Letter to the board of the Swedish IFA Branch

WebJournal on International Taxation in Sweden no 1/2012 (February 21 2012)


Stockholm January 17 2012

To the Board of the Swedish IFA branch

For quite some time I have been contemplating an idea where I believe IFA/Sweden with its expertise, integrity and experience could play an important role in the field of international taxation namely the function and structure of our tax treaties and the policies that should be adopted regarding these treaties.

As we are all aware, both the National Audit Office (Riksrevisionen) and the Federation of Swedish Enterprise (Svenskt Näringsliv) have recently submitted quite critical reports to government and parliament for their long lasting neglect of our tax treaty network. This, it is suggested, has had negative effects for the competitiveness of our industry and international commerce. The National Audit Office has also complained that our information exchange has not been updated with important secrecy jurisdictions and that old treaties are still being abused for unwarranted tax avoidance purposes.

It can now be expected that the government will step up its treaty making activities but one should not be content herewith. Now should therefore be a good point in time also to take more interest in how our treaties are structured and to make proposals to this effect. International developments both in Sweden and abroad require that we take a closer look att our treaty policies. And this should be a concern not only for the government and the finance department but should become an issue for debate in wider circles. This also, as noted below, should also lead to considerations for changes of parts of our domestic international tax regime.

Today the negotiation of tax treaties takes place behind closed doors where the tax payer community is presented with the a final and signed treaty as a faite accomplie. Only the Tax Administration and the Tax Appeals Court in Stockholm are invited to express their views on technical matters of the initialled text. Only once, as far as I recall, was an initialled text regarding the treaty with Germany made public which also gave rise to widespread interest and requests for changes. Sometimes in the past the negotiators would inquire at the Federation of Swedish Industries and the Institute of Foreign Law about requests and ideas when a new treaty was being contemplated. The aforementioned report by the Federation of Swedish Enterprize indicates that this custom has been discontinued.

As mentioned IFA/Sweden would be a very suitable institution for taking the lead in a promotion of a new approach to the making of our tax treaties. I suggest that one put together a working party comprising a select group of IFA members representing tax payer, government ant tax administration interests to work out a report which could then be distributed to all members and discussed at a seminar.

A starting point for considerations of our treaty policy should be an examination of our own domestic, albeit unofficial, model tax treaty (which long ago I commented in IUR-INFO.) This in itself would no doubt give rise to plenty of ideas.

But I also have a number of ideas that could be brought up in a discussion of this kind. This discussion should be as broad as possible and as already mentioned cover also suggestions for changes of domestic tax law and various methods for the application of tax treaties:

1. First of all it could be questioned whether we should really have so many treaties as today and thus suggest that some of them be terminated. For instance, do we really, with all respect, need treaties with such countries as e.g. Mauritius, Zambia and Trinidad and Tobago? Instead of treaties one could consider having domestic rules for specific and less ”important” countries where Swedish investors – and they are probably quite few – could be given tax reliefs corresponding to those in our treaties. For instance full credit for the foreign tax or a credit for taxes above a certain level imposed in the other country. Investments in Sweden by companies in the pertinent country
could also be given the same treatment as in a treaty e.g a reduced withholding tax on dividends. These investments can also be expected to be very few. How many companies in for instance Trinidad and Tobago are doing business in Sweden where they can have any benefits of the treaty? Moreover, our domestic tax regime for foreign residents already dovetails the OECD model in many respects which also reduces the importance of a treaty. This applies for instance to our SINK-regime for foreign residents deriving employment and pension income in Sweden and our definition of permanent establishments. The advantage of settling these matters in domestic law is that one gains complete control of the legislation, that one avoids problems of treaty interpretation etc. If undesired situations appear it is easier to correct them ad hoc. Rules on exchange of information, however, would of course always have to be drawn up in bilateral treaties.

2. And why not completely abolish the so called golden rule declaring that preference to the treaty should only occur when it reduces tax liability? There is no specific reason why this rule shall be considered carved in stone. And it need not be a general rule. Depending on the circumstances one could ordain that preference be given to the treaty in one respect and vice versa in another respect. For instance, one could prescribe that a treaty rule allowing the imposition of a source tax on interest should apply, despite that not being possible under domestic law, and at the same time, if desired, disallow the application of the ”effective management” rule (in OECD article 4.3) which represents an extension of the residence test under Swedish law.

3. When negotiating treaties Sweden should employ local tax expertise in the other contracting state to safeguard our interests. The purpose thereof would be to gain information about the finer points of the other country´s international tax regime and treaty policies. It is difficult for our negotiators to fully grasp such matters or to rely on the information provided by the treaty partner representatives. It could also be a good idea (in some cases) to retain this private tax expertise mentioned to provide current information of changes made in the domestic law of the other country or of important tax cases that could affect the application of the treaty.

4.Our treaties should be construed not to allow unwarranted tax avoidance for instance double tax exemptions. Subject-to-tax rules should therefore be considered both where Sweden is the state of residence of the tax payer and where it is the source state. In the commentaries to article 1 of the OECD model there are also a number of anti- tax avoidance recommendations that should be given consideration.

5. Anti- treaty shopping rules should also be studied, the reason being that treaties are bilateral and that the tax sacrifices provided therein should benefit only the tax payers of the contracting states. One should thus take advantage of limitation-of-benefit rules to a larger extent. One could also impose special taxes or restrictions for payments made to blacklisted tax haven recipients or tax priviledged companies in the other contracting state such as is the case in some of our treaties already. Malta and Switzerland e.g.are treaty partners where such rules already exist.

6. Our new domestic participation exemption rules have made such rules in our treaties unnecessary and could thus be abolished.

7. Due to new directives imposed by the EU e.g on withholding taxes such rules in our treaties can also be abandoned. On the whole our treaties should be adapted more carefully to the prevailing circumstances in each and every treaty.

8. More efforts should be given to negotiating bilateral information exchange rules working out the application of automatic exchange of information. Considering that bank secrecy in the wake of the finacial global meltdown has now virtually been given up as far as communicating the information to tax administrations is concerned such rules should more easily be possible to negotiate. The mere knowledge that a bilateral information agreement is being worked out should have a very positive preventive effect regarding tax payers harbouring ideas to hide their income or capital in such countries.

9. In the past, during a couple of years, we had a domestic law on the application of tax treaties. (It was introduced due to the panic that arose after the ”Kenya 1 ruling” by the Supreme Administraive Court.) One should consider if such a law could have posirive effects today. For instance, it could be used for a general rule establishing the relationship between domestic law and treaties discussed above. It could also contain the rule, which is now repeated in every law of intrduction of treaties, that the exemption with progression rule in our treaties shall not apply. Even better is of course to abolish that rule alltogether in our treaties. The new law could also be used for providing more detailed information to be provided by tax payers benefitting from a treaty.

10. More structured efforts should be made to prevent tax avoidance by the use of tax treaties. A well known and widespread abuse of our treaties is the tax planning regarding migrating capital gains and our ten year rule. This indeed is the specific area of taxation brought up by the National Audit Office. In that context one should consider if there is reason to restrict the ten year rule. In my opinion quoted shares should be exempted from the ten year quarantine and apply only to closely held shares. It is a well known fact that the negotiation of these rules in our treaties give rise to problems especially as regards the agreement of the quarantine period. In the French treaty it has been reduced to only two years. A possible solution would be to offer the other state a reversed credit mechanism in these cases so that this state is relieved of the obligation to give tax relief for the Swedish tax. Considering that the tax planning in these cases always is directed to low- or no-tax jurisdictions regarding capital gains, the loss of revenue to the Swedish treasury by such a credit will be quite negligible. Reversed credits could maybe also be considered in other situations.

11. One should renew the discussions on source taxation of royalties and impose a source tax on gross payments. Considering our general treaty policy of a zero source tax on royalties one could even consider abolishing such taxes alltogether in domestic law. Possibly with reservations visavi payments to tax haven recipients.

12. One should definetely discontinue the right of dual resident tax payers to deduct interest expense under domestic law when, at the same time no tax is imposed on interest receipts under a treaty. This is a senseless and pure corruption of our international tax regime. (For a long time such deductions have been stopped for corporate tax payers.)

13. In order to avoid conflicts of interpretation of treaties one should specifically spell out that they do not prevent the application of domestic anti avoidance and CFC rules of the contracting states. And why does our general anti avoidance rule not apply to our dividend withholding tax?

14. We have subject-to-remittance-rules with a number of treaty partners. How are they monitored? Probably not at all. Regulations hereon could be drawn up in the afore mentiond law on application of tax treatiers.

15. Treaties should also include rules of mutual collection of taxes.

16. Rules on taxation of foreign trust must be put in place. After the abolition of our gift tax such trusts have become very interesting tax planning instruments. And allways in such situations a lot of money is involved.

17. One should draw up a sheet for providing information by tax payers benefitting from tax treaties. A simple thing would be to oblige the tax payer to provide a copy of the tax return submitted in the other country.

The afore mentioned suggestions are merely the result of a spontaneous and unstructured brainstorming of ideas to be considered in order to improve our tax treaties and their application.

More important is to get started! And, as already emphasized, I believe that IFA/Sweden is a perfect institution for taking a lead in these matters and for inspiring a project of this kind.

Best regards

Peter
peter@sundgren.net