The Compatibility of Limitation on Benefits Provisions in Tax Treaties with EC Law

Abstract: Most bilateral tax treaties contain provisions with the objective of preventing different types of treaty abuse. Limitation on benefits clauses are an example of such provisions, and are generally found in United States tax treaties. These include various tests, which need to be fulfilled by a taxpayer wishing to enjoy the benefits of a tax treaty. Most of the United States tax treaties with EU Member States contain LoB provisions, although the form of those clauses can vary from treaty to treaty. Many scholars are of the opinion that such provisions are contrary to Community law. There is, at the time of writing, no judgment issued by the European Court of Justice on this topic. Conclusions therefore have to be drawn from the Court's complex case law in the area of direct taxation, as well as from case law in other areas of Community law. This thesis has a special focus on the new LoB clause of the income tax treaty between the United States and Sweden. A hypothetical case has been used to examine whether that provision is in conformity with Community law, and, what the consequences would be if it is not. The conclusion is not obvious. At first look, the LoB clause seems to be a clear infringement of Community law. In particular, the freedom of establishment and the free movement of capital. Strong arguments can be presented on behalf of this conclusion. However, the development in the Court's case law, suggests that it is introducing a more Member State friendly approach in the area of direct taxation, resulting in a drastic departure of its previous well established path, where the Court would rule in favour of the taxpayer. This could very possibly mean that the Court would find that no infringement is at hand. There are possibilities both under the comparability analysis or the Rule of reason assessment to support this view. Another uncertain aspect is the involvement of a non Member State. This may very likely play a role in the outcome of a infringement assessment. A strong case can be made for not treating capital movements between Member States, and capital movements between Member States and third states equally. If there is an infringement, state liability for damages could be a consequence. In the author's opinion the outcome of such an assessment is in some ways easier to foresee. Strong arguments can be presented against there being a sufficiently serious breach in order for state liability to ensue. In any event, for a long time solution, Member States will be obliged to renegotiate the incompatible LoB provision. This leads to a number of problems, such as how to protect the balance and reciprocity of the tax treaty, and the risk of ending up with no tax treaty at all.