Supreme Court Holds that Treaty to Avoid Double Taxation Doesn’t Apply On Account of Treaty Abuse

1.    Background

In 2003, Molinos Río de La Plata S.A., an Argentine company (“Molinos Argentina”), incorporated Molinos de Chile y Rio de la Plata Holding S.A., a Chilean company governed by the special tax regime for “Investment Platform Companies” established by Chilean Law No. 19,840 (“Molinos Chile”). At the time, Molinos Argentina transferred to Molinos Chile its controlling interest in three Uruguayan companies (“Molinos Uruguay”) and a Peruvian company (“Molinos Peru”).

Between 2004 and 2009, Molinos Chile paid dividends to Molinos Argentina, which mainly derived from dividend distributions made by Molinos Uruguay and Molinos Peru.

Molinos Argentina believed those dividends were non-taxable in Argentina pursuant to article 11 of the Convention to Avoid Double Taxation between Argentina and Chile (the “DTT,” after its Spanish acronym). At that time, the DTT was still in force and established that: “dividends… shall only be taxable in the contracting state where the company that distributes them is domiciled.” By that rationale, Molinos Argentina contended that the dividends it received were only taxable in Chile and not in Argentina.

In 2011, the Argentine Tax Authority (“AFIP,” after its acronym in Spanish) challenged Molinos Argentina’s position contending instead that dividends paid by Molinos Chile were subject to income tax in Argentina. AFIP argued that there had been “treaty abuse” resulting in “double non-taxation” and, therefore, the provisions of Article 11 of the DTT did not apply. 

The AFIP’s alleged “double non-taxation” argument stemmed from the following:  

(iii)    In Chile, Law No 19,840 which was passed in 2002, established that income from foreign sources obtained by “investment platform companies” (such as dividends from foreign investments) was not subject to Chilean income tax; and

(iv)    In Argentina, article 11 of the DTT, then in force, stated that dividends may only be taxable in the contracting state where the company that distributed them was domiciled (in this case, Chile).

On the grounds of the so-called “principle of economic reality” contained in section 2 of the Argentine Tax Procedure Law (which is similar to the US “substance over form principle”), AFIP contended that Molinos Argentina had abused the DTT by creating a “conduit company” under the investment platform regime established by Chilean domestic provisions; and it had done so with the sole purpose of circumventing taxation in both Argentina and Chile of the dividends received from Molinos Uruguay and Molinos Peru.

2.    Prior decisions and Attorney General’s Opinion

Molinos Argentina appealed AFIP's resolutions before the Argentine Tax Court (“TFN,” after its acronym in Spanish). The TFN rejected Molinos Argentina’s appeal and upheld AFIP's position on the following grounds: (i) Molinos Argentina had incurred “treaty abuse” or “treaty shopping,” which invalidated the application of the DTT; (ii) the “economic reality principle” does not conflict with the DTT and is valid for preventing improper and abusive use of the latter; and (iii) a conduit company cannot be deemed as “beneficial owner” of the dividends received. For further details on this judgment, please visit: https://www.marval.com/publicacion/inaplicabilidad-de-convenio-para-evitar-la-doble-imposicion-6018.

The Federal Court of Appeals (“CNCAF,” after its acronym in Spanish) upheld the TFN’s decision. In particular, based on the facts of the case as seen under the light of the “economic reality principle,” the CNCAF concluded that Molinos Chile was a “conduit company” and, therefore, the tax benefits provided under the DTT were not applicable to the particular case. The CNCAF claimed that Molinos Chile’s lack of substance was demonstrated by: (i) the absence of a real economic relationship between Molinos Chile and the companies located in Uruguay and Peru; (ii) the absence of an operational structure in Molinos Chile; and (iii) the fact that Molinos Chile immediately transferred to Molinos Argentina the income paid by Molinos Uruguay and Molinos Peru, and therefore it did not remain in the equity of the holding company. For further details, please visit: https://www.marval.com/publicacion/confirman-inaplicabilidad-de-convenio-de-doble-imposicion---comentario-al-fallo-molinos-rio-de-la-plata-12782.

Molinos Argentina appealed the CNCAF’s decision before the Argentine Supreme Court (“CSJN,” after its acronym in Spanish).

On November 28, 2017, the Attorney General on tax matters, Laura M. Monti, filed her legal opinion with the CSJN in which she sided with the taxpayer. She believed that the DTT did not contain an “anti-abuse” clause that required the dividend distributing company’s transactions to have a commercial purpose or minimum substance. She also argued that “the honest effort on behalf of taxpayers to minimize their tax burdens is not per se illegal; that is, legal tax savings are not questionable.” For further details, please visit: https://www.marval.com/publicacion/dictamen-de-la-procuracion-general-de-la-nacion-favorable-a-molinos-rio-de-la-plata-sa-13125.

3.    Argentine Supreme Court Decision

In short, the CSJN, by majority vote, substantially upheld CNCAF's decision and, therefore, ruled for the AFIP on the following grounds:   

(v)    On legal hierarchy and treaty abuse: The DDT should be interpreted in accordance with the principles of public law recognized in the Argentine Constitution, including the fact that rights are by nature non-absolute and any regulation restricting those rights is subject to a reasonableness standard. By that rationale, “good faith” is the main standard when interpreting international treaties and therefore no international treaty in force in Argentina can be used abusively, regardless of whether the treaty expressly includes an anti-abuse clause or not. 

(vi)    On the interpretation of article 11 of the DTT in light of the good faith standard: The purpose of the DTT was to prevent double taxation between Argentina and Chile on specific income (including dividends). However, Molinos Argentina’s actions suggest that the company’s aim was not to avoid double taxation but to benefit from double non-taxation on income that would otherwise have been subject to tax (since Argentina had not signed a DTT with Uruguay or with Peru granting the benefits contained in article 11 of the DTT). Therefore, that “double non-taxation” is not a substantially valid result of the DTT when interpreted in good faith.

(vii)    On the feasibility of using domestic anti-abuse rules: Domestic anti-abuse rules (including the “economic reality principle”) are applicable to the interpretation and application of DTTs.

(viii)    On the application of the economic reality principle to the specific case: The economic reality principle allows AFIP to consider the “actual economic transaction” and disregard inappropriate legal forms and structures adopted by taxpayers. Based on the evidence of the case, there are reasonable grounds to conclude that the legal structure of Molinos Argentina and Molinos Chile had no substance and could be recharacterized by the tax authorities in light of the principle of economic reality.

Thus, in the majority vote, the CSJN found that article 11 of the DTT does not validate the use of platform companies under Chilean domestic law to avoid paying income tax in Argentina. This is so because of the harmonious confluence of the principle of reasonableness and non-abusive exercise of rights (article 27 of the Argentine Constitution) with the principle that treaties must be interpreted in good faith and purposefully (article 31 of the Vienna Convention on the Law of Treaties) and the principle of economic reality (section 2 of Argentine Tax Procedure Law).

On the other hand, Justice Rosenkrantz's dissenting opinion was grounded on the following:

(iii)    On the interpretation of article 11 of the DTT: A good faith interpretation of the treaty requires a textual analysis of article 11, which offers no difficulty and leads to the conclusion that Chile was the only Contracting State of the DTT with the power to tax the dividends distributed by Molinos Chile. It is not appropriate for judges to add distinctions that are nowhere to be found in the wording of the statute or for them to add requirements that the constitutional bodies responsible for negotiating the treaties did not consider necessary or applicable. 

(iv)    On the “source principle” of the DTT and the taxing power of the Contracting States: The source principle, adopted by the DTT (under which income can only be taxed in the country where the income is sourced) may validly lead to a scenario where certain income is non-taxable in both contracting States like in the case at law, where the source State (who is the only one with taxing authority) chose not tax certain income. In fact, the DTT established that the benefits therein were applicable even if one of the countries waived the exercise of the exclusive taxing right granted to it by the DTT.  

(v)    On the application of anti-abuse rules not included in the DTT: To avoid fraud, the only rule foreseen in the DTT provided that any situation deemed fraudulent by either Contracting State must be resolved by “mutual agreement” between the competent authorities of the Contracting States through consultations or information exchanges. The DTT did not establish a rule that enabled either of the Contracting States to unilaterally use its domestic legislation to override the treaty provisions in the event of alleged fraud. Consequently, applying the economic reality principle from domestic Argentine regulations to this specific case is unacceptable.

Justice Rosenkrantz concluded that the commitment assumed by each Contracting State of the DTT must be obeyed even when the enforcement of its provisions results in double non-taxation, regardless of any possible value judgement about that double non-taxation. It is not up to the courts to judge the moral correctness or convenience of the provisions adopted by the other branches of government in the exercise of their powers. The courts must restrict their work to the enforcement of those provisions as they were conceived.

4.    Closing Remarks

This case’s relevance lies in that it analyzes in depth an international structure that led to double non-taxation through the application of DTT provisions. The CSJN’s majority vote addressed relevant and sensitive matters, such as the “treaty abuse” doctrine, the principle of reasonableness and good faith, the principle of economic reality, etc. Based on the facts and evidence of previous instances, the CSJN concluded that the taxpayer's structure was not valid when it came to benefitting from the provisions of the DTT. However, it is worth noting that this decision was made against a particular factual background. Therefore, the CSJN’s conclusions should be taken lightly, as they may not apply in the same way to other cases involving treaties aimed at preventing double taxation.