September 06, 2005
Conglomerate Junior Scholars Workshop: Mason on US/EC Tax Treaties
Posted by Christine Hurt

Welcome back to Week #3 of Conglomerate Junior Scholars Workshop!  This week we have two papers; today's paper is U.S. Tax Treaty Policy and the European Court of Justice by Ruth Mason.  We are excited to branch out into the tax policy realm today.  Our expert reviewer for this international tax piece is guest blogger Allison Christians, who is just settling in to her new digs at the University of Wisconsin School of Law and who has also written in the area of tax treaties. 

Allison's introductory comments should get the discussion rolling:

Ruth Mason’s paper, “U.S. Tax Treaty Policy and the European Court of Justice,” argues that the United States and the member states of the EU need to engage in proactive and pre-emptive efforts to enter into a multilateral tax treaty, and they need to do so quickly, before the European Court of Justice (ECJ) invalidates the network of bilateral treaties that currently exists between these nations.

In essence, domestic taxes are high on cross-border transactions in the United States and EU, and tax treaties are used to lower them. Although most tax treaties are based on model language—drafted by the OECD, with explanations and notes on interpretation (commentary)—they are typically bilateral and terms depend on the individual negotiations between pairs of countries. Thus, terms vary among bilateral treaties, sometimes significantly, so investors from some countries will get better tax treatment in the United States than investors from other countries, and vice versa. For example a UK parent company wholly owning a US subsidiary enjoys zero United States taxation on dividends received, while if the parent company was Italian it could only reduce its United States tax burden to 5%, and if it was Spanish, only to 10%. Mason argues correctly that this divergence is in diametric conflict with the EU treaty, which envisions the unfettered movement of businesses, workers, services, and capital throughout the EU, and the eradication of nationality discrimination. Thus enters the ECJ.

The risk of treaty override or nullification by the ECJ to prevent nationality discrimination and achieve unfettered movement has already been seen in some areas, with member countries being forced to unilaterally comply with ECJ rulings despite their obligations under existing treaties with non-EU member countries. Mason rightly argues that we can expect more interference from the ECJ, as the Court is only recently testing its role in regulating income taxation in the EU. Taxation has been a touchy subject because of the traditional adherence to the notion that income taxation is a sacrosanct vestige of sovereignty in a world of harmonization and standardization. In its relentless march towards harmonization and standardization, however, Mason argues the EU cannot sidestep the problem of divergent international tax rules for much longer. EU treaty norms goals are only achievable if restrictions are lifted and the member states do not discriminate between persons and transactions that are within their individual borders versus those that are foreign but within the borders of the EU. But tax treaties, by replacing the domestic laws that would otherwise apply, introduce discrimination between persons and transactions covered by a treaty compared to those not covered by a treaty or covered by a treaty with less beneficial terms.

Pointing particularly to the varying provisions in US-EU member treaties regarding the limitation of treaty benefits to bona fide residents of the contracting states, Mason notes the high potential for interference and override by the ECJ on grounds of discrimination or restriction of movement or both. She therefore argues that standardization of terms between the United States and EU member countries is critical, and best achieved through a multilateral tax treaty. Although Mason acknowledges that the idea of a multilateral treaty has been discussed and rejected to date, she argues that increasing ECJ interference provides a strong impetus to conclude such a treaty now, or face the ECJ’s overruling and invalidating of current treaties.

According to Mason, the United States and the EU should primarily revisit the idea of a multilateral treaty because of potential ECJ override, but the old reasons why a multilateral treaty would be superior to a network of bilateral treaties are also valid incentives. For example, Mason argues that a multilateral treaty would better accomplish enforcement of tax laws, as information sharing would be better facilitated in a multilateral treaty. She also argues, perhaps less convincingly, that a multilateral treaty would fix bilateral treaty shortcomings, particularly the problem of conflicting domestic interpretations of treaty terms, because a multilateral treaty could incorporate more OECD-model standards. The problem of interpretation conflicts is one that I fear a reliance on OECD commentary will do little to overcome, but certainly Mason is right that a multilateral treaty would achieve efficiency gains for investors, who would be spared the arduous task of consulting myriad treaties and protocols in pursuing cross-border transactions.

Although there is no denying that a multilateral treaty would be an effective protection against the uncertainty of possible ECJ interference, it seems the cost, both political and administrative, to achieving 26-way agreement on anything but the most basic terms is enormous and probably prohibitive. Mason references a couple of alternative intermediate steps, but doesn’t dwell on them. For example, Mason references a 1986 study that encourages the adoption of treaty principles into United States domestic laws (which would automatically ensure uniform treatment to all comers, whether EU or not as well as whether covered by a treaty or not), and the practice of introducing most favored nation clauses into United States tax treaties (which is a small but not insignificant step towards harmonization of United States tax treaty terms for all comers, at least from treaty countries). It may be that these alternatives are the only real hope for harmonization of treatment between the United States and the EU member countries, so it seems to me more attention should be paid to these efforts.

Indeed, though not discussed in detail in this paper, the primary and fundamental function of treaties is to introduce discrimination, that is, to provide preferred terms to selected persons and transactions based on the relationships between sovereign nations. Achieving uniformity of terms among treaties is but one step towards global harmonization of tax treatment, the ultimate goal of a US-EU member multilateral treaty. Nevertheless, reaction in the EU to controversial rulings on related matters should serve as a harbinger of things to come, so Mason’s argument that the potential for interference from the ECJ should spring countries into preemptive action is timely and well-made.

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