Inapplicability of a Treaty to Avoid Double Taxation

The facts

The Company Molinos Río de La Plata S.A. (hereinafter, the ‘Appellant’) appealed before the Tax Court two resolutions of the Argentine Tax Authorities (hereinafter, the ‘AFIP’). Through the Resolutions, AFIP had assessed Income Tax for tax periods 2004 to 2009. The Appellant considered it inadmissible because the AFIP, in violation of Section 11 of the Treaty to avoid the double taxation of income tax signed with Chile in the year 1976 (hereinafter, the ‘Treaty’), had incorporated to the taxable amount of the income tax the dividends distributed by the Company Molinos de Chile y Río de la Plata Holding S.A. (hereinafter, the ‘Holding Company’), that was a company created in Chile by the Appellant and established as an “investment platform company” under the Chilean law No. 19,840.

By the Law No. 23,228 (given in 1985), Argentina approved the Treaty signed on 11-13-1976. Under Section 11 of the Treaty, dividends may only be taxed by Chile if the company paying dividends is domiciled in Chile, because the Treaty provides taxing rights for the source state of the income.

Then, in the year 2002, Chile signed the Law No. 19,840 and created the structure of “investment platform companies”, that allows foreign investors to establish in Chile a company, without Chilean residence, in order to administrate the different investments in foreign countries and in Chile. This investment platform regime provides an exemption for foreign source dividends received by the platform company and also for their subsequent distribution abroad.

The Appellant incorporated the Holding Company Molinos de Chile y Río de la Plata Holding S.A. in 2003 under the regime established by Law No. 19,840 (business platform regime). According to the ruling of the Court, the Appellant had full control of the Holding Company with the 99.99% of the shareholding.

In April and November 2004, the Appellant assigned to the Holding Company, through an in-kind contribution, its direct participation in subsidiaries located in Uruguay and Peru, expanding the capital of the Holding Company. Also, in 2009, the Appellant assigned, indirectly, its capacity as controlling shareholder of a related company linked to Spain, and in that way, its participation in other companies located in various countries (e.g. Switzerland and Italy).

In that context, between 2004 and 2009, the Chilean Holding Company paid dividends to its Argentine parent company, the Appellant, and, as those dividends were essentially paid out of foreign source income (the dividends distributed from Uruguay and Peru subsidiaries), they were neither taxed in Chile, because of having a foreign source, nor in Argentina (under Section 11 of the Treaty).

In the resolutions, The AFIP - based on the general anti avoidance rule (hereinafter, ‘GAAR’) contained in Section 2 of the Tax Procedure Law (hereinafter, ‘TPL’) - considered this structure to be an abusive use of the Treaty, stating that the Holding Company was just a ‘conduit company’ and its only objective was to transfer the dividends of the subsidiaries from Uruguay and Peru without paying any tax in Argentina or in Chile. Due to the fact of this abusive use, the AFIP established that the Treaty was not applicable in this particular case.

Court Decision

The court upheld the position of the AFIP concerning to an abusive practice of the Treaty by the Appellant. Basically, the court delivered the following arguments:

(i) As the Treaty is an international agreement, the interpretation rules contained in Sections 31 and 33 of the Vienna Convention on the Law of Treaties, are applicable to it. These rules establish that that interpretation has to be made according to good faith, the common sense of the terms involved and the final objective of the treaty under analysis.

ii) Most of the international case-law gives preference to the substance of the business over the legal shape of it, in order to avoid the ‘treaty shopping’ (i.e. an abusive use of a treaty).

(iii) The rules against treaty shopping contained in the national legislation of each treaty partner should not be regarded as contrary of that treaty, since those rules are directed to destroy its abusive and disloyal use.

(iv) If one of the treaty partners makes a change in the national tax law that will totally or partially disturb the treaty signed with another nation, that other nation –in the case, Argentina- is able to apply the GAAR contained in Section 2 of its Tax Procedure Law (hereinafter, ‘TPL’) referred to the economic reality of the situation, that is perfectly applicable, even if it is not expressly provided in the Treaty. For this purpose, the Court quotes case-law and legal opinions in this regard.

(v) Sections 10 and 12 –regarding the pay of dividends, interests and royalties- of the OECD’s Model Tax Convention on Income and on Capital introduced the concept of ‘beneficial owner’ with the purpose of avoid the abusive use of the internationals agreements made in that sense. Years later, thanks to the elaboration of commentaries and reports of the OECD and the Financial Action Task Force on Money Laundering (hereinafter, ‘FATF’), the concept of `beneficial owner’ has been refining to the actual sense that has on this days. Since 2003, the aforesaid term has been understood as the person liable for income from a tax perspective. In that scenario, the clauses of the convention are not valid when they are able to benefit an individual that does not have a right established by the agreement because he/she has residency in a non-partner state and establishes a ‘conduit company’ as an intermediary between him or her and the payer of the rent in order to benefit with the convention.

(vi) A conduit company –whose only purpose is to act as a legal structure to receive the benefits of a convention- may not be considered as a `beneficial owner’, even when it is the legal owner of those dividends, interest or royalties, since that conduit company does not have real power over those incomes and its only function is to transfer those incomes immediately to the real owner, reducing or annulling the global tax burden of an economic group by the use of that structure.

(vii) With the emerging of these conduit companies it is revealed a real elimination of the taxation both in the source nation and in the nation where the conduit company has its residence, also the taxation in the nation where the individual who has organized all the structure had residence is eliminated, which is a mayor and unacceptable tax evasion phenomenon.

viii) Even though it is valid to plan in order to reduce the tax burden, in the case, the Appellant -by the use of the Holding Company situated in Chile- has totally annulled the entire tax burden related to the pay or distribution of dividends, moving away from the objective looked at by the Treaty.

(ix) A report from the Chilean Tax Authority of the situation has considered that it is valid to use the local GAAR (in the case, Section 2 from the TPL) in the event the Treaty does not have any particular regulation regarding that subject.

(x) In conclusion, with all those said and with all the evidence produced in the case, the Court deemed proven that the Appellant is the `beneficial owner´ of the dividends indirectly paid by the Chilean Holding Company, that acts like a conduit company in order to avoid the payment of the income tax in both nations abusing of the legal background of the case.

(xi) The Holding Company created by the Appellant has no real bond with the subsidiaries located in Uruguay or Peru; also, the incomes paid by those subsidiaries do not remain in the Holding Company but are sent immediately to the Appellant. In the same order, there is no sign of real presence of economic activities or an actual operational structure of any kind in the Holding Company, which only acts as an intermediary or conduit company for the payment of the dividends made by the subsidiaries. All these features fit the prior postulation of `treaty shopping´, or abusive use of the Treaty. The court quotes case-law and legal opinions in this regard.

(xii) This is a case of “double no taxation” that nullifies the aim of the Treaty, which is inadmissible.

This Court resolution sets a precedent definitely relevant as it analyses, among others, the possibility to apply rules, such as the Section 2 from the TPL, in the context of a Treaty to avoid double taxation. This judgment begins to determine the limits between tax planning, in order to minimize tax payable, and the abusive use of the benefits arising from those Treaties.