a result of the way the tax legislation is designed the legal action cannot be considered as tax avoidance. 99 If however there had been an advance agreement between the buyer and seller that the seller would buy back the shares for 100 the lack of risk could have been enough to apply the GAAR USA There does not seem to be a specific US corporate tax avoidance rule in the United States to address, or rather deny, tax benefits resulting from the transaction described in the fact pattern of Case 1. In addition, no specific US international tax law provision seems to exist that would result in a denial of benefits. If it is assumed in this case that the dividend A received from B is tax exempt (based on some sort of acceptable exemption rule), then there is likely not an issue here in the US RÅ 1999 not It should be noted that, in the actual US system (which is devoid of necessary assumptions for the purpose of this case), even though there does not seem to be a specific US anti-avoidance rule applicable to the case at hand, the existence of such rule would likely not prove necessary. Such a transaction has little bearing on US international tax law in a real-life situation for several practical reasons. There will be no dividend-received deduction in this case, because this fact pattern involves a US company and a non-us company. The dividend-received deduction does not apply unless the two companies are both US companies. 75

76 The US common-law anti-abuse doctrines would also likely not be invoked in this case. Of the available doctrines, the two that would most likely be pursued (if any at all) by the IRS and/or the courts are the sham transaction doctrine and the economic substance doctrine. Concerning the economic substance doctrine, the two-pronged test employed by the US Supreme Court case Frank Lyon (1978) focuses on both the subjective intent of the taxpayer entering into the transaction (business purpose) and the objective economic substance of the transaction (economic substance). To satisfy the subjective prong, a taxpayer must be able to show that its choice to enter into the transaction was motivated by an opportunity for profit or some other business purpose other than tax avoidance. Intent of the taxpayer is key to the determination of this prong by the court. A court could attempt to find that the taxpayer s sole intent for the transaction was to avoid taxation, however the taxpayer would likely prevail on this prong (given the opportunity to come up with some sort of economic intent here). To satisfy the objective prong of the test, a taxpayer must show that there was a meaningful and appreciable enhancement in the net economic position of the taxpayer (other than to reduce its tax). The taxpayer could also likely show some sort of modified economic position or entered-into economic risk (given the capacity for fluctuation in the open market) that would result in the meeting of this second prong s requirements. Additionally, in some courts (those that apply the disjunctive test), only meeting one of the two prongs is enough to satisfy the economic substance as pertains to the transaction. Concerning the sham transaction doctrine, there could be an argument that sham in substance (or economic sham) exists. 101 Economic sham is one in which the alleged transactions actually took place, but are nonetheless without economic substance. As noted above, the taxpayer could likely show an economic risk and resulting economic substance, thus meeting the sham transaction criteria. As a result of the foregoing analysis, the transaction would likely be considered acceptable and appropriate, resulting in no denial of tax benefits Conclusion To some readers of this paper, this first case will certainly be regarded as a tax avoidance case in their country. To others it will not be clear how their tax authorities 101 Sham in fact is not a possibility here, given the fact that there is an actual corporation created, all transactions are disclosed, and there is no attempted fraud or tax evasion. 76

77 will characterize this issue. Because of the fiscal sovereignty of each country, legislations and doctrines differ when borders are crossed. There is however one question that arises in every country: how do tax authorities deal with this case? Tax Authorities tend to tax as much as possible and therefore they will try to deny the deductibility of the capital loss of company A. To simplify matters, in the solution of this case, every country has been placed in a bucket. The first bucket contains the countries to which this case is certainly regarded as tax avoidance (Belgium, France and Hungary). For Italy, Spain and the US the aforementioned case is not considered to be tax avoidance they form a second bucket. The last bucket contains the special cases, namely Austria, Germany the Netherlands and Sweden, whereby it is uncertain how this case will be characterized. For each bucket it has been investigated in the paper how tax authorities tackle these schemes. For the first group, to which it is certainly tax avoidance, a first subcategory can be made according to the question whether the GAAR will be applied or not. In the France and Hungary the GAAR will be applied. These countries are however not alike, since in France L-64 is a statutory provision and in Hungary sham is regarded as the GAAR. For Belgium, it is a case of tax avoidance, but the GAAR is not likely to be used. Tax authorities will try to tackle it with the general article concerning the deductibility of costs. For the countries to which it is not a clear case of tax avoidance, the second bucket, further distinction can again be made. Both Spain and Italy apply a specific rule in tax law for this case and consider it to be a particular case of non deductible capital gain. Like Hungary, the US consider it to be a sham. To the US sham is however not the GAAR, but judicially developed doctrines (business purpose doctrine, economic substance and economic sham). As to the third bucket, for Austria the question whether it is avoidance or not depends on the answer to the following questions: can this case be regarded as unusual 77

78 and inappropriate and is there a relevant motive other than tax avoidance? For Germany only the criteria of inappropriateness would be investigated if we assume that there has never been a specific rule. The answer to these questions is not clear for Germany and Austria. For the Netherlands, this is a case of tax avoidance when there is a predominant motive of tax frustration and there is a conflict with the goal and purpose of the legislation. Furthermore one special case has to be mentioned. Due to the requirement, in the Swedish GAAR, that a transaction has to be contrary to the purpose of the legislation it is necessary to find a provision, a statement in the preparatory works or possible something in the design of the legislation itself which indicates that the transaction is unwanted. In this case this operation is difficult since the dividend would have been taxed according to Swedish law. When, as in the case, the dividend is not intended to be taxed it is doubtful if the transaction can be found to be contrary to the purpose of the legislation. To summarize: as to this case, it may be very clear that the exact or correct answer for every country does not exist. Even in this relatively simple example, with 10 different countries, we have different approaches. 78

79 5. CASE 2 Corporation A fiscal resident in country A wants to buy shares in corporation C fiscal resident in country C in order to sell the appreciated shares at a later date - approximately three months. A does not want to buy C directly because A would be taxed on the capital gains. A therefore creates a shell holding corporation B, that is present in country B that does not tax capital gains. Corporation B does not have any employees or physical location or property or office in country B. After approximately three months, B sells shares of C with no capital gains tax consequence. B subsequently distributes dividends to A equal to the amount of the capital gains. We suppose that no specific anti-avoidance rules or other doctrines may be applied to tackle the case except GAAR(s). Below we discuss the application of GAARs to this hypothetical case in each country represented in this paper. The discussed country shall be country A and resident country to company A. 79

80 Figure 1 Figure 2 Figure 3 Figure 4 Figure 5 Figure 6 80

81 Figure 7 Figure 8 81

82 5.1 Austria This is a valid transaction therefore it is not a case of sham. Capital gains would be taxed in country A because of the application of Section 22 FFC (abuse of law) in one of the following ways: (1) an unusual and inappropriate economic aim is involved in the transaction (Austria Supreme Administrative Court) or (2) B does not generate income, therefore the income has to be taxed at A Belgium Sham is the situation in which parties enter into an apparent act, the effects of which they have agreed to modify or destroy by another act to which only the parties are privy. In this case however, there is no disguised act. Corporations do not infringe any legal act and when parties accept all the legal consequences of their act. Sham will not apply under Belgian law. Corporation B continues to exist in this case, therefore the Belgian GAAR could normally not be applied because the consequences of the application of the GAAR would not be similar to the consequences of a direct sale (Supreme Court 4 November 2005: the effects of the recharacterized act must be similar to those of the acts initially characterized by the taxpayer ). Depending on several other factors, not detailed in the introduction of this case, the GAAR could be applied France The French tax authorities usually apply the substance over form doctrine to foreign investment structures that appear to be contrived to avoid tax. Typically, such structures use foreign holding companies. For the French tax administration, this case characterizes clearly an abuse of law. It can be also recognize like a sham situation or simulation. Indeed, in two other cases, the facts are similar: Sté Pléiade, SA Sagal In the case, the company has not got any employees, or physical office (or property). Therefore, this company has no economic substance, it is fictitious in character and has no economic interest. In addition, the company has no business justification. The only aim of the operation is to avoid tax. The Company B was exclusively incorporated to benefit from participation exemption on dividends received. That is why this case characterizes a situation of abuse of law. 82

83 For sham, it is the same because the sham is a part of the Art L64 (abuse of law by simulation). But in France, it is not completely clear, because the tax administration (in the two cases), did not say if there is an abuse of law by simulation or an abuse of law by fraus legis. That is why, the situation is unclear. Resume: There is clearly an abuse of law (lake economic substance, avoidance tax, ect..), but we do not know if the French tax administration use the first criteria: the simulation (the sham) or the second criteria: the fraus legis, to characterize this abuse of law. We have to wait the next cases to have more precision about this question Germany This is a valid transaction therefore it is not a case of sham. The distinguishing feature of sham in relation to evasion of the law is the missing intent to be legally bound. If a valid contract is required, e.g., for tax purposes, it is assumed that the transaction is not simulated. The case may be ruled tax avoidance when certain requirements are met: (1) B has existed for a longer period (not specified in the statute) and (2) B bears the economic risks of the transaction Hungary There is not a disguised or simulated contract therefore there is no sham. The transaction is however considered abuse of law and therefore tax avoidance when there is no valid business purpose. In this case the GAAR would be applied because B could not possibly fulfill any genuine business purpose Italy This would be neither a case of sham, nor of fictitious interposition, nor of tax avoidance. The question is whether the holding company is fiscal resident in Italy. According to Article 73 of Legislative Decree n. 917 of 1986, in order to establish what is the country of residence of a private holding company for tax purposes, there are three points (criteria) to consider: the legal seat, the seat of administration, and the location of the majority of business conducted. Since it would be difficult for the tax administration to demonstrate that one of these criteria is met, Paragraph 5-bis and 5-ter of Article 73 provide also the possibility to simply presume them (if certain conditions are met). 83

84 5.7. Netherlands There is not a disguised or simulated contract therefore there is no sham. Fraus legis is met when two conditions are fulfilled. The first one is the predominant reason of the taxpayer with its transaction(s) is the reduction of tax and secondly, there is a conflict with the goal and purpose of the law when the taxpayer his aimed goal is followed. The first condition can be proved because of the empty shell. The second condition must be proved by investigating the goal and purpose of the law Spain Such transactions would not be considered as sham or simulation because the taxpayer is not concealing any actions or information. The purchase and sales of stocks and distribution of capital gains as dividends by B to A also would be upheld as valid transactions because they were not wholly performed in the tax haven. Therefore, the GAAR would not be applied Sweden There is not a disguised or simulated contract therefore there is no sham. For the application of the GAAR violation of the legislative intent would need to be proved which is extremely hard in Sweden. The GAAR could be applied if preliminary agreement existed between parties thus no economic risk was involved in the transaction USA If common law anti-abuse doctrines alone are applied to the fact pattern provided, then it is possible that two doctrines - the sham transaction doctrine (embracing the concept of economic sham) and the economic substance doctrine - could be invoked to attempt to deny the desired tax benefits. Economic sham is one in which the alleged transactions actually took place, but are nonetheless without economic substance. The taxpayer could also likely show some sort of modified economic position or entered-into economic risk (given the capacity for fluctuation in the open market), thus meeting the criteria necessary to avoid characterization as a sham transaction. In addition, courts could attempt to invoke the economic substance doctrine, using either a conjunctive or disjunctive test; intent of the taxpayer is key to the determination of this prong by the court. 84

85 5.11. Conclusion We have found three ways in which tax authorities would tackle this case: (1) in Spain, Sweden and Italy and there would be no sham and not tax avoidance. (2) In Hungary, Austria and Germany the transaction would be considered no sham but tax avoidance would be argued for. (3) In France, Belgium, the Netherlands and the U.S.A. the resolution of this case relying on only GAAR is unclear; there are no set criteria or interpretation of the GAARs according to which the courts could rule the case tax avoidance. 85

86 6. APPENDICES Appendices to follow on the next page. 86

87 6.1. Appendix 1: General Anti-Abuse Concepts 87

88 6.2 Appendix 2: GAAR Concepts 88