Tag: Absent the tax benefits

Colombia vs SONY Music Entertainment Colombia S.A., July 2021, The Administrative Court, Case No. 20641

SONY Music Entertainment Colombia S.A. had filed transfer pricing information and documentation, on the basis of which the Colombian tax authorities concluded that payments for administrative services provided by a related party in the US had not been at arm’s length. SONY Colombia then filed new transfer pricing information and documentation covering the same years, but where the tested party had been changed to the US company. Under this new approach, the remuneration of the US service provider was determined to be within the arm’s length range. The tax authorities upheld the assessment issued based on the original documentation. A complaint was filed by SONY and later an appeal. Judgement of the Administrative Court The court allowed the appeal and issued a decision in favor of SONY. Excerpts “The legal problem is to determine, for the tax return of the taxable period 2007 of the plaintiff: (i) Whether it is appropriate to take into account the correction of the transfer pricing information return submitted by the plaintiff and its supporting documentation, and whether the information submitted is sufficient to determine compliance with the arm’s length principle. … In the present case, the DIAN [tax authorities], by means of the contested acts, disregards operating expenses of $1,963,235,000 of the plaintiff’s income tax return for the taxable period 2007, because it considered that the administrative expenses that the plaintiff paid to its related party in the United States of America (United States) were not adjusted to market prices, which had been agreed with other suppliers. In order to justify the disregard of the aforementioned expenses, the DIAN took as reference the individual informative declaration of transfer prices (DIIPT) and the supporting documentation initially submitted by the plaintiff, in which it was determined that it was outside the market range. Furthermore, it stated that if the corrections to the DIIPT and the supporting documentation are taken into account, there is no reason to justify that the analysis of administrative expenses should be carried out for the company located abroad. For its part, the plaintiff considers that the DIIPT and the initial supporting documentation should not have been taken into account, due to the fact that the correction was made in which it is demonstrated that the expenditure operation was carried out at market values, since the related company in the United States should be analysed, and not the company in Colombia as was done in the original declaration. … From the cited provisions it is clear that there is room to impose a sanction in the case of the correction of the individual informative declaration or of the supporting documentation, in the event of errors or inconsistencies in these documents. On previous occasions, this Court has recognised that it is appropriate to correct the information return and supporting documentation. However, regardless of whether the correction of the return or of the supporting documentation is punishable, such corrections should be examined by the Administration, in order to determine whether the transactions recorded by the taxpayer with his economic partners were in accordance with the arm’s length principle. …. In addition, the documentation clarifies that the reason for the study from the company abroad was an administrative services contract that had been in place since 2005, for which the company abroad was paid $3,569,194,000, a payment that was corroborated by the DIAN in the audit process by means of the withholdings made, transactions carried out and items paid. This contract was submitted to the file and shows that Sony Colombia and Sony United States agreed that “The Services provided by SBME will be invoiced to the Company at a rate calculated at cost plus an increase of 8%. The Services will be billed periodically, but in no case will they be billed for periods longer than one year”, a clarification together with the global situation of the music industry that justifies the Markup analysed, and the comparable companies in the supporting documentation. … Consequently, it is reiterated that the change of the tested party was supported and it is clarified that such change only affects the information of the administrative services transaction, since the transfer pricing methods apply to individual transactions, as determined by article 260-2 of the Tax Statute. … In this context, the plaintiff could correct its DIIPT and its supporting documentation, the information submitted in its corrections should have been taken into account, the plaintiff was free to choose to carry out its analysis of the foreign company, and it complied with the requirements of its supporting information together with the arm’s length principle. Consequently, the contested measures should be annulled, and the other pleas in law are dismissed as the main plea is well founded.” Click here for English translation Click here for other translation Colombia vs SONY Music Entertainment Colombia S.A., July 2021 ORG ...

Canada vs Bank of Montreal, September 2018, Tax Court of Canada, Case No 2018 TCC 187

The Court found that section 245 (GAAR) of the Canadian Income Tax Act did not apply to the transactions in question. Subsection 245(1) defines a “tax benefit†as a reduction, avoidance or deferral of tax. The Respondent says that the tax benefit BMO received was the reduction in its tax payable as a result of subsection 112(3.1) not applying to reduce its share of the capital loss on the disposition of the common shares of NSULC. In 2005, the Bank of Montreal (“BMOâ€) wanted to lend a total of $1.4 billion USD to a number of its US subsidiaries referred to as the Harris Group. BMO chose to borrow those funds from third parties. Tower Structure It would not have been tax efficient for BMO to simply borrow the funds and lend them to the Harris Group. Such a structure would have resulted in BMO having to pay US withholding tax on the interest payments it received from the Harris Group. As a result, BMO implemented what is commonly referred to as a “tower structureâ€. A tower structure is a complicated structure often used by Canadian companies to finance US subsidiaries in a tax efficient manner. It allows the deduction of interest costs by the Canadian company for Canadian tax purposes and the deduction of the corresponding interest costs by the US subsidiary for US tax purposes without having to pay withholding tax to the US on the repatriation of the funds. The tower structure implemented by BMO consisted of the following entities: (a) a Nevada limited partnership named BMO Funding L.P. (“Funding LPâ€) in which BMO had a 99.9% interest and a wholly owned subsidiary of BMO named BMO G.P. Inc. (“BMO GPâ€) had a 0.1% interest; (b) a Nova Scotia unlimited liability company named BMO (NS) Investment Company (“NSULCâ€) that was wholly owned by Funding LP; and (c) a Delaware limited liability company named BMO (US) Funding LLC (“LLCâ€) that was wholly owned by NSULC. BMO borrowed $150 million USD from a third party. It invested those funds in Funding LP. Funding LP, in turn, used those funds to acquire shares of NSULC which, in turn, used those funds to acquire shares in LLC. LLC then took the funds that it had received and lent them to the Harris Group. The balance of the required $1.4 billion USD came from a $1.25 billion USD loan obtained by Funding LP from a third party. Again, Funding LP used those funds to acquire shares of NSULC which, in turn, used those funds to acquire shares in LLC. LLC then took the funds that it had received and lent them to the Harris Group. Interest payments and dividends flowed through the tower structure at the end of each fiscal quarter. The Harris Group would pay interest to LLC. LLC would then use the money to pay dividends to NSULC. NSULC would pay corresponding dividends to Funding LP. Funding LP would use the funds it received to pay interest on the $1.25 billion USD that it had borrowed and would distribute the balance to BMO and BMO GP. BMO would, in turn, use the funds it received from Funding LP to pay interest on the $150 million USD that it had borrowed. The dividends received by BMO from NSULC (indirectly through Funding LP) were taxable dividends. BMO benefited from a subsection 112(1) deduction in respect of those dividends. From a business point of view, by borrowing US dollars to make an investment in a US asset, BMO effectively hedged its foreign exchange risk. If the Canadian dollar decreased in value against the US dollar between 2005 and 2010, then the increase in value (in Canadian dollars) of BMO’s indirect US dollar investment in the Harris Group would be matched by the increased cost (in Canadian dollars) of repaying the $1.4 billion USD in borrowed funds. Conversely, if the Canadian dollar increased in value against the US dollar between 2005 and 2010, then the decrease in value (in Canadian dollars) of BMO’s indirect US dollar investment in the Harris Group would be matched by the decreased cost (in Canadian dollars) of repaying the $1.4 billion USD in borrowed funds. However, from a tax point of view, BMO faced a potential problem with hedging its foreign exchange risk. There would not be any problem if the Canadian dollar decreased in value. Any increase in the value of the NSULC shares held by Funding LP that arose from a decrease in the value of the Canadian dollar would be taxable as a capital gain. That capital gain would be offset by the corresponding capital loss that would arise on the repayment of the $1.4 billion USD in borrowed funds. On the other hand, BMO would have a problem if the Canadian dollar increased in value. The resulting decrease in the value of the NSULC shares held by Funding LP would give rise to a capital loss. However, the stop-loss rule in subsection 112(3.1) would reduce that capital loss by an amount equal to the value of any non-taxable dividends that Funding LP had received from NSULC. As a result, the reduced capital loss would not be sufficient to fully offset the capital gain that would arise on the repayment of the $1.4 billion USD in borrowed funds. To avoid this potential mismatch of the capital gain and capital loss, BMO implemented a modification to the tower structure. Subsection 112(3.1) applies separately to each class of shares. Therefore, BMO decided to create a structure whereby NSULC had two classes of shares. When the first set of quarterly dividends was being paid, instead of paying a cash dividend, NSULC paid a stock dividend consisting of preferred shares. This resulted in Funding LP holding two classes of shares of NSULC: common shares with a high cost base and preferred shares with a low cost base. From that point forward, all quarterly dividends were paid on the preferred shares. By isolating the dividends in this manner, BMO ensured that, ...

New Zealand vs BNZ Investments Ltd, July 2009, HIGH COURT

The case: Is each of six similar structured finance transactions entered into by the plaintiffs (the BNZ) a ‘tax avoidance arrangement’ void under s BG 1 Income Tax Act 1994? That is the primary issue in these five consolidated proceedings brought by the BNZ against the Commissioner, challenging his assessments issued after he voided each of the transactions pursuant to s BG 1. The BNZ claims the transactions are not caught by s BG 1. A second issue, arising only if s BG 1 applies, is the correctness of the way in which the Commissioner has, pursuant to s GB 1, counteracted the tax advantage obtained by the BNZ under the transactions. The Commissioner disallowed the deductions claimed by the BNZ, as its costs of the transactions. The BNZ claims the deductions should be disallowed only to the extent they are excessive or ‘overmarket’. A third, and perhaps strictly antecedent, issue is whether the guarantee arrangement fee (GAF) or guarantee procurement fee (GPF) charged in each transaction is properly deductible under s BD 2. The transactions are so-called ‘repo’ deals: the BNZ made an equity investment in an overseas entity on terms requiring the overseas counterparty to repurchase that investment when the transaction terminated. The transactions were structured to enable the BNZ to deduct its expenses of earning the income yielded by its investment, while receiving that income free of tax. In the case of the first transaction, that tax relief resulted from a credit for foreign tax paid. The BNZ’s income from the five subsequent transactions was relieved of tax by the conduit regime. That domestic tax ‘asymmetry’ – tax deductible costs earning tax exempted income – made the transactions highly profitable for the BNZ. The BNZ contends each of these transactions involved real obligations, notably those resulting from the BNZ raising $500 million on the New Zealand money market and advancing that to the counterparty upon a repo obligation. Further, the BNZ’s case is that the transactions made legitimate use both of crossborder tax arbitrage and the domestic tax ‘asymmetry’ just described. Cross-border tax arbitrage refers to the different tax treatment of the transaction in New Zealand and the foreign counterparty’s jurisdiction. New Zealand tax law treated the transactions as equity investments, the counterparties’ jurisdictions (the United States of America for the first three transactions; the United Kingdom for the later three) as secured loans. That enabled the counterparties to deduct, as interest, the distribution they made which the BNZ received free of tax in New Zealand. The BNZ submits that the evidence establishes that “tax driven structures and tax arbitrage are common and accepted elements of international financeâ€. The Bank says the central or critical question in the case is the appropriate approach in law to the asymmetry between deductible expenditure and tax relieved income around which these transactions or arrangements were structured. The essential bases on which the Commissioner asserts s BG 1 catches the transactions are: a) They substantially altered the incidence of tax for the BNZ. Indeed, that was their only purpose or effect. It certainly was not a merely incidental purpose or effect. The Commissioner adopted the description of one of his witnesses: … A prime purpose of the profit-maximising actions of these transactions was to use the tax base to make money. They had no commercial purpose or rationale. Absent the tax benefits they generated, the transactions were loss-making, in that the BNZ provided funding to the counterparties at substantially less than its cost of funds. The Commissioner contended “the tax tail wagged the commercial dogâ€. They were not within the scheme and purpose of the regimes they utilised to generate tax exempted income, the foreign tax credit (FTC) and conduit relief regimes respectively. In the case of the FTC regime utilised by the first (Gen Re 1) transaction, the transaction also did not comply with the applicable specific provisions. d) The principal deductible expenses claimed by the BNZ (the fixed rate it paid on an interest rate swap and the GAFs or GPFs) were contrived and artificial. e) The transactions were structured on a formulaic basis, which had the artificial consequence that, the higher the transaction costs, the higher the tax benefits they generated. The six transactions in issue span eight income tax years between 1998 and 2005. Three further transactions, two of them earlier in time, also featured in the evidence. While those three further transactions have a similar structure, they have the distinguishing feature of being New Zealand tax positive. The BNZ obtained binding rulings from the Commissioner on each of those three transactions, which I will call ‘the ruled transactions’. Approximately $416 million of tax hinges on the outcome of these proceedings. Challenge proceedings brought by the Westpac Banking Corporation began in Auckland on 30 June. Proceedings brought by other New Zealand trading banks have yet to come on for trial. If occasional press reports are accurate, the total amount of tax in issue is over $1.5 billion. The Court found in favor of the tax authorities. The case was later settled out of court. New Zealand vs BNZ Investments Ltd v Commissioner of Inland Revenue 15 july 2009 ...

Poland vs “OLD-GAAR”, May 2004, Constitutional Court, K 4/03

On 17 February 2003, the President of the Polish Supreme Administrative Court and the Ombudsman requested the Constitutional Court to declare that Article 24b par. 1 of the Tax Ordinance of 29 August 1997 – by giving the tax authorities and fiscal control bodies, while resolving a tax case, the right to disregard the effects of legal transactions which may give the taxpayer an advantage in the form of reduction of tax liability, increase of overpayment or refund of tax – violates the principle of citizens’ trust in the state and the created law resulting from Article 2 of the Constitution of the Republic of Poland and violates the principle of freedom of economic activity expressed in the freedom to arrange one’s civil law relations, i.e. Article 22 of the Constitution of the Republic of Poland. Article 24b of the Tax Ordinance had the following wording: “Art. 24b par. 1. Tax authorities and tax inspection bodies, when settling tax cases, shall disregard the tax consequences of legal actions, if they prove that from the performance of these actions one could not expect any significant benefits other than those arising from a reduction in the amount of tax liability, increase in loss, increase in overpayment or refund of tax. Par. 2. If the parties, by performing a legal transaction referred to in par. 1, have achieved an intended economic result for which another legal transaction or transactions is appropriate, the tax consequences are derived from that other legal transaction or transactions”. Judgement of the Constitutional Court In a split decision, the Court declared the provision in Article 24b § 1 of the Tax Ordinance inconsistent with the Constitution of the Republic of Poland. Excerpts “The infringement of the Constitution consists in enacting unclear and ambiguous provisions, which do not allow a citizen to foresee the legal consequences of his actions” /Judgement of 22 May 2002, K 6/02 – OTK ZU 2002 nr 3/A poz. 33 p. 448/. It follows from the principle of determinacy that “every legal regulation should be constructed correctly from the linguistic and logical point of view – it is only when this basic condition is met that it can be assessed in terms of the remaining criteria”.” “Phrases such as: “could not have been expected”, “other significant benefits”, “benefits resulting from the reduction of the amount of the liability” definitely do not allow to assume that “their jurisprudential interpretation will indeed be uniform and strict” and that “from their wording it will not be possible to derive a law-making power of the applying bodies”. It is worth noting here, that the aforementioned reservation, that a provision using indefinite phrases should not become the object of law-making activity of organs applying the law, has been formulated by the Constitutional Tribunal first and foremost in relation to the normative provisions applied by the courts” “In the opinion of the Constitutional Tribunal, such a statutory solution does not withstand criticism in the light of art. 93 clause 2 of the Constitution. On the one hand, it leads to a dangerous and undesirable blurring of the distinction between lawmaking and its interpretation, which results from giving the value of extended validity to the official interpretation, which is supposed to perform exclusively the function of subjectively limited ordering and unification of the jurisprudential activity. On the other hand, it makes acts addressed formally only to the internal structure of the state apparatus a means of influencing the sphere of taxpayers’ rights and freedoms, i.e. the sphere which may be regulated only by acts included in the closed category of sources of universally binding law. This kind of impact is not permissible either through sources of law of an internal character, or even less so through acts, which only seemingly have the value of purely interpretative actions, but in practice assume features similar to those displayed by normative acts. Therefore, apart from the inconsistency with art. 93 sec. 2 sentence 2 of the Constitution, the solution adopted in art. 14 par. 2 of the Tax ordinance may lead to “disruption” of the whole concept of the system of sources of law adopted by the legislator.” NB. A new Polish anti-avoidance clause was introduced by the Act of 13 May 2016 amending the Tax Ordinance and has been in force since 15 July 2016. Pursuant to the amended anti-avoidance provision in Article 119a § 1 o.p. – an act performed primarily for the purpose of obtaining a tax benefit, contradictory in given circumstances to the object and purpose of the provision of the tax act, does not result in obtaining a tax benefit if the manner of action was artificial (tax avoidance). Click here for English translation. Click here for other translation Poland case K 4_03 - Wyrok TrybunaÅ‚u Konstytucyjnego z 2004-05-11 ...