Investment treaty
arbitration in tax matters
Dr. Marcus Desax and Dr. Marc Veit
India Branch of International Fiscal Association Mumbai, 4 December 2012
– What are investment treaties?
– Indian investment treaties
– Features of Indian investment treaties – Investment treaty arbitration
General framework
– Bilateral/multilateral treaties for protection and promotion of foreign investment
– Allow investors to bring claims against the host state for treaty violations to international arbitration.
– No need to first litigate in local courts or involve own government on their behalf.
– Distinct from DTAA
What are investment treaties?
– India has concluded more than 80 investment treaties since the 1990ies (Currently negotiation with USA and Canada).
– Comprehensive Economic Cooperation Agreements (CECAs) with various countries, including Japan and Singapore. Cover wide range of issues, including
investment, trade, competition policies and IP rights.
(Currently negotiating with Indonesia, Mauritius, NZ) – Negotiating Free Trading Agreement with EU.
Indian investment treaties (1)
– Investment treaties with 9 of its top 10 sources of FDI and with 5 of the top 10 destinations for Indian FDI.
– Very modern treaties that give investors broad rights.
Indian investment treaties (2)
– Broad concept of „investment“: Covers a multitude of activities and contributions that lead to the aquisition of any right or asset by the investor.
– Protection in addition to normal contractual rights (e.g. rights in concession agreements).
– Directly enforceable against the Host State.
– Claims can also be brought by Indian investors against foreign governments.
Prominent features of Indian investment
treaties
– Unprecedented increase of cases over last few years.
– Most cases at ICSID (International Centre for the
Settlement of Investment Disputes, member of the World Bank Group).
– ICC, SCC, UNCITRAL arbitration
Investment treaty arbitration (1)
– Indian BITs contain broad jurisdiction clauses („Any disputes which may arise (...) in connection with an investment (...)“).
– ICSID arbitration or ad hoc arbitration under UNCITRAL Rules.
– India has not signed ICSID Convention.
– UNCITRAL arbitration (with ICJ as appointing authority) as long as one of the parties is not an ICSID member.
– „Fork in the Road“ Clause: Choice between national remedies or arbitration.
Investment treaty arbitration (2)
– Protection from expropriation or nationalization without compensation
– Protection from indirect/regulatory expropriation without compensation
– Fair and equitable treatment – Full protection and security – National treatment
– Most‐favoured‐nation treatment
– Protection against breach of legal obligation: „Umbrella“ clause
Common principles of protection under
investment treaties
– Promises investors market‐value compensation in case of expropriation/nationalisation
– Expropriation is not prohibited, if
– For public purpose – Non discriminatory
– In accordance with due process
– Subject to prompt, adequate and effective compensation
Protection from expropriation or
nationalization without compensation
– Abusive regulatory or taxation maeasures may amount to indirect expropriation, if they erode the economic value of an investment to such an extent that it is
effectively worthless, notwithstanding that the Host State may not actually deprive an investor of its
property.
– Remedy: Compensation
Protection from indirect/regulatory
expropriation without compensation
– Host states must not take any arbitrary, grossly unfair or discriminatory measures against foreign investments
(vigilance and protection).
– Must provide a transparent and predictable regulatory framework for the investment.
– Respect the legitimate expectations upon which the investors relied when they made their investment.
– No denial of justice.
– Principle of proportionality as part of FET (Occidental vs Ecuador, 5 October 2012)
Fair and equitable treatment
– Host States are under an obligation to exercise due diligence by physically protecting the foreign
investment, including the investment‘s officials, employees and facilities.
– Awards suggest that protection and security
obligations also include a guarantee of regulatory and legal security for investments.
Full protection and security
– Foreign investors must be treated equally with local competitors.
– Host states cannot offer more favourable conditions to their own nationals or companies, or place more
onerous conditions on foreign investors.
National treatment
– Host states often promise not to treat investors of the Home state worse than investors of other countries.
– Investors may therefore be able to rely upon more
favourable commitments in other treaties entered into by Host State.
– Treaties often contain exceptions to the MFN principle for the purposes of taxation and obligations imposed by free trade agreements or custom areas.
Most-favoured-nation treatment
– Host States must observe any legal obligations they have entered into with foreign investors or in relation to their investments.
– Effect of „Umbrella“ clauses: a breach by a State of a contract or license entered into with a foreign investor may also amount to a breach of treaty, entailing
international law remedies and procedures
Protection against breach of legal
obligation: „Umbrella“ clause
– Commitment not to restrict investors‘ freedom to
transfer capital and returns from investments of out the Host state and into another currency.
– A few early Indian investment treaties permit
restrictions on this right to achieve certain regulatory objectives (avoiding balance of payment difficulties)
Right to repatriate investment and returns
– General principles – Tax exceptions
– Limited jurisdiction
Do investment treaties apply to taxation
matters?
– Purpose BITs: Grant protection to foreign investors by imposing standards of treatment and other obligations – BITs do not intend to impose tax reductions or
exemptions or to impose measures to reduce double taxation ≠ DTAA
– Otherwise, investment treaties generally apply to tax matters
Do investment treaties apply to taxation?
– General tax exceptions can be found in investmentntreaties:
– „The provisions of this Agreement shall not apply to matters of taxation in the territory of each Contracting Parties. Such
matters shall be governed by any Avoidance of Double Taxation Treaty between the Contracting Parties and the domestic tax
law of each Contracting Party.“ (art. V ASEAN Investment Treaty)
– Can general tax exception trump customary
international law such as the minimum standard of treatment of aliens and denial of justice?
Tax exceptions?
– Some investment treaties limit jurisdiction of arbitral tribunals to specific rights. E. g. Art. 8(2)(a) Swiss‐
Russian BIT:
– „A (...) dispute concerning the procedure and the amount of
compensation in connection with an expropriation according to Article 6 of this Agreement shall be submitted to an arbitral
tribunal upon the request of one disputing party.“
Limited jurisdiction
– Nationals
– Discrimination on the basis of lack of residence?
– Limitations
Application of national treatment in tax
matters
Art. 4(2) BIT India‐Netherlands:
“Each Contracting Party shall accord to such investments including their operation, management, maintenance,
use, enjoyment or disposal by such investors, treatment which shall not be less favourable than that accorded either to investments of its own investors or to
investments of investors of any third State, whichever is more favourable to the investor concerned.”
National treatment (1)
– “Nationals” may be defined otherwise in BITs than in DTAAs
– E.g. Model BIT of the Netherlands includes in “nationals”
legal entities constituted anywhere in the world or in the Host state, but controlled, directly or indirectly, by
individuals or legal entities of the state of the investor.
– As under DTAAs, discrimination on the basis of residence remains an unsettled issue. The non‐discrimination
clauses in DTAAs usually add the requirement of both
beining “in like circumstances”. The same criterion my also apply under a BIT.
National treatment (2)
In Feldman v. Mexico (2002) foreign investors were refused excise tax refunds for exported cigarettes with the argument that the invoices did not contain the
required information. The Tribunal held:
“Also, given that this is a case of likely de‐facto discrimination, it does not matter for purposes of Art. 1102 [national treatment under NAFTA] whether in fact Mexican law authorizes the tax authorities to provide excise tax rebates to persons who are not formally excise tax taxpayers and do not have invoices setting out the tax
amounts separately, as has been required by the excise tax law consistently since at least 1987 and perhaps earlier. The question, rather, is whether rebates have in fact been provided for domestically owned cigarette exporters while denied to a foreign re‐seller. Mexico is of course entitled to strictly enforce its laws, but must do so in a non‐discriminatory manner, as between foreign investors and domestic investors.
Thus, if the excise tax Article 4 invoice requirement is ignored or waived for domestic cigarette resellers/exporters, but not for foreign‐owned cigarette
resellers/exporters, that de‐facto difference in treatment is sufficient to establish a
National treatment (3)
Art. 4(4) BIT India‐Netherlands:
“The provisions paragraph 1 and 2 in respect of the grant of national treatment and most favoured nation treatment shall also not apply in respect to any international agreement or arrangement relating wholly or mainly to taxation or any domestic legislation or arrangement consequent to such legislation relating wholly or mainly to taxation.”
Hence, the BIT does not require that relief granted under a DTAA to third country residents be granted to its investors.
Limitation
– Definition
– Wide meaning of expropriation
– When does taxation become confiscatory?
Expropriation in tax matters
Art 5(1) BIT India‐Netherlands:
“Investments of investors of either Contracting Party shall not be nationalized, expropriated or subjected to measures having effect equivalent to nationalization or expropriation, hereinafter
referred to as ‘expropriation’, in the territory of the other
Contracting Party except in the public interest and in accordance with law on a non‐discriminatory basis and against
compensation. Such compensation shall represent the genuine value of the investment effected, shall include interest at a
normal market rate until the date of payment, shall be effectively realizable without undue delay, and shall be freely convertible
and transferrable.”
Expropriation
Art. 19(3) Convention on the International Responsibility of States for Injuries to Aliens, 1961
‘Taking of property’ includes not only an outright taking of property but also any such unreasonable interference with the use, enjoyment or disposal of property as to
justify an inference that the owner thereof will not be able to use, enjoy, or dispose of the property within a reasonable period of time after the inception of such
Wide meaning of expropriation
In Link Trading (2002) the Modavan government reduced the amount of duty‐free goods that retail customers are
entitled to take out of the Free Economic Zone. The Tribunal held:
“As a general mater, fiscal measures only become
expropriatory when they are found to be an abusive taking.
Abuse arises where it is demonstrated that the State has
acted unfairly or inequitably towards the investment, where it has adopted measures that are arbitrary or discriminatory in character or in their manner of implementation, or where the measures taken violate an obligation undertaken by the State in regard to the investment.”
When does taxation become confiscatory?
(1)
When the “investment becomes useless”:
‐ A decrease of profitability does not suffice.
‐ Neither does a high tax rate.
‐ The investment must be affected in such a way that it loses its economic value immediately or in the
foreseable future.
When does taxation become confiscatory?
(2)
– Due diligence in tax matters – Prohibition of denial of justice – Prohibition of arbitrariness
– Transparency
– Good faith and legitimate expectations of investors
Application of FET to tax matters
Art. 4(1) BIT India‐Netherlands:
„Investments of investors of each Contracting Party shall at all times be accorded fair and equitable treatment and shall enjoy full protection and security in the territory of the other Contracting Party.“
Similar language found in virtually all investment treaties.
FET in Indian BITs
– Obligation of the State to control its functions and the measures taken by officials that illegal treatment does not occur.
– In particular, tax collection measures are permissible
as long as they have a basis in domestic law and do not violate international law.
– If illegal activities are found to exist, the State must take measures to stop them.
Due diligence in tax matters
– The principle of access to justice is part of international law.
– «Denial of justice» = wrongdoing by courts in terms of procedure and substantive justice.
– Tax assessments that are unlawful under domestic law are not (yet) automatically violations of international law.
– They only amount to «denial of justice» if the
Prohibition of denial of justice (1)
– Errors by domestic courts do not necessarily amount to denial of justice under international law (Encana vs.
Ecuador, 2004).
– Only if the error is of such significance or the
procedure is so unusual and unfair that it puts into question the legitimacy of the whole proceeding.
Prohibition of denial of justice (2)
There is denial of justice:
‐ If the relevant courts refuse to entertain a suit; or
‐ they subject it to undule delay; or
‐ they administer justice in a seriously inadequate way; or
‐ there is a clear and malicious misapplication of the law.
Prohibition of denial of justice (3)
Examples:
‐ absence of possibility of appeal against tax assessments
‐ blatant disregard of fundamental rights or fairness, of right to
defense, of rule or law, of good faith, of proper rules of procedure
‐ no timeliness of appeal, too short times to file submissions, excessive costs
‐ requirement of payment of disputed taxes leading to bankruptcy of taxpayer
‐ grossly unjust decision “shocking in the sense of legal property”;
willful disregard of the law, application of rules of procedure that are clearly dishonest to the investor.
Prohibition of denial of justice (4)
Occidental vs. Ecuador (2004):
“Although fair and equitable treatment is not defined in the treaty, the Preamble clearly records the agreement of the Parties that ‘such treatment is desirable to maintain a stable framework or investments and maximum effective utilization of economic resources'. The stability of the legal and business framework is thus an essential element of fair and equitable treatment.
The Tribunal must note in this context that the framework under which the
investment was made and operates has changed in an important manner by the
actions adopted by the [tax authorities]. (…) The law was changed without providing any clarity about the meaning and extent and also the practice and regulations were also inconsistent with such changes.
(…) The totality of these circumstances demonstrate a lack of orderly process and timely disposition in relation to an investor of a Party acting in the expectation that
Prohibition of arbitrariness
Art. 10(1) U.S. Model BIT:
“Each Party shall ensure that its:
(a) laws, regulations, procedures, and administrative rulings of general application: and
(b) adjuratory decisions respecting any matter covered by this Treaty are promptly published or otherwise made publicly
available.”
Transparency (1)
Metalclad vs. Mexico:
The absence of a clear rule concerning constructions permit requirements in Mexico had “failed to ensure a transparent and predictable framework for Metalclad’s planning an investment”. Mexico’s failure to ensure the transparency required by the North American Free Trade Agreement (NAFTA) was a breach of this Treaty’s
obligation of fair and equitable treatment.
Transparency (2)
‐ Requirement of acting in good faith laid down in the Charter of the United Nations and in the Vienna
Conventions on the Law of Treaties.
‐ Dealing in good faith entails respect of the legitimate expectations of the treaty partner.
‐ Under certain circumstances, investors may reasonably expect the Host state to conduct itself in a certain
manner.
Good faith and legitimate expectations of
investors (1)
– In some investment law arbitrations, the tribunals have referred to the legitimate expectations of the
foreign investor with respect to the policy of the host state.
– While Host state is free and sovereign to issue
regulations detrimental to investors, if circumstances exist that make it unreasonable for the Host state not to respect the investors reasonable expectations, the
Good faith and legitimate expectations of
investors (2)
Issue arose in Occidental vs. Ecuador decided on 5 October 2012 – Facts:
– Since 1980, Oxy had been operating in Ecuador
– 1993: Ecuador issued new legislation allowing government to take part of the profits of oil companies
– 1999: After long negotiations, Ecuador and Oxy signed an agreement allowing Oxy to keep a share of the crude oil it extracts.
– 2000: Oxy, in violation of its contract with Equador, remitted to a third party a part of its oil produced in Equador.
– 2001: Ecuador reversed earlier VAT regulations, resulting in large sum becoming payable by Oxy to Ecuador.
Oxy initiated arbitration against Ecuador.
1 July 2004: Tribunal awarded $75m to Oxy, finding Ecuador‘s conduct unfair and discriminatory
The first Oxy case (2004)
2 August 2004: Ecuador adopted VAT interpretive law:
„Article (...) is hereby interpreted in the sense that reimbursement of Value Added Taxes, VAT, is not applicable to petroleum activities when referring to extraction, transportation and commercialization of oil, since petroleum is not produced, but is extracted from the respective reservoirs.“
Retroactive change of law by Ecuador
5 October 2012, tribunal found against Ecuador and awarded $2.3bn damages and interest:
– „In the view of the Tribunal, the VAT Interpretive Law, unfairly and arbitrarily, frustrated the legitimate expectations of the Claimants (...) and is thus also in breach of the Treaty.
As such, as between the Claimant and the Respondent, the VAT Interpretive Law, is
without legal effect and should not be taken into account as a factor which impacts the fair market value of the Claimants‘ investment.“
– „As the Tribunal emphasized earlier, nullus commodum capere de sua iniuria propria: A state cannot be allowed to take advantage of ist own wrongful act. The result of this well‐known implementation of international law is that ‚the effects of actions taken by the nationalizing State in relation to the enterprise which actions may have depressed ist value‘ must be disregarded in the determination of that value.“
– „The Tribunal recalls that the VAT Award held that [Oxy] has ‚a right to reimbursement (of the VAT) under the law‘ and that ‚this reimbursement was not included in [Oxy‘s]
contract‘. The right of the Claimants to be reimbursed the Value Added Tax has now been legislated out of existence.“
