Public International Law

Smoke and Mirrors: The G8 Tax Proposals Will Change Nothing

The Lough Erne Declaration, like most summit communiqués, is replete with bold statements of intent. G8 leaders have pledged to ‘fight the scourge of tax evasion’, with a focus on transparency and information sharing. However, the reality is that administrative reforms to international taxation will change very little – if anything – without substantive reforms to International Tax Law. And while the Declaration contains a statement of intent to ‘change rules that let companies shift their profits across borders to avoid taxes, and [make] multinationals […] report to tax authorities what tax they pay where’, with over 2,000 Double Taxation Treaties to amend, changing the rules in any substantive way is a herculean task.

How do firms avoid tax?

The key to reducing your tax liability is, rather obviously, to reduce your taxable profits in high-tax jurisdictions, and shift them to law-tax countries. While international tax rules, in theory, provide for taxation of business profits at source where a business has a ‘permanent establishment’ in that jurisdiction, it is possible to substantially reduce that liability through the use of – in particular – royalty payments and loan finance.

The Dutch Sandwich

Companies A and C are incorporated in Ireland. A is headquartered (and therefore taxable) in Ireland, C in somewhere like Bermuda. Company B is incorporated and resident in the Netherlands. All of these companies are ultimately part of Group X, probably incorporated and resident in the US. Tech firms domiciled in Ireland earn profits primarily from IP. The IP is owned (or substantially controlled) by Company C, but the operating arm is Company A. Company A earns a profit, but wants to shift that profit to a tax haven. Company A pays royalties to Company B (as there is no withholding tax in Ireland for royalty payments to EU countries). Company B then makes royalty payments to the ultimate owner – Company C – as there is no withholding tax between the Netherlands and Bermuda. Non IP-related profits can also be reduced through the use of loan finance funneled in the same way. For the purposes of Irish tax law, Company C is tax resident in Bermuda. For the purposes of US tax law, Company C is tax resident in Ireland.

The Double Irish

As above, except that, as Ireland has recently changed its rules relating to withholding tax on royalty payments, the Dutch company is no longer necessary. Payments can be made directly from Company A to Company C. The Double Irish, however, is only of use where profits from intellectual property are concerned. Where loan finance is used as a means of reducing profits a Dutch company is still necessary to channel profits out of the EU.

Where do these rules come from?

Current international tax rules find their genesis in the work of the Fiscal Committee of the League of Nations in the 1920s. Most of the principles that presently make up international taxation law were agreed by the four experts who were charged with drafting a set of model treaty articles – Professors Bruins, Einaudi, and Seligman; and Sir Josiah Stamp. Today, the rules as they are in force are contained in a network of over 2,000 Double Taxation Treaties (DTTs) – most of which are based on one of three models: The OECD Model; The UN Model; and the US Model. The OECD Model is the most prevalent, although the key clauses in the other models are fairly similar to that of the OECD.

Why not a multilateral treaty?

It was initially thought that agreeing a multilateral treaty would be nigh-on impossible. Instead, the League proposed model articles on which bilateral treaties should be based. It was hoped that once the principles of the model articles had been bedded-in by bilateral treaties, that states would eventually move to multilateral treaties – however few have ever emerged.

Why have they never changed?

Quite simply, because it would be too difficult. Agreeing even modest amendments to the Model Convention can take years – while the core principles of permanent establishment and arms length accounting have never been amended. Instead, the OECD has opted to amend their highly authoritative commentary on the Model Convention. Of course, even if amendments to the OECD Model could be agreed – it remains merely a set of model articles. The thousands of DTTs currently in force would then have to be amended – which cannot be assured of success. The dangers of having a patchy net of tax treaties are usually thought greater than the comprehensive but imperfect network that currently exists.

But these changes will work, right?

Doubtful. The focus of the G8 Summit at Lough Erne has been on information sharing and transparency. However the reality is that shedding light on companies’ tax arrangements will usually reveal that all is perfectly legal and above board. While it is the case that they may be forced to do in public what they formerly did in private, when it comes to a choice between pleasing tax campaigners and substantially lowering their tax bills, multinational corporations are going to elect to continue to do what they have been doing all along. What is needed is a genuine drive to alter the substance of international tax rules – rather than the manner in which they are administered.

Sovereignty and Independence Lite

Despite the fact that my PhD is a contemporary study of the impact technology has had on international taxation law, I’ve found myself delving into the concept of “sovereignty”. The link between international taxation and sovereignty is, in fact, far more significant than it first appears however I’ll bore you with that in a future post.

When considering Sovereignty in Scotland there are two issues: the internal constitutional question as to in whom it vests, and the question of what, externally, it will mean in the future.

The first is fairly straightforward, or at least one would think so. Our Austinian conception of sovereignty was best summarised by Harrison, thus:

The source of all positive law is that definite sovereign authority which exists in every independent political community, and therein exercise de facto the supreme power, being itself unlimited, as a matter of fact, by any limits of positive law.

From a jurists perspective sovereignty is the ultimate source of law within any legal order. It founds executive power, legislative competence, and jurisdiction. Hart would describe it as the “ultimate rule of recognition”.

Even a first year student of Constitutional Law would be able to tell you that sovereignty in the United Kingdom vests in Parliament, and would quote Dicey and Jennings at you until you until they were blue in the face to prove it. Yet this seems to have escaped the SNP’s notice completely.

In November 2007 Alex Salmond wrote:

We in the Scottish Government believe that sovereignty in Scotland lies with its people.

This, the First Minister has re-stated a number of times. But unlike Dorothy in the Wizard of Oz closing your eyes and repeating “there’s no place like home” won’t make it come true. The people of Scotland are not sovereign. Parliament may remain sovereign by common consent but that does not make the people the supreme source of law. Perhaps what Alex Salmond meant to say is that he believes the people of Scotland should be sovereign, which I don’t doubt for a minute.

However sovereignty isn’t merely an element of constitutional law but also an important concept in in international law. Mutual recognition of the sovereignty of other states is one of the fundamental elements of international law. Independence is an essential aspect of that sovereignty, as was discussed by Oppenheim:

Inasmuch as it excludes dependence upon any other authority, and in particular from the authority of another state, sovereignty is independence. It is external independence with regard to the liberty of action outside is borders in the intercourse with the intercourse with other States which a State enjoys. It is internal independence with regard to the liberty of action of a State inside its borders.

If there’s one point of fact on which I’m certain Alex Salmond would agree it is that Scotland is not independent.

This brings me onto the second of the two issues which is what sovereignty will mean in the future. Certainly if Alex Salmond wishes the people of Scotland to be sovereign then Scotland needs to be independent. But how much independence does Scotland need before you can describe it, or its people, as sovereign?

Adapting the old adage, independence is like an elephant – difficult to describe but instantly recognisable. Certainly it is not a binary concept. Even when Oppenheim considered sovereignty and independence in the 1950s sovereign nations were heavily dependent on each other. Nonetheless you’d be hard pressed to claim that a nation lacked independence because of its membership of the EU, or the WTO, or even if it were dependent on foreign aid. Independence does not mean self-sufficiency.

“Independence lite” – which would involve sharing (or, more likely, contracting out) defence, foreign affairs, and even social security – appears to be preferred option of the Scottish Government. What this would involve remains quite unclear. For example, would Scotland and the remainder of the United Kingdom (rUK) have joint, or shared embassies? Would such embassies have a joint ambassador? Or two ambassadors sharing an office? Or one ambassador with two hats? Certainly it seems quite absurd for one person to be accredited as ambassador for two sovereign nations.

Presumably Independence lite means sharing a place on the world stage. We would remain a single Member State of the European Union, our membership of the United Nations would still be through the United Kingdom, and we would still sign treaties as a single entity. In that circumstance it’s hard to see how Scotland would be externally independent as Oppenheim describes, and would therefore lack one of the essential components of sovereignty in international law. From an external perspective Independence-lite would not appear to be any different from Devolution-max.

The difference, therefore, between Indy-lite and Devo-max appears to be one of internal sovereignty. Devolution max would preserve the unitary state, with sovereignty continuing to vest in the UK Parliament. Independence lite would effectively create a confederated state – two internally sovereign nations within one externally sovereign state. Within those nations internal sovereignty could vest differentially. One would expect that within rUK Sovereignty would continue to vest in Parliament, while in Scotland it would vest in the people.

Independence-lite may well create the internal appearance of sovereignty – certainly Alex Salmond’s belief that the people of Scotland should be sovereign could be realised. But it’s difficult to see how such a settlement could be objectively described as “independence”.

Will the National Transitional Council hand Megrahi over to the USA?

Scotland may well find itself facing another diplomatic row with the United States of America. New Jersey Senators Robert Menendez and Frank Lautenberg have called on the Libyan National Transitional Council to hand Lockerbie-bomber Abdelbaset Ali Mohmed al-Megrahi over to the United States. Until yesterday it was easy to dismiss this call as just another stunt by vote-hungry US Senators but with the National Transitional Council (NTC) on the cusp of full control of Tripoli it has become a question that warrants some consideration.

Of course, legally and politically the situation is far more complex than Lautenberg and Menendez would have us believe. Leaving aside the dubiousness of the original conviction there are questions as to jurisdiction, international law, United States law, as well as the diplomatic, political and practical considerations.

At first glance jurisdiction seems simple. The flight blew up shortly after crossing the corner of the Solway Firth into Scotland and fell out of the sky towards Lockerbie and Langholm. Ergo, the bombing of flight Pan Am 103 is subject to the criminal law of Scotland, right? Well, things are slightly different where aircraft are concerned. The United States has never been shy about extending its jurisdiction extra-territorially, and the Tokyo Convention on Offences and Certain other Acts Committed on Board Aircraft 1963 creates the so-called “Aircraft Jurisdiction”. The Convention provides that the Country in which an aircraft is registered has jurisdiction over criminal acts while the aircraft is in flight or on the surface of the high seas. The United States has therefore always claimed jurisdiction over the bombingof flight Pan Am 103.

However public international law also comes into play where the Lockerbie trial is concerned. The United States along with the United Kingdom jointly sponsored Security Council Resolution 1192, binding members to accept the jurisdiction of a Scottish Court constituted in Camp Zeist in the Netherlands as the trial venue for Megrahi and his co-accused Lamin Khalifah Fhimah. The United States cannot unilaterally ignore this resolution, though as a permanent member of the Security Council it could propose a resolution overturning it. Without a further resolution, as Professor Robert Black points out, the Federal Government would not only be in breach of International Law but also of Art. VI, Clause II of their own Constitution.

But wait! “What about double jeopardy?” I hear you ask…

The famous double jeopardy rule contained within the Fifth Amendment to the United States Constitution is not as airtight as it first appears. The dual sovereignty exception, which was developed by the Supreme Court in order to protect the rights of the federal government and the states to prosecute crimes independently of each other, appears to have been extended to foreign prosecutions [U.S. v. Richardson 580 F.2d 946 (9th Circuit 1978)]. Therefore provided the United States remains in compliance with its international obligations there is no bar on Megrahi standing trial again in the U.S.

So handing Megrahi over to the U.S. to stand trial is, theoretically speaking, possible in law however the politics make things even more difficult. The Obama administration is understandably keen to avoid being seen to be flouting Security Council Resolutions, so if they wanted Megrahi back they would have to have the acquiescence of fellow permanent member, the United Kingdom – but would they receive it?

In both Government and Opposition David Cameron has been clear about his objections to the release of the Lockerbie bomber. He has continued to maintain that he felt it was wrong that Megrahi was released though has never stated that he believes he should be returned to prison (despite what his spokesperson seemed to think today). The political row that returning Megrahi to the United States would create would be one that I believe David Cameron would wish to avoid.

Alex Salmond appears to relish in the controversy his Government has created. He has succeeded in putting successive UK Governments in a tricky-spot over Megrahi, and in attracting the ire of Hillary Clinton has been elevated to the status of a world statesman. I do not believe David Cameron would put Whitehall on yet-another collision course with Holyrood, particularly given the concessions the UK Government has already made to the Nationalists. Nor would Cameron wish to further enhance Alex Salmond’s quasi-Presidential status in the run up to a referendum on Scottish Independence.

From a practical perspective – at present we do not know where Megrahi is. Megrahi was released on license and returned to a Government, which for the most part doesn’t exist any more. East Renfrewshire Council, the local authority responsible for monitoring Megrahi’s release on license, admits it is in “uncharted territory” in monitoring his license and is urgently trying to make contact with him.  Furthermore Tripoli could remain in turmoil for some time to come and Megrahi may well slip through the net.

Finally, given the uncertainty as to what kind of state may emerge in Libya, there’s no guarantee that the new regime will be any more acquiescent with the United States than its predecessor. Even if they manage to find Megrahi they may not hand him over. And given that it took the joint efforts of the United Kingdom, the United States, the United Nations Security Council and the passage of more that ten years to extradite him the first time around – Senators Lautenberg and Menendez may have to accept that Megrahi will never see the inside of a prison cell again. To paraphrase Kenny McAskill: the next judgment Megrahi faces will almost certainly be that of a higher power.

The above post was written for Better Nation.