Impact of GAARs and mandatory disclosure on client advice

Daniel Bolwerk

Loyens & Loeff, Amsterdam, Netherlands

Daniel.bolwerk@loyensloeff.com

Report on a panel discussion at the 16th IBA/ABA US and Latin America Tax Practice Trends Conference in Miami

Thursday 13 June 2024

Session chair

Ariadna Artopoulos Bomchil, Buenos Aires

Speakers

Eduardo Cukier Olashan Frome Wolosky, New York

Mike Dolson McCarthy Tétrault, Toronto

Charlotte Kiès Loyens & Loeff, Amsterdam

Ivonne Montano Galicia, Mexico City

Introduction

Domestic law is often used to combat abuse and tax planning. Some countries apply anti-avoidance rules independently if there is no anti-avoidance clause included in the relevant tax treaty to avoid double taxation. Other tax treaties expressly authorise it, among others due to the entry into force of the multilateral instrument (MLI). Clients are increasingly facing the application of general anti-avoidance rules (GAARs) in connection with anti-avoidance rules included in tax treaties, together with increased mandatory disclosure rules (MDRs). This panel discusses GAARs and MDRs in several jurisdictions, and the impact thereof on client advice.

Panel discussion

GAAR

Eduardo Cukier said GAAR can be compared to the video assistant referee (VAR) used in various sports. Similar to how the VAR closely follows the rules of the game and assists the referee during crucial plays, Cukier finds that the GAAR examines transactions retrospectively, analysing them from different angles. It considers relevant facts, legislation, case law and additional doctrines such as the GAAR, to determine whether there was an attempt to avoid taxes.

Cukier further went into the United States economic substance doctrine (ESD) which has been codified in US tax law. The question arose whether the principal purpose test (PPT) applicable in the European Union has an effect in the US. Cukier indicated that the US is also moving towards the application of a PPT. The ESD is applied similarly to the PPT. A taxpayer must demonstrate that business reason(s) outweigh the tax advantage. The business reasons follow from the arrangement. When the statute is clear, you can consider the textual arrangement. If not, you consider the intent of the arrangement.

Mike Dolson stated that Canada does not have an ESD but does have a GAAR that applies if there is a tax benefit which is a resulting from an avoidance transaction considered abusive. Dolson indicates that the Canadian GAAR has recently been subject to change. Previously the primary purpose was relevant, but the Canadian GAAR has shifted to looking at one of the main purposes (similar to the PPT). The threshold for determining the main purpose is very low. However, there is a tendency that court cases involving the application of tax treaties generally do not favour the Canadian tax authorities, unless the cases are very clear, such as those with no connection to Canada other than residency. In such cases, the Canadian tax authorities win not based on the GAAR but on the concept of beneficial ownership. Convincing a Canadian court to apply the GAAR in tax treaty shopping cases is challenging.

Charlotte Kiès said that Pillar Two questions on GAAR application arise frequently. Kiès suggests that countries should consider caution when applying the GAAR, especially since countries have already expressed their attention points and needs during the Pillar Two negotiations. The peer-to-peer review process should already safeguard proper implementation of the Pillar Two rules. The inclusion of a GAAR in the Canadian Pillar Two rules is very unique.

With respect to country-by-country reporting (CbCR), Kiès indicated that the EU is taking steps with the introduction of the public CbCR. These rules could become relevant for foreign multinationals which have a presence in the EU and meet the CbCR threshold. The effective date is set for financial year 2025, but certain EU Member States are implementing the CbCR rules earlier.

Kiès highlighted the increasing relevance of CbCR, considering that many CbC reports are currently not in line with OECD guidelines. This could adversely affect a taxpayer’s Pillar Two position.

Ivonne Montano mentioned that the Mexican GAAR has recently been introduced into the Mexican tax code, in 2020. However, Montano has not seen audits and litigations based on the application of the Mexican GAAR. The GAAR along with the MDR will have a significant role in combating tax evasion and avoidance schemes. It will specifically target transactions lacking economic substance, empowering the Mexican tax authorities to disregard transactions that do not reflect their economic reality.

Montano further indicated that Mexican tax authorities are using known tools. These include, for example, requesting parameters of transactions. She further notes that tax treaty benefits are out of scope of the Mexican GAAR. A pending discussion revolves around whether a transaction could be recharacterised and subsequently could benefit from a tax treaty.

Kiès responded by noting that since the Mexican energy reform, many investments into Mexico were made through Dutch entities. From a Dutch tax perspective, the GAAR and MLI in tax treaties are linked to domestic anti-avoidance rules in the Netherlands. Kiès expects the Mexican tax authorities to be aggressive in combating such structures if tax treaty benefits are being claimed. In contrast, the Canadian court does not seem to apply its domestic GAAR in tax treaty cases. However, Kiès anticipates that Mexico will take a different approach.

Montano clarified that the GAAR has not been used to combat investment structures. Instead, Montano indicated that the Mexican tax authorities focus on more basic elements when scrutinising transactions.

Mandatory disclosure rules

Cukier kicked the discussion off by stating that the ESD only reduces a penalty. It is mandatory to disclose information but it could be mandatory in order to reduce the penalty. Furthermore, it is relevant to mention that if a non-US person does not file a tax return, eg, claiming that it has no PE in the US, this could result in the Internal Revenue Service (IRS) denying deductions when this position is challenged. Cukier therefore recommended filing a tax return and disclosing the transactions in that tax return. Cukier further indicated that a second reason to file a tax return could be that the statute of limitation starts from the moment of filing. If a non-US person claims a tax treaty position, the filing of the tax return preserves the right to apply a treaty. However, the tax return needs to be complete in order to be characterised as filed.

Dolson continued to outline the requirements of reporting according to MDR: ie, having an avoidance motive and meeting certain hallmarks. An avoidance motive is typically assumed so it is most relevant to see whether a hallmark is met. Dolson indicated that if a client fails to disclose a transaction, the GAAR may apply and/or an avoidance motive may be assumed.

Kiès followed by outlining EU MDR directive requirements, which also include hallmarks for transaction disclosure. Unlike Canada, some hallmarks include a main benefit test which should be met for a transaction to be reportable. Currently, many transactions are disclosed without having a tax-aggressive element. Kiès suggested that the EU and the Netherlands should reconsider implementing the main benefit test to all hallmarks.

Kiès highlighted an ongoing discussion within the EU regarding the question whether intermediaries can legally disclose client information. The European Court of Justice has ruled that disclosure could be an infringement of attorney client privilege. Kiès indicated that, currently, Dutch attorneys can invoke this privilege, but Dutch civil notaries cannot. Dolson noted a similar discussion in Canada: can lawyers report under their legal privilege?

Montano indicated that the recently introduced MDR places the obligation to disclose on taxpayers. If the taxpayer fails to disclose, the tax adviser must reveal the scheme. MDR covers specific reportable transactions, including those related to potential tax avoidance, cross-border transactions and transactions involving preferential tax regimes. Tax benefits are assessed in line with the GAAR. Montano emphasises reviewing transactions to determine eligibility for these features and the resulting tax benefit. There is an exemption from disclosure when a tax benefit of a transaction is below $5m. Montano concluded by stating failure to disclose can lead to an audit from the tax authorities.

Conclusion and final remarks

A comment from the audience

In a recent case, the IRS claimed that late tax return filing would waive treaty benefits. However, the US court ruled otherwise. The appeal from the IRS has been denied. The comment concluded that timely tax return filing preserves access to tax treaty benefits.

Cukier mentioned that case law from the US Supreme Court emphasises that the corporate element of an entity should be respected: ie, board directors, corporate formalities etc. However, US courts considers the entire transaction. Cukier raised questions on how to deal with this, also taking into account the Liberty Global case.

Montano emphasised the importance of carefully reviewing information disclosure to prevent detailed audits of a structure.

Dolson concluded by stating that Canadian transfer pricing rules have a high recharacterisation threshold. If there is a willing participant who would enter into the transaction at any price, recharacterisation is not possible. Dolson anticipates changes to these rules in the future.