28 - Shu-Chien Chen

Shu-Chien Chen Toward a Neutral Corporate Tax for the Transportation Industry – Rethinking the Transportation Industry Formula of the Common Consolidated Corporate Tax Base Directive Proposal under EU Law

Shu-Chien Chen graduated from the National Taiwan University and passed the Taiwanese lawyer examination. Before moving to the Netherlands, Shu-Chien worked at Keelung Customs, Ministry of Finance in Taiwan as a legal officer. Later, she studied in Leiden University and Radboud University Nijmegen in the Netherlands and received LL.M degrees.

Currently, she is a Ph.D candidate at Erasmus University Rotterdam (also in the Netherlands). She has been doing the Bluebook traineeship at the European Commission since March 2020.

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This paper explores how the Common Consolidated Corporate Tax Base (CCCTB) Directive Proposal under the EU law should be designed to allocate cross-border income earned from MNE taxpayers of the transportation industry.

The transportation activity is mobile in nature, and thus creates the difficulty of designing the relevant tax law. Allocating sovereign States’ taxing rights on the cross-border income of the transportation industry is inherently disputed.

The OECD Model Convention, as an important starting point for negotiating bilateral tax treaties, has established the ‘effective place of effective management’ (POEM) as the criterion for allocating the primary taxing rights to one single State, where a taxpayer‘s effective place of effective management (POEM) is found. It is an all-or-nothing rationale.

Formulary Apportionment (FA) follows an opposite rationale other than the all-or-nothing mentality, by using a formula consisting of different weighting factors to allocate taxing rights for all jurisdictions involved. Taking the metaphor of cross-border taxable income as a pie, a formula would be a knife. At the subregional level, such as States of the US, FA is widely adopted. The CCCTB Proposal is the EU’s attempt to transplant FA from the US. Some jurisdictions also adopt a formula in their national corporate tax law for the shipping industry.

To our surprise, the CCCTB proposal follows the POEM criterion established in the international tax regime and excludes the shipping and airline industry from its scope of application.

Therefore, this paper further discusses if the shipping industry provision under the current CCCTB Proposal is still rational. This paper compares the CCCTB to experiences from OECD and US to seek an answer to this question. In conclusion, since the CCCTB has adopted formulary apportionment as its basic setting, it does not need to follow the traditional international tax regime’s approach of ‘POEM’ adopted by OECD, or the residence criterion adopted by the US, because neither of them can reflect the mobile (while highly-integrated) feature of the international transportation 248

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industry or address the old tax-planning scenarios. Instead, this paper argues that the CCCTB should include the transportation industry in the scope of application, and uses both ‘departure’ and ‘arrival’, being equally weighted, for the sales factor of the transportation industry. ‘ A page of history is worth a volume of logic Justice Oliver Wendell Holmes1

1. Introduction

T

he international tax law regime has the main purpose of allocating taxing rights between sovereign States on cross-border economic activities; more specifically, the international tax law regime is based on the network of various bilateral tax treaties, aiming to eliminate ‘double taxation’, which occurs inevitably due to cross-border economic activities.

The current international tax law regime is largely based on the work of the League of Nations carried out in the early 20th century,2 and later the OECD and UN also played an important role by providing bilateral tax convention models3 and commentaries to the States as the starting point in negotiating their own bilateral tax. The OECD and UN Model Convention have been updated regularly and have become a well-accepted starting point for many States. The US also has its own bilateral tax treaty model.

These three popular models have much in common, especially regarding categories of income.4 1 New York Trust Co. v. Eisner, 256 U.S. 345 (1921) 2 The short history, see Reuven S Avi-Yonah, Advanced Introduction to International Tax Law (Edward Elgar Publishing 2019)..

3 Brian J Arnold, International Tax Primer (Kluwer Law International BV 2019)., 8.3-8.7; 4 According to IBFD International Tax Glossary: ‘The US Model Income Tax Convention is the model used by the United States as the basis for bilateral tax treaty negotiations. It is issued by the US Treasury Department and accompanied by a Technical Explanation that provides a detailed commentary for each article of the treaty. The current version of the US Model Income Tax Convention is dated 17 February 2016. The United States has also issued a US Model EState and Gift Tax Treaty, dated 20 November 1980, and accompanying Technical Explanation.’

The IBFD International Tax Glossary is published at the IBFD data base: tax research forum https://research.ibfd.org/#/ (a separate access required)

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There were three widely accepted principles5 established in the international tax regime, which is also reflected in the tax treaty models. First of all, the original aim of the international tax regime is to eliminate double taxation on cross-border activities. To achieve this aim, the OECD Model Convention has categorized 16 types of income, and the taxing right of each income has been decided in each Article and is attributed to ‘one State’. One scholar refers such approach as ‘the single taxation principle’.6 Secondly, the allocation of taxing rights to prevent double taxation has the residencesource dichotomy7; Third, as to allocate profits earned by a multinational corporate group to each subsidiaries/group members, the Arm’s Length Principle (ALP)8.

See J.A. Becerra, Chapter 6: Interpretation and Application of Tax Treaties in the United States, Juan Angel Becerra, Interpretation and Application of Tax Treaties in North America (Second revised edition, IBFD 2013)., Books IBFD (accessed 10 Nov. 2019).

5 It should be noted that, these consensus or principles are not (yet) ‘customary international law’ in the public international law context. See Reuven S Avi-Yonah, ‘International Tax as International Law’ (2003) 57 Tax L. Rev. 483.. OECD’s commentary is often seen as influential ‘soft law’. See Alberto Vega, ‘International Governance Through Soft Law: The Case of the OECD Transfer Pricing Guidelines’ [2012] SSRN Electronic Journal <http://www.ssrn.com/ abstract=2100341> accessed 14 November 2019.; Allison Christians, ‘Hard Law, Soft Law, and International Taxation’ (2007) 25 Wis. Int’l LJ 325.

6 Reuven S Avi-Yonah, ‘Who Invented the Single Tax Principle? An Essay on the History of US Treaty Policy’ [2013] SSRN Electronic Journal <http://www.ssrn.com/abstract=2226309> accessed 14 November 2019.; Reuven S Avi-Yonah, ‘Full Circle? The Single Tax Principle, BEPS, and the New US Model’.

The criticisms of the single tax principle, see Shaviro, Daniel, The Two Faces of the Single Tax Principle (November 2, 2015). NYU School of Law, Public Law Research Paper No. 15-47; NYU Law and Economics Research Paper No. 15-19. Available at SSRN: https://ssrn.com/abstract=2664680 or http://dx.doi.org/10.2139/ssrn.2664680; Julie Roin, Taxation Without Coordination (2002), http://papers.ssrn.com/paper.taf?abstract_id=302141 ; Mitchell A. Kane, Strategy And Cooperation In National Responses To International Tax Arbitrage, 53 Emory L.J. 89; Adam H. Rosenzweig, Harnessing The Costs Of International Tax Arbitrage, 26 Va. Tax Rev. 555. Most contributions from Single Taxation? (J.C. Wheeler ed., IBFD 2018) are critics too.

L.E. Schoueri & G. Galdino, Chapter 3: Single Taxation as a Policy Goal: Controversial Meaning, Lack of Justification and Unfeasibility in Single Taxation? (J.C. Wheeler ed., IBFD 2018); F. De Lillo, Chapter 1: In Search of Single Taxation in Single Taxation? (J.C. Wheeler ed., IBFD 2018); Daniel Shaviro, The Two Faces of the Single Tax Principle (November 2, 2015). NYU School of Law, Public Law Research Paper No. 15-47; NYU Law and Economics Research Paper No. 15-19. Available at SSRN: https://ssrn.com/abstract=2664680 or http://dx.doi.org/10.2139/ssrn.2664680; E. Gil García, The Single Tax Principle: Fiction or Reality in a Non-Comprehensive International Tax Regime?, 11 World Tax J. (2019), Journal Articles & Papers IBFD (accessed 26 Sep. 2019).

7 Arnold (n 3)., Chapter 2 Jurisdiction to Tax 8 The basic ideas and introduction of the arm’s length principle are published at OECD website, see OECD (2017), ‘The Arm’s Length Principle’, in OECD Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations 2017, OECD Publishing, Paris. DOI: https://doi. org/10.1787/tpg-2017-5-en Adam Biegalski, ‘The Arm’s Length Principle: Fiscalism or Economic Realism? A Few Reflec-

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However, since the international tax regime has been established almost for a century, it has been subject to aggressive tax planning and treaty abuses. Moreover, due to digitalisation, the old international tax regime now faces the even greater challenge of allocating taxing rights to economic activities. These three principles are now also being debated and reconsidered, especially by the OECD/G20 global campaign ‘Base Erosion and Profit Shifting (BEPS)’’s action plans.9 The BEPS reform focuses on not only ‘eliminating double taxation’, but ‘double non-taxation/Stateless income’10; The BEPS reform project also admits to the easiness of manipulating the form of ‘residence’ or ‘permanent establishment’11; besides, the BEPS reform project also re-assesses the current transfer pricing practices and proposes a reformed ‘Arm’s Length Principle’.12 In short, these long-standing principles are also being debated and facing reform.

In the context of international tax reform, the EU has taken several actions as response. One of the most revolutionary actions is the Common Consolidated Corporate Tax Base (CCCTB) Directive Proposal. Being initiated since early 2000’s and first released in 2011 and withdrawn and re-launched in 2015, the CCCTB has now multiple policy paradigms.13 One the one hand, the CCCTB is intended to combat international BEPS problems; on the other hand, the CCCTB also aims at facilitating further integration of the EU internal tions’ (2010) 38 Intertax 177..; Luis Eduardo Schoueri, ‘Arm’s Length: Beyond the Guidelines of the OECD’ (2015) 69 Bulletin for International Taxation 690.. The literature overview of the arm’s length principle, see Stefan Greil, ‘The Arm’s Length Principle in the 21st Century – Alive and Kicking?’ [2019] SSRN Electronic Journal <https://www.ssrn.com/abstract=3379092> accessed 14 November 2019.

9 The official website of the actions https://www.oecd.org/tax/beps/ 10 The term is first used by Edward D. Kleinbard. See Kleibard’s work has explored the idea of ‘Stateless income’ extensively especially from the perspective of USA Multinationals, Edward D Kleinbard, ‘The Lessons of Stateless Income’ (2011) 65 Tax Law Review 99.;Edward D Kleinbard, ‘Stateless Income’ 11 Florida Tax Review 699. although this concept is popular after the BEPS actions, from the historical archive, such concept had been existing. According to Jogarajan’s research, experts in 1920 have been aware this issue. ‘The possibility of profit-shifting and double non-taxation had already been recognized by the 1925 Experts almost 90 years ago.’ See Sunita Jogarajan, Double Taxation and the League of Nations (Cambridge University Press 2018).

11 BEPS Action 7 ‘Preventing the Artificial Avoidance of Permanent Establishment Status’, reports and guidance see https://www.oecd.org/tax/beps/beps-actions/action7/ 12 Reflections on the Arm’s length principle, see J Scott Wilkie, ‘Reflecting on the ‘Arm’s Length Principle’: What Is the ‘Principle’? Where Next?’, Fundamentals of International Transfer Pricing in Law and Economics (Springer 2012).; Schoueri (n 8).

13 Niazi, Shafi U. Khan. ‘Re-Launch of the Proposal for a Common Consolidated Corporate Tax Base (CCCTB) in the EU: A Shift in Paradigm.’ Legal Issues of Economic Integration 44.3 (2017): 293-314.

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id-dritt market, eliminating tax law obstacles due to disparities of individual national tax law in EU Member States, and making the EU more business-friendly.14 In the current CCCTB Directive Proposal, there is a specific provision addressing the shipping and airline industry, which excludes these industries from the application of the Directive. The research question of this paper is to analyze the background, the rationale, and the appropriateness of this provision. The research method used is to study and compare approaches used to allocate taxing rights in the transportation industry, in the field of international tax regimes, including OECD, UN and US tax model conventions, as well as some national examples. This paper further analyzes the US State taxation rules that the CCCTB project largely transplants from. Such research method is corresponding to the functional approach in the comparative legal research discipline15, but the author does not choose the precise comparable jurisdictions, because the CCCTB is an EU tax reform effort and the author would like to seek a more comprehensive conceptual framework.

The paper is structured as follows. Section 1 is an introduction to the topic at hand. Section 2 elaborates the theatrical framework of the international tax reform (BEPS), the CCCTB as one of EU’s responses, and the specific issues in the transportation industry. Section 3 discussed further the provisions of allocating taxing rights of the transportation industry in the CCCTB Directive Proposal, the OECD tax model convention, the UN tax model convention and US tax model convention. Section 4 demonstrates variety and diversity of formula examples of the transportation industries in US State taxation.

Section 5 compares and reflects from these different approaches, extracts the lessons, and argues that CCCTB should made its own decision to adopt its own transportation industry formula.

14 See The preamble of the CCCTB Directive proposal, ‘Alongside the anti-tax avoidance function of the CCCTB, the re-launched project would also retain its features as a corporate tax system which facilitates cross-border trade and investment in the internal market. ‘ available at https://ec.europa.eu/taxation_customs/sites/taxation/files/com_2016_683_en.pdf 15 Reuven Avi-Yonah, Nicola Sartori and Omri Marian, Global Perspectives on Income Taxation Law (Oxford University Press 2011) <http://www.oxfordscholarship.com/view/10.1093/ acprof:oso/9780195321357.001.0001/acprof-9780195321357> accessed 14 November 2019.,p.4.; Carlo Garbarino, ‘An Evolutionary Approach to Comparative Taxation: Theory, Methods and Agenda for Research’ [2008] SSRN Electronic Journal <http://www.ssrn.com/abstract=1116686> accessed 14 November 2019. Grabarino esepcially mentions CCCTB as an example that the CCCTB Directive extracted the common function of the group taxation systems of different Member States.

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2. The Theoretical Framework of Addressing The Base Erosion And Profit Shifting (BEPS) Problems in the Transportation Industry 2.1 International Tax Reform Effort: Base Erosion and Profit Shifting Action Plans The necessity to conduct the international tax reform is obvious. As indicated above, the current international tax regimes and practices that have been developed since the early 20th century16 are now being heavily criticised for failing to levy corporate tax from giant multinational taxpayers ‘fairly’ in the current globalised and digitalised world.17 Such failure is systematic, due to incoordination, complexity and various mismatches of the current system, as well as the rapid development of technology and digital economy. Since 2013, OECD has been working on the BEPS project, i.e. tax reform campaign especially on multinational enterprise (MNE) taxpayers to address the systematic failures of the international tax regime.

There are 15 action plans in the BEPS project.18 It reviews the most wellknown structural problems of the international tax regime and proposes practical suggestions. Since 2013, the BEPS project has been the center of international tax debates and cooperation and it is an ongoing project.19 Amongst these 15 actions, it pursues three policy goals: coherence, substance, and transparency. Coherence refers to actions eliminating problems definition or tax law disparities; substance refers to abuse of treaty provisions or the taxable nexus threshold (permanent establishment); transparency refers to multilateral procedures that can facilitate disputes resolution and information exchange for tax authorities. All these actions are mainly triggered by today’s digital economy. As to the administrative cooperation, Action 15 has created the Multilateral Convention to Implement 16 The early history of the international tax regime (and critical remarks), see Michael J Graetz, ‘The David R. Tillinghast Lecture Taxing International Income: Inadequate Principles, Outdated Concepts, and Unsatisfactory Policies’ (2000) 54 Tax L. Rev. 261.”plainCitation”:”Michael J Graetz, ‘The David R. Tillinghast Lecture Taxing International Income: Inadequate Principles, Outdated Concepts, and Unsatisfactory Policies’ (2000 17 Steven A Bank, ‘The Globalization of Corporate Tax Reform’ (2012) 40 Pepp. L. Rev. 1307.

18 An introduction of the BEPS project, see Yariv Brauner, ‘What the BEPS?’ (2014) 16 Florida Tax Review.

19 The BEPS Actions Reports since 2013 are available at <https://www.oecd.org/ctp/ beps-reports.htm>

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Tax Treaty Related Measures to Prevent Base Erosion and Profit Shifting (MLI).20 Although there are still criticisms and sceptical remarks on the BEPS project as well as resistance to the reform, it is undeniable that the BEPS project has initiated a comprehensive reform. Although such reform project appears to be triggered by ‘digital economy’, this reform is not limited to such economy.

Figure 1: Base Erosion and Profit Shifting Overview Source: OECD website 2014 (the number refers to the specific action)

20 The official website of MLI, <https://www.oecd.org/tax/treaties/multilateral-convention-to-implement-tax-treaty-related-measures-to-prevent-beps.htm>. The signatory SStates are continuously increasing until 2019/10/30.

The history of a multilateral tax treaty, see DM Broekhuijsen, A Multilateral Tax Treaty: Designing an Instrument to Modernise International Tax Law (Kluwer Law International BV 2018).; criticism on the MLI for still being complex and uncertain, David Kleist, ‘The Multilateral Convention to Implement Tax Treaty Related Measures to Prevent BEPS—Some Thoughts on Complexity and Uncertainty’ (2018) 2018 Nordic Tax Journal 31.

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2.2 The EU’s Corporate Tax Reform in Response to BEPS: Common Consolidated Corporate Tax Base Directive Proposal To understand and analyse the CCCTB Directive Proposal and its development21, it is necessary to understand the CCCTB Directive Proposal in a broad context. The context involves failures of the current international tax regime as ‘Base Erosion and Profit Shifting (BEPS)’ recognised by OECD, as well as the EU internal market.22 In brief, CCCTB is the EU’s tax reform response23 to the failures of the current international tax regime and the BEPS campaign since 2013. The consensus to address BEPS problems has become also part of in the development context of the CCCTB.24 By a metaphor of ‘a pie and a knife’, a multinational enterprise (MNE) group active in different EU Member States can file their harmonised consolidated tax base from all qualifying group members from different EU Member States, and such consolidated tax base resembles a big pie, jointly contributed to by all group members; and the formula resembles a knife to divide the share/a piece of the pie which is apportioned to each group member. Intra-group transactions are regarded as ‘fiscally non-existent’/eliminated. Profits and losses from all group members are offset with each other.25 Therefore, each group member’s apportioned share of the taxable pie of the whole group would be calculated as: The consolidated tax base× ( (1/3 × (the member^’ ssales) / (group sales) + 1/3 × (the member^’ s assets) / (group assets) + 1/3 × (the member^’ s labour) / (group labour)) 21 Discussions prior to the 2011 version of CCCTB is released see Joann Martens Weiner, ‘Practical Aspects of Implementing Formulary Apportionment in the European Union’ (2006) 8 Fla. Tax Rev. 629.

22 Base Erosion and Profit Shifting problem is detrimental for EU Member States. Empirical data estimated that 40% of foreign profits are shifted to tax haven, and non-tax haven EU Member States are the ‘losers’ of BEPS scenarios. see Thomas R Tørsløv, Ludvig S Wier and Gabriel Zucman, ‘The Missing Profits of Nations’ (National Bureau of Economic Research 2018).

23 A short overview of EU’s responses to the BEPS until 2018, see the note deArnaud de Graaf and Klaas-Jan Visser, ‘BEPS: Will the Current Commitments and Peer Review Model Prove Effective?’ (2018) 27 EC Tax Review 36.

24 See the preamble of the 2016 CCCTB Directive Proposal.

25 The group loss-offsetting mechanism under the CCCTB, see Shu-Chien Chen, ‘The Strategy of Shifting-To-Losses: The Case of Common Consolidated Corporate Tax Base (CCCTB) in the European Union’ (2019) 2 UCPH Fiscal Relations Law Journal (FIRE Journal).

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Figure 2: The Common Consolidated Corporate Tax Base Directive Overview Source: The Author This Directive proposal uses a pre-determined ‘formula’ to apportion taxable income of MNE taxpayers. This legislative proposal is a tax reform effort at the EU level to provide all EU Member States a uniform consolidated (i.e. group) corporate tax base and a formula to divide their taxing powers on multinational enterprise (MNE) taxpayers’ income. It would replace the bilateral tax treaties between these EU Member States when being adopted.

It should be noted that, although EU has more than 50 years history, 256

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corporate taxation is still rarely harmonised by EU legislations. When the CCCTB Directive Proposal is adopted unanimously by EU Member States, it would be a milestone also for the development of EU law as a whole.

The approach that the CCCTB adopts is the so-called formulary apportionment (FA). Such approach has been widely used in State taxation in the US26 as well as Germany and Switzerland27. Formulary apportionment has several distinctive features from the traditional tax regime. For one, the FA approach does not pursue the ideal result of the ‘arm’s length principle’ (ALP), when allocating the taxing rights on income earned from MNE taxpayer groups as if these subsidiaries in a multinational group are independent from each other. The ALP now has been criticised for being deviated from economic reality, but the BEPS action plan still includes the ALP as its principle, though the essence of the ALP has been changed.

Another feature of the FA system is that it does not follow the residence versus source dichotomy in the traditional international tax law regime. In the classic international tax regime, implemented by the OECD Model Convention, different types of income follow different allocation rules, either to the residence State or to the source State. It is an all-or-nothing rationale, and the State instead adopts a very broad sense ‘source’ concept28, and does not focus on ‘residence’ anymore, but focuses on weighting factors in the formula.

2.3 The International Tax regime and the Transpiration Industry: The place of effective management (POEM) has advantages as well as weaknesses Regarding taxation on income earned by international shipping and air transportation, the OECD Model Convention Article 8 provides that the exclusive taxing right is allocated to the jurisdiction where the taxpayer’s 26 Peggy B Musgrave, ‘Interjurisdictional Equity in Company Taxation: Principles and Applications to the European Union’ (2000) 2000 Taxing Capital Income in the European Union: Issues and Options for Reform, Oxford 46.; Peggy B Musgrave, ‘Principles for Dividing the State Corporate Tax Base’, The State Corporation Income Tax: Issues in Worldwide Unitary Combination, vol 1984 (Stanford 1984).

27 Stefan Mayer, Formulary Apportionment for the Internal Market, vol 17 (IBFD 2009).., Chapter 3.

28 For a formulary apportionment supporter, ‘all States’ can be source. See John A Swain and Walter Hellerstein, ‘State Jurisdiction to Tax Nowhere Activity’ (2013) 33 Va. Tax Rev. 209., at p.267.

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place of effective management (POEM) takes place. The more detailed provisions are elaborated and discussed in Section 3.2.

Since BEPS problems concern multinationals, including the transportation industry, the OECD has also issued a public consultation to address and reform the old rules on allocating taxing rights on international traffic.29 Transportation industries, including land, shipping, and aviation industries have an inherent mobile nature, and have a long history as the development of international tax law.30 In fact, BEPS problems are not new to the transpiration industry. In fact, due to the inherent mobile feature of transportation activities31 and specific maritime law practice such as flag of convenience, tax planning issues are already detected for the transpiration.32 One scholar observes that nontaxation of shipping industry in the international level is as problematic as the shifting of intangibles.33 This is because, from the current international tax regime, it is quite easy to divide the transportation activities and ‘the place of management’ or ‘residence’ of a transportation corporate group. To adopt a formal criterion, such as POEM or residence, has become an invitation for a multinational taxpayer to conduct aggressive tax planning, and it is also contrary to the value creation alignment.

However, even the tax reform advocates do not propose an innovative solution to the BEPS problems in the transportation industry.34 For example, Avi-Yonah and Oz’s proposal to the OECD Model Convention Article 8 still 29 OECD, Proposed Changes To The OECD Model Tax Convention Dealing With The Operation Of Ships And Aircraft In International Traffic, Public discussion draft, 15 November 2013 – 15 January 2014 30 Guglielmo Maisto, ‘The History of Article 8 of the OECD Model Treaty on Taxation of Shipping and Air Transport’ (2003) 31 Intertax 232.

31 A. Hemmelrath & L. Marquardsen, Chapter 1: Direct Taxation of Air Transport Activities in Guglielmo Maisto, Taxation of Shipping and Air Transport in Domestic Law, EU Law and Tax Treaties (IBFD PUBLICATIONS BV 2016).

32 Sang Man Kim and Jingho Kim, ‘Flags of Convenience in the Context of the OECD BEPS Package’ (2018) 49 Journal of Maritime Law & Commerce.; The tax planning data from Japanese multinationals of the shipping industry by using the flag of convenience (FOC), see Ryo Izawa, ‘Who, Me? Tax Planning and Japanese Multinational Enterprises, 1887–2019’..

33 Richard J Vann, ‘Current Trends in Balancing Residence and Source Taxation’ [2015] Current Trends in Balancing Residence and Source Taxation (December 14, 2014). BRICS AND THE EMERGENCE OF INTERNATIONAL TAX COORDINATION, Y. Brauner, P. Pistone, eds, IBDF, The Netherlands.

34 Reuven S Avi-Yonah and Oz Halabi, ‘A Model Treaty for the Age of BEPS’ [2014] U of Michigan Public Law Research Paper 14.

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embraces the POEM criterion. Some scholars even mistakenly argue that BEPS actions apply only to Internet-based MNEs, and do not involve the traditional international transportation industry.35 It seems that many scholars are not willing to accept the fact that ‘the digital economy is no longer just a part of the economy, but is becoming the actual economy itself’.36 Digitalisation has made economic activities of MNE taxpayers more globally integrated, and also make it more difficult to allocate States’ taxing rights.

Such difficulty applies to all the industrial sectors.

Adopting the POEM criterion or the residence criterion does have the advantage of ‘simplicity’, because it is not necessary to worry about dividing taxing rights on transportation MNE groups with their various ticket offices or subsidiaries globally. However, such convenience will have the corresponding problem of disalignment of value creation or tax planning scenarios. This is directly contrary to the spirit of the BEPS actions.

In the following Section 3, I will introduce the CCCTB as well as tax model conventions of the current international tax regime, focusing on the international transportation industry. While analysing these provisions, it is important to bear in mind that the popular POEM criterion is still quite formalistic, even though its name implies a ‘substantial’ element.

3. Transportation Industry in the Cross-Border Tax Regime: Mobility as the Inherent Difficulty in Allocating Taxing Rights 3.1 The CCCTB Directive Proposal: Carving Out the Transportation Industry It should be noted that the CCCTB Directive Proposal aims to harmonise the ‘corporate tax base’ of EU Member States, and therefore, it excludes some special tax regimes from application. As to the transportation industry, such special tax regime often refers to ‘tonnage tax’.37 However, not every EU 35 Kim and Kim (n 32).

36 This quote is from the keynote speech of Rita de la Feria in May 2017 at EESC, see <https://www.eesc.europa.eu/en/news-media/press-releases/eu-tax-rules-are-not-currently-prepared-digital-economy> 37 CCCTB Directive, Article 2(4).

See also Ton Stevens, Taxation of Shipping Transport Activities (Including Tonnage Tax Systems), in Maisto, Taxation of Shipping and Air Transport in Domestic Law, EU Law and Tax

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Member State adopts a tonnage tax system, and not every shipping company is subject to such tonnage tax system. As long as a company is still subject to national corporate tax of an EU Member State, it is still subject to the CCCTB Directive, regardless of whether it forms part of a shipping industry or not. Therefore, the following discussions will not address the issues of the tonnage tax system, but the more fundamental question of ‘how to allocate taxing rights of income earned from the transportation industry’.

As for shipping, inland waterways and air transport industries, Article 4338 provides a special formula. Article 43 provides:

3.1.1 Shipping, inland waterways transport and air transport The revenues, expenses and other deductible items of a group member whose principal business is the operation of ships or aircraft in international traffic or the operation of boats engaged in inland waterways transport shall be excluded from the consolidated tax base and not be apportioned in accordance with the rules laid down in Article 28. Instead, those revenues, expenses and other deductible items shall be attributed to that group member on a transaction-by-transaction basis and be subject to adjustments for pricing in accordance with Article 56 of Directive 2016/xx/EU. Participations in and by the group member shall be taken into account for Treaties (n 31).; Dennis Weber and Tonnage tax and EU law, in ibid.

38 It is comparable to Article 101 of 2011 CCCTB Directive Proposal: ‘‘The revenues, expenses and other deductible items of a group member whose principal business is the operation of ships or aircraft in international traffic or the operation of boats engaged in inland waterways transport shall not be apportioned according to the formula referred to in Article 86 but shall be attributed to that group member. Such a group member shall be excluded from the calculation of the apportionment formula’.’

Article 101 of 2011 CCCTB Directive Proposal has quite comprehensive different official language versions, including Maltese: ‘‘Artikolu 101 Tbaħħir, trasport bil-mogħdijiet interni tal-ilma u trasport bl-ajru Id-dħul, l-ispejjeż u elementi deduċibbli oħra ta’ membru ta’ grupp li n-negozju prinċipali tiegħu jkun it-tħaddim ta’ vapuri jew inġenji tal-ajru fit-traffiku internazzjonali jew it-tħaddim ta’ dgħajjes involuti fit-trasport bil-mogħdijiet interni tal-ilma, għandhom jitqassmu skont il- formula msemmija fl-Artikolu 86 iżda għandhom jiġu attribwiti lil dak il-membru tal-grupp. Tali membru tal-grupp għandu jiġi eskluż mill-kalkolazzjoni tal-formula tat-tqassim.’’

Avialble at <https://eur-lex.europa.eu/legal-content/MT/TXT/PDF/?uri=CELEX:52011PC0121&from=EN>

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the purpose of determining whether there is a group as referred to in Articles 5 and 6.

As to the subjective scope, Article 43 applies to three industries: sea transportation; inland waterways transportation; and air transportation.

Although the term ‘shipping’ or ‘operation of ships’ seems to have a broad definition, Article 43 refers to the water ‘transportation’ industry only. This interpretation can be more clearly found in the Dutch39 and French40 versions of Article 101 of the the 2011 CCCTB Directive. Only sea transportation, inland waterway transportation, and air transportation industries are in the scope of Article 43.

Article 43 excludes the application of a standard formula from the taxable income earned by a group member whose principal business is sea, inland waterways transportation, or air transportation. In other words, if a CCCTB group consists of members conducting these water transportation activities as well as others, the group can only calculate the sharing formula based on group members not conducting sea, inland waterways, or air transportation activities. As for tax base from group members conducting these transportation activities, the tax base will neither be consolidated nor subject to the apportionment formula.

The underlying reason or explanation of Article 43 was missing in the CCCTB working documents prior to 2011. CCCTB Working Document No. 60 does not even mention ‘inland waterways transportation’ nor ‘shipping’ as a type of special industry, but mentions merely the airline and ‘railway’ industry. However, in the end the railway industry is left out in the current text of Article 101.

39 The Dutch version of Article 101 of the CCCTB Directive: ‘Artikel 101 Zeescheepvaart, binnenscheepvaart en luchtvaart De opbrengsten, kosten en andere aftrekbare posten van een groepsmaatschappij waarvan het hoofdbedrijf bestaat in de exploitatie van schepen of luchtvaartuigen in internationaal verkeer of in de exploitatie van binnenschepen worden niet verdeeld volgens de formule van artikel 86 maar toegerekend aan die groepsmaatschappij. Een dergelijke groepsmaatschappij wordt uitgesloten van de berekening van de toerekening.’

40 The French version of Article 101 of the CCCTB Directive: ‘Article 101 Transport maritime, transport fluvial et transport aérien Les produits, charges et autres éléments déductibles d’un membre du groupe dont l’activité principale consiste en l’exploitation de navires ou d’aéronefs aux fins du trafic international ou en l’exploitation de navires dans le cadre du transport fluvial ne sont pas répartis conformément à la formule visée à l’article 86 mais sont attribués à ce membre du groupe. Le membre du groupe concerné est exclu du calcul de la répartition.’

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In order to understand Article 43, it is necessary to read legislative history and discussions regarding Article 101 of the 2011 CCCTB Directive. In the 2012 Commission CCCTB room document,41 the Commission explains the rationale of the special formula for shipping, inland waterways transport and air transport:

3.1.2 ‘Shipping, inland waterways transport and air transport A group member whose principal business is the operation of ships or aircraft in international traffic or the operation of boats engaged in inland waterways transport shall be excluded from the calculation of the apportionment formula.

The revenues, expenses and other deductible items shall be attributed to the group member instead. The provision is drafted in the lines of Article 8 of the OECD Model Double Tax Convention according to which the profits of these activities are taxable only in the Contracting State in which the place of effective management of the enterprise is situated. The shipping or air transport companies shall continue to be group members but do not consolidate their revenues with the other group members. Article 101 (of the 2011 CCCTB Directive) shall be read in conjunction with Articles 59, 78 and 79 (of the 2011 CCCTB Directive), as the revenues of these companies shall be determined on an arm’s length basis.’

Despite the explanation provided in 2012, there are unclear points. First, it is not clear how ‘the shipping or air transport companies shall continue to be group members but do not consolidate their revenues’. The 2012 Commission CCCTB room document reaffirms that ‘the international air and sea companies are still part of the group.’ Thus, via systematic interpretation of the CCCTB Directive, these transportation industry companies should still form part of the CCCTB group. It seems that the legal consequence of being part of the CCCTB group is to preclude tax treaty applications. Since these international air and sea companies still form the CCCTB group, the CCCTB Directive still applies, and national tax rules or tax treaties are not applicable.

Secondly, the method of calculating the consolidation tax base of a consolidation group containing the transportation industry group member 41 Commission Services, ROOM DOCUMENT #2, Working Party on Tax Questions – Direct Taxation, 28 September 2012, not published, requested from the Council Register for Access for the documents.

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is not clear. As Simonis sharply asks,42 should the loss offsetting rules for the group still apply to these transportation group members? According to the Commission’s 2012 room document, the consolidation rules should not apply, and the revenue earned by these companies or losses generated by them, will not be consolidated with other group members either.

Thirdly, it is unclear whether intra-group transactions between the transportation industry group members and another non-transportation industry group member should also be regarded as eliminated or not. These special group members are still part of the group, although their taxable incomes are not consolidated for the purpose of calculating other non-air or non-water shipping industry group members’ apportioned tax base. In this regard, the Commission’s 2012 explanation clarifies that Article 101 (of the 2011 CCCTB Directive) should be read in conjunction with Article 59, Article 78, and Article 79 (of the 2011 CCCTB Directive). That is to say, within a subgroup of non-transportation companies, intra-group transactions are regarded as eliminated. As to transactions between non-transportation companies and transportation companies, these transactions should be calculated and adjusted according to the arm’s length principle (see Article 78 and Article 79 of the 2011 CCCTB Directive, comparable to the current Article 56 and Article 57 of the 2016 CCCTB Directive). The arm’s length principle will only apply to the transactions between transportation group members with the non-transportation group members.

In other words, the intra-group transactions are still regarded as nonexistent for transactions between non-transportation group members, whereas the transfer pricing rules regarding associated enterprises should apply to the transactions between transportation group members and nontransportation group members. It seems an illogical Statement because Article 59 of the 2011 CCCTB Directive has an inherent contradictory rationale with Article 78 and Article 79 of the 2011 CCCTB Directive. Article 59 regards intra-group transactions as invisible, whereas Article 78 and Article 79 refer back to the traditional transfer pricing rules. The only logical way to interpret the Commission’s 2012 explanation is not to treat the non-transportation group members in a consolidated sub-group, but treat the transportation group members as ‘separate entities’ for the purpose of consolidation and apportionment. The transactions in the sub-group of non-transportation 42 P. Simonis’ Commentary to the Common Consolidated Corporate Tax Base, in D WEBER, Proposal for a Council Directive on a Common Consolidated Corporate Tax Base (CCCTB)– Comments’ (2011) 4 Highlights and Insights on European Taxation, 5. June 2011, p. 68.

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group members are regarded as non-existent, but the transactions between the of non-transportation group members and the transportation group members should be subject to the arm’s length principle. The text of the new Article 42 is also consistent with this interpretation approach.

Last but not least, it should be noted that Article 43, i.e. the formula for shipping companies, does not apply to shipping companies under the special tonnage tax regime, according to Article 2(4) of the 2016 CCCTB Directive.

Furthermore, Article 43 is based on the OECD Model Convention’s Article 8, which does not include the tonnage tax.43 The 2012 Commission CCCTB room document affirms this perspective.44 The relation between Article 43 and other Articles of the CCCTB Directive can be illustrated as follows. An airline or water transportation group needs to follow different articles of the CCCTB Directive. According to Article 43, there will be a sub-group of all non-transportation subsidiaries which are subject to the sharing formula, and the tax base of the transportation member does not form part of the consolidated tax base, nor is it subject to the sharing formula. The transactions between the transportation group members and the non-transportation group member are not ‘intra-group transactions’, and need to be consistent with the arm’s length principle. In other words, the carving-out approach will create a sub-group with a group. Such approach might result in more complexities instead of the expected simplification by carving-out.

3.2 Developments of Taxing the Transportation Industry’s CrossBorder Activities: Puzzles of Formula versus ‘POEM’/Residence 3.2.1 OECD Model Convention Article 8 The transportation industry, including air transportation, shipping and land transport, enjoys the features of ‘remoteness’ and ‘mobility’. Therefore, the transportation industry is a typical and classical example of taxing cross43 See Guglielmo Maisto, ‘Article 8: International Transport and Other Operations’, Global Tax Treaty Commentaries (IBFD 2015).

44 The Commission Services, Room Document #2, Working Party on Tax Questions Direct Taxation, 28 September 2012, Proposal for a CCCTB Chapter XVI-Apportionment of the consolidated tax base, not published, requested from the Council Register of Access for the document.

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border activities. Tax authorities are also facing challenges of taxing MNE of the international transportation industry due to the increased frequency of cross-border transportation activities and multiple jurisdictions involved.45 Since this whole section asks the question “what rules are suitable for a transportation industry formula under the CCCTB?”, it is necessary to revisit the experiences in US taxation. I will first explore the relevant discussions in the field of international tax law and the ‘tonnage tax’, which is also a special type of tax for the shipping industry.

As indicated above, in the field of international tax law, the method of allocating international transportation income has been decided in Article 8 of the OECD Model Convention as well as Article 8 of the UN Model Convention.46 They adopt the same criterion of the ‘place of effective management’ (POEM) for the taxation of profits from maritime and air activities for a bilateral tax treaty. The POEM criterion grants the exclusive taxing right to the State where effective management takes place.47 Article 8 of OECD Model Convention48 reads, Article 8 International Shipping And Air Transport 1. Profits of an enterprise of a Contracting State from the operation of ships or aircraft in international traffic shall be taxable only in that State.

2. The provisions of paragraph 1 shall also apply to profits from the participation in a pool, a joint business or an international operating agency.

Setting aside the difficult question of where effective management takes place, it should be noted that the POEM criterion is an all-or-nothing approach, as like a typical tax treaty provision: only one State is granted/ 45 A. Hemmelrath & L. Marquardsen, Chapter 1: Direct Taxation of Air Transport Activities in Maisto, Taxation of Shipping and Air Transport in Domestic Law, EU Law and Tax Treaties (n 31).

46 I. Richelle, Chapter 6: Place of Effective Management versus Residence in ibid.

47 The overview of different ways of allocating taxing rights on international shipping industry, see Tatiana Falcão, ‘Taxing Carbon Emissions from International Shipping’ (2019) 47 Intertax 832.

48 The latest version of the OECD Model Convention, see <https://www.oecd.org/ctp/ treaties/articles-model-tax-convention-2017.pdf>

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assigned the taxing power, and there is no possibility of ‘sharing or apportioning’ by the POEM criterion. The POEM has its historical reasons49 for administrative convenience (i.e. needing not check the existence of a permanent establishment and avoiding technical difficulties50), but inevitably leads to possible non-taxation in the POEM State in some circumstances, such as in case of the tonnage tax system.51 In 2013, OECD experts suggested that POEM should be replaced by the residence State, but such suggestion might still face the risk that taxpayers choose a residence State merely as a registration State, and completely disconnect the possible source of transportation activities income. It seems that international tax law would continuously adopt the POEM or the residence rule in attributing international transportation income. Furthermore, the OECD Model Convention only covers air transpiration and water transpiration, not land transportation. There is no specific explanation regarding this omission in the OECD Model Article 8, but some national treaties have extended to transport by road vehicle or railway.52

3.2.2 UN Tax Model Convention Article 8 While the OECD Model Convention mainly represents developed countries’ perspective, the UN Tax Model Convention represents developing countries’ interests. The latter convention is also based on the consensus of the international tax regime, including the overview, categories of income, and other basic assumptions (such as residence versus source and the all49 This POEM approach can be traced back to 1925, but at that time experts also admitted that this is a mere compromise. Historical and archive analysis, see Jogarajan (n 10). , P.144 50 G.W. Kofler, Chapter 7: Article 8 OECD Model: Time for a Change? in Maisto, Taxation of Shipping and Air Transport in Domestic Law, EU Law and Tax Treaties (n 31)., citing Double Taxation and Tax Evasion – Report and Resolutions Submitted by The Technical Experts to the Financial Committee of the League of Nations (Document F.212, February 7, 1925), p. 31. ‘When an industrial concern carries on its activities throughout the whole world, the importance of the actual headquarters, or the ‘brain’ of the enterprise, becomes paramount; and, above all, very serious technical difficulties may be encountered in determining an apportionment of the profits. The representatives of the Maritime Sub- Committee of the League of Nations have asked how it is possible to determine the profits earned in each of the twenty or twenty-five ports at which a vessel belonging to a trans-Atlantic company may have loaded or discharged cargo, when ten or fifteen different countries have to be taken into consideration.’

51 Ibid, Chapter 7: Article 8 OECD Model: Time for a Change? in ibid. , 7.2.3.

52 Ibid, at 7.3.3, these countries include Turkey, Bulgaria, Croatia, Russia and South Africa, Serbia, ibid, at footnote 84.

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or-nothing rationale indicated in introduction above).

Article 8 of the UN Model Convention provides two alternatives; Alternative A represents developed countries’ interest more; Alternative B represents developing countries. Since 2011, there have been several updates pertaining to Article 8. In the 2011 version, the main differences between the alternatives lay in paragraphs 1 and 2 of Article 8. The remaining paragraphs are Roughly the same.53 In 2017, the UN issued the latest versions of the Tax

53 Ibid, Commentary on Article 8, A. General considerations Table 1: UN Model Convention Article 8 shipping, inland waterways transport and air transport （2011） Article 8 (alternative A)

Article 8 (alternative B)

1. Profits from the operation of ships or aircraft in international traffic shall be taxable only in the Contracting State in which the place of effective management of the enterprise is situated.

1. Profits from the operation of aircraft in international traffic shall be taxable only in the Contracting State in which the place of effective management of the enterprise is situated.

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2. Profits from the operation of boats engaged in inland waterways transport shall be taxable only in the Contracting State in which the place of effective management of the enterprise is situated.

2. Profits from the operation of ships in international traffic shall be taxable only in the Contracting State in which the place of effective management of the enterprise is situated unless the shipping activities arising from such operation in the other Contracting State are more than casual.

If such activities are more than casual, such profits may be taxed in that other State.

The profits to be taxed in that other State shall be determined on the basis of an appropriate allocation of the overall net profits derived by the enterprise from its shipping operations. The tax computed in accordance with such allocation shall then be reduced by ___ per cent. (The percentage is to be established through bilateral negotiations.)

3. If the place of effective management of a shipping enterprise or of an inland waterways transport enterprise is aboard a ship or a boat, then it shall be deemed to be situated in the Contracting State in which the home harbour of the ship or boat is situated, or, if there is no such home harbour, in the Contracting State of which the operator of the ship or boat is a resident.

3. Profits from the operation of boats engaged in inland waterways transport shall be taxable only in the Contracting State in which the place of effective management of the enterprise is situated.

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Model Convention54 and Article 8: Alternative B is especially is worth discussion, and it is different from OECD

4. The provisions of paragraph 1 shall also apply to profits from the participation in a pool, a joint business or an international operating agency.

4. If the place of effective management of a shipping enterprise or of an inland waterways transport enterprise is aboard a ship or boat, then it shall be deemed to be situated in the Contracting State in which the home harbour of the ship or boat is situated, or if there is no such home harbour, in the Contracting State of which the operator of the ship or boat is a resident.

5.

The provisions of paragraphs 1 and 2 shall also apply to profits from the participation in a pool, a joint business or an international operating agency.

54 The full text of ‘United Nations Model Double Taxation Convention between Developed and Developing Countries’, available at <https://www.un.org/esa/ffd/wp-content/uploads/2018/05/MDT_2017.pdf > Table 2: UN Model Convention Article 8 shipping, inland waterways transport and air transport （2017）

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Model Convention Article 8.55 As Lennard indicated, ‘The background to

Article 8 (alternative A) 1.

2.

Article 8 (alternative B)

Profits of an enterprise of a Contracting State from the operation of ships or aircraft in international traffic shall be taxable only in that State.

The provisions of paragraph 1 shall also apply to profits from the participation in a pool, a joint business or an international operating agency.

1. Profits of an enterprise of a Contracting State from the operation of aircraft in international traffic shall be taxable only in that State.

2. Profits of an enterprise of a Contracting State from the operation of ships in international traffic shall be taxable only in that State unless the shipping activities arising from such operation in the other Contracting State are more than casual.

If such activities are more than casual, such profits may be taxed in that other State. The profits to be taxed in that other State shall be determined on the basis of an appropriate allocation of the overall net profits derived by the enter- prise from its shipping operations. The tax computed in accordance with such allocation shall then be reduced by ___ per cent.

(The per- centage is to be established through bilateral negotiations.)

3.

The provisions of paragraphs 1 and 2 shall also apply to profits from the participation in a pool, a joint business or an international operating agency.

55 Michael Lennard, ‘The UN Model Tax Convention as Compared with the OECD Model Tax Convention–Current Points of Difference and Recent Developments’ (2009) 29 Asia-Pacific Tax Bulletin 4.

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this alternative is that many developing countries lacked strong domestic shipping lines, and did not consider they should forego this revenue where the link to the economy was more than casual. The Commentary to the UN Model Convention explains that the phrase ‘more than casual’ means ‘a scheduled or planned visit of a ship to a particular country to pick up freight or passengers.’56 Therefore, Alternative B can sometimes be implemented as ‘freight tax’57, which focuses on transportation activities represented by freight, and not merely on the management of the shipping/airline companies. Although Alternative B is rarely used in practice58, it offers another justification to the allocation taxing rights on the transportation industry.

3.2.3 US Tax Model Convention Article 8 The US has their own model convention for them to negotiate their bilateral tax treaty, to represent their national interests.59 As to the structure and the basic assumptions, the US tax model convention resembles the OECD and UN tax model conventions.60 Article 8 61 paragraph 1 of US tax Model provides: 56 Ibid, p. 8.

57 International Chamber of Shipping (ICS), Comments on The United Nations Model Double Taxation Convention between Developed and Developing Countries, 2012, available and archived at UN website , <https://www.un.org/esa/ffd/wp-content/uploads/2014/09/8STM_ Letter-from-ICS-on-Article8-Transportation-ShippingAspects.pdf> 58 Alternative B is rarely used in practice, see Wim Wijnen and Jan de Goede, ‘The UN Model in Practice 1997-2013’ [2013] IBFD Bulletin for International Taxation., section 2.10.

59 For example, in response to OECD’s BEPS actions, in 2016 USA Model Convention released new measures ‘for the parties to unilaterally override the negotiated treaty rates in specified circumstances.’ See Allison Christians and Alexander Ezenagu, ‘Kill-Switches in the New US Model Tax Treaty’ (2016) 41 Brooklyn Journal of International Law. 60 For example, The comparison of early editions of USA and OECD Model Convention, Harry A Shannon III, ‘Comparison of the OECD and US Model Treaties for the Avoidance of Double Taxation’ (1986) 12 Int’l Tax J. 265.

61 This is based on the latest edition (in 2016) of USA tax model Convention. But the text of 2016 edition and 2006 edition are almost identical. It is not the change in 2016 edition.

Therefore, the technical explanation of Article 8 of USA tax model Convention is still valid, since IRS has not (yet) released the corresponding technical explanation for the 2016 tax model convention.

The full text of Article 8: ‘ 1. Profits of an enterprise of a Contracting State from the operation of ships or aircraft in international traffic shall be taxable only in that Contracting State 2. For purposes of this Article, profits from the operation of ships or aircraft include, but are not limited to: a) profits from the rental of ships or aircraft on a full (time or voyage) basis;

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Article 8 Shipping And Air Transport 1. Profits of an enterprise of a Contracting State from the operation of ships or aircraft in international traffic shall be taxable only in that Contracting State.

As Guglielmo observed, the US tax model convention, ‘unlike the OECD Model Treaty, the exclusive right to tax is granted to the State of the enterprise operating the aircraft or ship. The OECD criterion of the effective seat of management is disregarded because it is unknown in the US tax system’.62 According to the technical explanation, the US convention has a broader definition of ‘residence’ than the OECD Model Convention, and thus, the ‘place of effective management’ under the US convention would fall within the definition of ‘residence’.

Article 8 paragraph 1 explains how such exclusive taxing right works.63 Briefly speaking, the US convention heavily relies on the concept of a (broad) residence, and negates that ‘a ticket office’ could be a sufficient taxable nexus in a jurisdiction. Such interpretation by the US convention has been b) profits from the rental on a bareboat basis of ships or aircraft if the rental income is incidental to profits from the operation of ships or aircraft in international traffic; and c) profits from the rental on a bareboat basis of ships or aircraft if such ships or aircraft are operated in international traffic by the lessee.

Profits derived by an enterprise from the inland transport of property or passengers within either Contracting State shall be treated as profits from the operation of ships or aircraft in international traffic if such transport is undertaken as part of international traffic.

3. Profits of an enterprise of a Contracting State from the use, maintenance, or rental of containers (including trailers, barges, and related equipment for the transport of containers) shall be taxable only in that Contracting State, except to the extent that those containers are used for transport solely between places within the other Contracting State.

4. The provisions of paragraphs 1 and 3 of this Article shall also apply to profits from participation in a pool, a joint business, or an international operating agency.’

62 Guglielmo Maisto, ‘The’Shipping and Air Transport’Provision (Art. 8) in the Italy-USA Double Taxation Agreement’ (1995) 23 Intertax 146. ., at p.146 63 Ibid, explanation of Article 8: ‘Paragraph 1 provides that profits derived by an enterprise of a Contracting State from the operation in international traffic of ships or aircraft are taxable only in that Contracting State. Because paragraph 6 of Article 7 (Business Profits) defers to Article 8 with respect to shipping income, such income derived by a resident of one of the Contracting States may not be taxed in the other State even if the enterprise has a permanent establishment in that other State. Thus, if a U.S. airline has a ticket office in in the other State, that State may not tax the airline’s profits attributable to that office under Article 7. Since entities engaged in international transportation activities normally will have many permanent establishments in a number of countries, the rule avoids difficulties that would be encountered in attributing income to multiple permanent establishments if the income were covered by Article 7.’

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implemented in many bilateral tax treaties with the US. For example, the USItaly Income Tax Treaty (1995)64 as well as Article 8 of the US-Malta Income Tax Treaty (2008)65 both contain identical technical explanations.

3.2.4 The Preliminary Remarks From these three tax model conventions and their commentaries, we can observe that, no matter representing developed countries’ interest like OECD or developing countries’ interest like UN (until 2011) or US’s national interests, the provision that allocates taxing rights, is replying on the single criterion of ‘place of effective management’ (OECD and UN alternative A) or ‘residence’ (US). Such criterion is formalistic and interprets ‘operation’ of ships/aircraft, as the place where the head office/the seat of the enterprise taxpayer is located. Although such approach has a long history of practice, and it does have the advantage of ‘simplicity’ and ‘administrative convenience’, it is still just based on the fear of administrative burden and not based on a solid theory. It has an apparently not-so-logical feature of over-emphasising the management over the transportation activities.

At the end of the day, these tax model conventions still follow the ‘allor-nothing rationale’ to allocate taxing rights to ‘one single State’ among all involved States. Such approach might still be the accepted approach in these tax model conventions but keeping it in a formulary apportionment system, such as the CCCTB, would make the CCCTB reform even more complicated.

3.3 National Examples: Australia and Hong Kong Instead of adopting the ‘all-or-nothing’ attribution rule of POEM, or the residence rule in the international tax law regime discussed above, some common law jurisdictions, including Hong Kong66 and Australia, have 64 The full text and technical explanation of USA-Italy income tax treaty is available at <https://www.irs.gov/businesses/international-businesses/italy-tax-treaty-documents> Maisto, ‘The’Shipping and Air Transport’Provision (Art. 8) in the Italy-USA Double Taxation Agreement’ (n 62).

65 The full text of USA-Malta Income tax treaty is available at IRS <https://www.irs.gov/ businesses/international-businesses/malta-tax-treaty-documents> 66 Cap. 112 Inland Revenue Ordinance ─ Section 23B Ascertainment of the assessable

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developed their own formulary apportionment provision in the tax law applicable for transportation industries in some circumstances. These examples are the Maritime Formula and the Calcutta Formula. 67 Although the name ‘maritime formula’ refers to ‘maritime’, such formula is also applicable to aircraft transportation industry.

In Australia, for ‘non-treaty airlines… a non-treaty airline means an airline that is a resident of a country that does not have a tax treaty with Australia’.68 In Australia practice, when there is no tax treaty, Australia adopts its own source rule to limit its taxing rights on income of the airline industry, as follows: In Hong Kong, the national tax law adopts a source rule69 for assessable profits of a ship-owner carrying on business in Hong Kong. Such source rule is based on an assessed ratio of: (The Hong Kong aggregated profits) / (The worldwide aggregated Profits) As to the scope of ‘ship-owner carrying on business in Hong Kong’, it is defined as ‘(a) the business is normally controlled or managed in Hong Kong; or (b) the person is a company incorporated in Hong Kong.’70 In other words, Hong Kong tax law limits its own taxing right for the shipping industry by the ratio, even if the company is incorporated in Hong Kong; at the same time, it should be noted that Hong Kong’s most bilateral tax treaties follow the profits of a ship-owner carrying on business in Hong Kong, 23B(3): ‘Subject to subsections (4), (4AA) and (5) and section 26AB, where a person is deemed to be carrying on a business as an owner of ships in Hong Kong under subsection (1) or (2), as the case may be, the assessable profits of that person from that business for a year of assessment shall be the sum bearing the same ratio to the aggregate of the relevant sums earned by or accrued to that person during the basis period for that year of assessment as that person’s total shipping profits for the basis period bear to the aggregate of the total shipping income earned by or accrued to that person during that basis period for that year of assessment. (Amended 27 of 2018 s. 32)’ 67 International Air Transport Association (IATA), Guidelines For Taxation Of International Air Transport Profits, 2015, available at <https://www.iata.org/policy/Documents/taxation_intl_ air_transport%20profits_final.pdf> 68 Australian Government Australia Tax Office, Practice Statement Law Administration (General Administration), PS LA 2008/2 (GA), 2008 available at <https://www.ato.gov.au/law/ view/document?docid=PSR/GA20082/NAT/ATO/00001> 69 Cap. 112 Inland Revenue Ordinance ─ Section 23B Ascertainment of the assessable profits of a ship-owner carrying on business in Hong Kong, 23B(3); Falcão, T. (2019). Taxing Carbon Emissions from International Shipping. Intertax, 47(10), 832-851., footnote 55.

70 Cap. 112 Inland Revenue Ordinance ─ Section 23B(1).

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traditional international tax regime.71 Based on these actual examples, we can observe that a specific formulabased rule for the transportation industry not only has a long history in US State taxation (see Section 4) but also exists in a piece of tax legislation even in a non-FA jurisdiction as a practical technique to levy tax on inherently mobile income earned from this industry. Although the OECD Model Convention’s POEM criterion is still the starting point for many States, there are more practical approaches adopted in national tax laws that combine a formula or ratio to decide the taxing right on the shipping activities.

4. Formulary Apportionment Experience on The Transportation Industry in US State Taxation 4.1 An Overview of State Taxation Formula and Transportation Industry Formulas In US: Diversity with the Spatial or Time Dimension of Transportation As indicated in Section 3.1, the European Commission had been learning formulary apportionment experiences from State taxation in US while preparing the text of the CCCTB Directive Proposal. In other words, the CCCTB is a legal transplantation project from State taxation in US. Therefore, it is important to understand how the same legal problem is addressed.

It should be clarified that the following discussions in Section 4 are within the scope of State taxation of US, where federal income taxation is governed by Internal Revenue Code as well as State taxation being freely levied by each State, provided that such State taxation does not infringe the US Constitution’s provisions72. There are imputation rules between State corporate income taxation and federal income taxation, which are not within the scope of this paper. Furthermore, signing an international tax treaty is also within federal competence, and therefore the US tax model convention 71 For example, the Hong Kong-Malta income tax treaty Article 8 (1) is identical with the OECD Model Convention. The full text may be found at <https://iconfinancemalta.blob.core. windows.net/libx-127-public/Double%20Taxation%20Treaties/Hong%20Kong.pdf> 72 For the general overview of the corporate taxation in USA, see JG Rienstra, ‘United States-Corporate Taxation’ [2015] IBFD database–Country surveys..; Richard D Pomp, State & Local Taxation (RD Pomp 2015). chapter 10.; Walter Hellerstein and others, State and Local Taxation: Cases and Materials (Tenth edition, West Academic Publishing 2014). Chapter 1.

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is governed by the federation, and thus it will ensure consistency of the whole US regarding eliminating international double taxation.

As to State taxation in US, States have quite wide discretion, provided that a piece of State taxation does not infringe the federal constitution. One important provision of the federal constitution clause in US is the ‘Commerce’ Clause. The ultimate aim of the dormant Commerce Clause is to ensure that cross-border and domestic commerce have the same opportunities to flourish.73 For European readers, this is quite similar to the concept of internal market mandate under EU law.74 The Supreme Court of the US and Court of Justice of European Union have used them as similar approach to strike down unconstitutional State legislation.75 To pursue uniformity regarding levying tax on multistate business income, in 1957, the Uniform Division of Income for Tax Purposes Act (UDITPA) was adopted. UDITPA apportions the ‘business income’ according to a three-equal-weighted factor: property, payroll, and sales.76 UDITPA is a uniform act in the US that States77 can voluntarily join for the purpose of pursuing uniformity.78 In addition to UDITPA, other stakeholders also work on 73 See the commentary, Michael S Knoll and Ruth Mason, ‘The Economic Foundation of the Dormant Commerce Clause’ [2017] Virginia Law Review 309. The dormant commerce clause does not address the double taxation issue but has the mandate to ensure cross-border activities are not discriminated against by protectionist State legislation.

74 Scholars have seen the comparable function of the internal market mandate in the EU law and the commerce clause in USA. See for example, Georg Haibach, ‘The Interpretation of Article 30 of the EC Treaty and the ‘Dormant’ Commerce Clause by the European Court of Justice and the US Supreme Court’ (1999) 48 International & Comparative Law Quarterly 155. , pp. 155-167; Although the internal market is the European counterpart of the commerce clause, there are still differences, see Klaudia Galka, ‘Borderless Market Legislation Practice in EU and USA: Competence of Central Authorities in the Federal Model’ (2013) 4 MaRBLe <http://openjournals.maastrichtuniversity.nl/Marble/article/view/168> accessed 18 November 2019.

75 USA Supreme Court seems more lenient to States than CJEU while invoking the Commerce Clause, though, see Reuven S Avi-Yonah, ‘Federalism and the Commerce Clause: A Comparative Perspective’, The State and Local Tax Lawyer. Symposium Edition (JSTOR 2007).

76 Such three-factor formula is so-called the ‘Massachusetts formula’, Joann M Weiner, ‘Using the Experience in the US States to Evaluate Issues in Implementing Formula Apportionment at the International Level’ (1999) 83 OTA paper., at p.10.

77 The States joining the UDITPA can be found in Uniform Law Commission’s website.

The enacting States are Alabama, Alaska, Arizona, Arkansas, California, Colorado, District of Columbia, Hawaii, Idaho, Kansas, Kentucky, Maine, Michigan, Minnesota, Missouri, Montana, New Mexico, North Dakota, Oregon, Pennsylvania, South Dakota, Texas, Utah, and Washington. See for more information:http://www.uniformlaws.org/LegislativeFactSheet.aspx?title=Division%20 of%20Income%20for%20Tax%20Purposes.

78 For the history and reform process of UDITPA, see Joe Huddleston and Shirley Sicilian, MultiState Tax Commission, The Project To Revise UDITPA, 2009, published at http://www.

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pursuing uniformity in the division of multiState taxable income. In 1967, a group of State tax administrators presented States ‘Multistate Tax Compact’, which copies UDITPA and establishes an inter-State agency ‘Multistate Tax Commission’ (MTC).79 For European readers, it is easier to understand MTC as a type of intergovernmental organisation like the OECD, not a supranational organisation like the European Union. Just like the OECD, MTC does have great de facto influence in States in US. MTC, as an intergovernmental State tax agency based on the Multistate Tax Compact80, issues soft laws for these States. Regarding the sharing formula, the MTC has recommended formulas for general corporations and corporations from specific industries. These recommendations are soft laws, but are developed by tax experts sent from all States. Therefore, States’ legislators and tax authorities would quite often follow these recommendations. A lower court in California even admitted the priority of Multistate Tax Compact as a legal source, even higher than the States’ enacted tax law, though not upheld by the higher court.81 Multistate Tax Commission lays down various detailed recommendations in the form of model regulations or model statutes on issues in State taxation.

It is expected that the States will adopt MTC recommendations voluntarily and the phenomenon of path dependency will happen, and thus the States’ taxation will gradually converge and achieve uniformity. Since UDITPA/ mtc.gov/uploadedFiles/MultiState_Tax_Commission/Uniformity/Minutes/The%20Project%20 to%20Revise%20UDITPA.pdf. See also the more extensive version of the above-mentioned report, JOE B HUDDLESTON and SHIRLEY K SICILIAN, ‘Should UDITPA Be Revisited?’, The State and Local Tax Lawyer. Symposium Edition (JSTOR 2009).

79 See their official website of MultiState Tax Commission: http://www.mtc.gov. Not only public servants, but also practitioners from American Bar Association (ABA), actively engage in MultiState Tax Commission’s work, see Philip M Tatarowicz, ‘A History of the State and Local Taxes Committee and Its Most Recent Quarter Century of Work’ (2014) 68 Tax Law. 595.

80 As to the constitutional status of MultiState Tax Compact, see Robert M White, ‘The Constitutionality of the MultiState Tax Compact’ (1976) 29 Vand. L. Rev. 453. Natasha N Varyani, ‘A Contract Among States: Capturing Income of the World’s Multijurisdictional Taxpayers’ (2016) 1 U. Bologna L. Rev. 219.

81 The California case, Gillette Co. v. Franchise Tax Board 62 Cal. 4th 468 (2015), the Court of appeal reversed the trial court and ruled that California may not unilaterally change repudiate mandatory terms of the Compact. The California Supreme court reversed again the Court of Appeal’s ruling and ruled that MultiState Tax Compact is not reciprocal binding to States and MultiState Tax Commission’s regulations are advisory only, California legislation can preclude MultiState Tax Compact’s specific rule.

Michigan court of appeals adjudicated on the same issue and concludes that MultiState Tax Compact is not binding to Michigan State legislation, see John A Biek, ‘Alternative Formulary Apportionment Under the MultiState Tax Compact’ (2013) 16 J. Passthrough Entities 41.

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Multi-state Tax Compact are soft laws82 and are not self-executing, States’ formulary apportionment rules are still in great variety.83 MTC and UDITPA are model laws, i.e. soft laws, and States are free to enact them into their State tax legislation. Therefore, as to the State income tax apportionment, not every State enacts UDITPA or MTC, and the States may have similar but different provisions that have the same functions.

Since the 1980’s, there has been a trend of adopting the single/double weighted sales factor formula as its standard formula for levying multistate corporate tax.84 The main assumptions of the single sales factor formula are the such formula would be a ‘built-in’ incentive to attract in-State investments and administrative simplicity,85 because States assume that MNEs would be more motivated to increase their in-State labour or assets within the State .The economic effect of such built-in incentive has been criticised by more 82 Although it has been accepted that MultiState Tax Compact is only the model law for the participating member States, the taxpayers have started to claim their rights to choose the formula provided by MultiState Tax Compact, even if such a formula is not provided by the State law. Therefore, it is disputed whether MultiState Tax Compact is also a valid legal source for taxpayers. In California, the Gillette case deals with this issue. The California Court of Appeal affirms the taxpayer’s right to elect the MultiState Tax Compact, even if California law does not, but the California Supreme Court rejects the MultiState Tax Compact as a reciprocal binding agreement between States, so taxpayers cannot claim rights based on it. For the California Supreme Court ruling, see The Gillette Company, et. al. v. California Franchise Tax Board, Case No. S206587 (Cal. 2015).

83 For the history and problems of adopting UDITPA, see James Smith, ‘UDITPA Turns 50’ (2006) 25 J. St. Tax’n 13.. Smith mentions the serious problem of nowhere sales in combination with a heavily weighted/single sales factor formula and the importance that the States adopt a uniform rule.

84 The overview of States adopting the single sales fator formula, see TA Pereira, International Aspects of the CCCTB in Europe (Maastricht University 2014).; Mayer (n 27).at 3.2.5.1. a survey Federal Tax Administration, until 2018/01/01 https://www.taxadmin.org/assets/docs/ Research/Rates/apport.pdf; Jerome R Hellerstein and Walter Hellerstein, State Taxation (3rd ed, Thomson Reuters/Tax & Accounting 2015).at 9.2; Mark L Nachbar and Brian L Browdy, ‘The Single Sales Factor Apportionment Method Origins and Development’ (2008) 27 J. St. Tax’n 31.

85 Most supporters of the single sales factor cited the empirical data and interpretation from Austan Goolsbee and Edward L Maydew, ‘Coveting Thy Neighbor’s Manufacturing: The Dilemma of State Income Apportionment’ (2000) 75 Journal of Public economics 125. ; Austan Goolsbee and Edward L Maydew, ‘The Economic Impact of Single Factor Sales Apportionment for the State of New York’ [2000] New York, NY: The Public Policy Institute of New York State, Inc. Reuven Shlomo Avi-Yonah and Kimberly A Clausing, Reforming Corporate Taxation in a Global Economy: A Proposal to Adopt Formulary Apportionment (Brookings Institution Washington, DC 2007).

There are also European authors advocating the single sales factor formula for the CCCTB, for example, M.F. de Wilde, Chapter 2: Some Thoughts on Fairness in Corporate Taxation in: Taxing Multinationals in a Global Market (IBFD 2017), Online 1 Books IBFD, at 6.4.5.2; Llopis, Estefanía López. ‘Formulary Apportionment in the European Union.’ Intertax 45.10 (2017): 631-641.

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recent data86, but such trend seems still continuous and lasting.

In US State taxation, transportation industry formulas have a long history.

In the early 20th century, there was a specific formula for the railroad industry.87 Such formula was in the form of ‘the unit rule’, which is actually the origin of the formulary apportionment, or unitary taxation in US State taxation.

The Multistate Tax Commission (MTC) has several transportation industry formulas.88 MTC regulations provide three regulations for transportation industries, including airlines,89 railroad,90 and trucking.91 Special formulas for these three transportation industries have features in common. They all involve mobile activities, properties, and employees, and therefore various pro-rata calculation methods are applied to calculate their ‘in-State activities’, i.e. the numerator of all the weighting factors.

There are still States adopting the special formula for the shipping industry.92 These State formulas are not uniform, and include one-factor,93 two-factor,94 and three-factor formulas.95 Among these formulas, the 86 See the replication of Goolsbee and Maydew’s work and negation, David Merriman, ‘A Replication of ‘Coveting Thy Neighbor’s Manufacturing: The Dilemma of State Income Apportionment’(Journal of Public Economics 2000)’ (2015) 43 Public Finance Review 185.

87 The early history of ‘the Unit Rule’ as one origin for current formulary apportionment, see Elcanon Isaacs, ‘The Unit Rule’ (1926) 35 The Yale Law Journal 838.

88 John A Wilkie, ‘Income Apportionment of Unitary Public Utility Corporations’ (1959) 15 Tax L. Rev. 467.

89 Multistate Tax Commission Recommendation Reg. IV.18.(e) Special Rules: Airlines.

[Adopted July 14, 1983], published at http://www.mtc.gov/uploadedFiles/Multistate_Tax_Commission/Uniformity/Uniformity_Projects/A_-_Z/SpecialRules-Airlines.pdf.

90 See Multistate Tax Commission Recommendation Reg. IV.18.(f) Special Rules: Railroads. [Adopted July 16, 1981] , at http://www.mtc.gov/uploadedFiles/MultiState_Tax_Commission/Uniformity/Uniformity_Projects/A_-_Z/SpecialRules-Railroads.pdf.

91 See Multistate Tax Commission Recommendation Reg IV.18.(g) Special Rules: Trucking Companies.

[Adopted July 11, 1986; amended July 27, 1989], http://www.mtc.gov/uploadedFiles/Multistate_Tax_Commission/Uniformity/Uniformity_Projects/A_-_Z/SpecialRules-Trucking.pdf.

92 The survey, see CCH TAX LAW EDITORS, U.S. MASTER MULTISTATE CORPORATE TAX GUIDE (2020). (CCH INCORPORATED 2019).,.There are 16 States adopting a special formula for the shipping industry. These States are Alaska, California, District of Columbia, Florida, Hawaii, Illinois, Indiana, Iowa, Kentucky, Louisiana, Maryland, Michigan, New Hampshire, Oregon, Pennsylvania, South Carolina.

93 For example, Florida adopts a single revenue-mileage factor formula, Fla. Stat. Ann. § 220.151(2)(c).

94 Louisiana adopts a two-factor formula consisting the property and income, LA Rev Stat § 47:287.95C. 95 For example, Hawaii adopts a three-factor formula consisting of ‘revenue tons,’ ‘voyage hours,’ and ‘originating revenue’, Haw. Code R. § 18-235-38-06.01.

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weighting factors include the voyage-days factor96, voyage-hours factor, revenue tons factor,97 mileage factor,98 etc. All these factors aim to describe the mobile shipping transportation activities, which might be difficult for the standard formula to catch. These factors represent the different aspects of the shipping activities, including time, space, and quantity of shipping: the voyage-days factor employs the time element; the mileage factor employs the spatial element; and revenue-tons factor employs the measurement of cargos, the shipment element. All these factors are designed to describe the in-State shipping transportation activities. Adopting the time element in the weighting factor is a smart approach because there might be some difficulty in recording the mileage in the high sea and within the State’s water territory, and the time element factor, such as ‘port-days’ or ‘voyage days’, describes the shipping activities from another objective view. In any case, these special formulas are deigned to catch ‘shipping transportation activities’ within the State.

4.2 The Airline Industry: The Flight Departures Ratio Applies to The Three Factors A typical cross-border transportation would inevitably involve ‘departure’, ‘voyage’ and ‘arrival’. This is the nature of transportation. Regarding air transportation, the voyage part of the activity, is also called ‘overflight’. Due to the mobility of airline transportation and that several jurisdictions are involved, it could be argued which jurisdiction is justified to levy or to be apportioned taxable income on airline industries99 In practice, States in the US adopt different types of rules for apportioning the multiState taxable income of airline industries.100 Some States follow the MTC Regulation, and some adopt other various formulas, such as the singlegrow-receipts factor, a single factor flight mileage formula, or a traditional three-factor formula with variations in order to fit the mobile nature of the airline business. The MTC Regulation IV Section 18(e) uses the indicator ‘the aircrafts’ departure’ in all three factors instead of using mileage as a proxy in State taxation practice, in order reduce the problem of ‘no-where income’ in 96 California, Cal. Rev. & Tax. Code § 25101; Cal. Code Regs. tit. 18, § 25101(b).

97 For example, South Carolina, SC Code Ann. § 12-6-2310(6).

98 Florida, Fla. Stat. Ann. § 220.151(2)(c).

99 Oregon has argued for its taxing rights based on overflight, see Gordon, Elizabeth A. ‘The Sky’s the Limit: The Apportionment of Overflights and Property Taxation after Alaska Airlines v. Department of Revenue.’ Willamette L. Rev. 26 (1990): 711.

100 The overview explanation, see Hellerstein and Hellerstein (n 85)., 10.03[6][c].

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the airline industry.101 MTC Regulation IV Section 18(e) provides a three-factor formula consisting of property, payroll, and sales for the airline industry, but items that form the numerators of three factors are all adjusted by the special ratio based on ‘instate aircraft departures’, respectively. The precise ratio is calculated as: departures of aircraft of a specific type departing from the locations in this State ) / ( aircraft of a specific type departing from everywhere) It is based on the value of the departure flights (hereafter the flight departures ratio). It should be noted that the flight departure ratio from different types of aircrafts should be calculated differently. For example, 747 and 727 aircrafts’ departure ratio are calculated separately.102 The airline industry formula also has a special rule for the payroll factor.

The payroll of non-flight personnel and flight personnel are calculated differently. With regard to non-flight personnel, compensation paid to such employees shall be included in the numerator fully. With regard to flight personnel (the air crew aboard an aircraft assisting in the operations of the aircraft or the welfare of passengers while in the air), compensation paid to such employees shall be included, but must be multiplied by ‘the flight departures ratio’.

As to the sales factor, it is in fact a ‘transportation revenue factor’: All the transportation revenue derived from transactions and activities in the regular course of trade or business of the taxpayer, and miscellaneous sales of merchandise, etc., are all included in the denominator. However, passive income items such as interest, rental income, dividends, and the proceeds or net gains or losses from the sale of aircraft will not be included. As for the numerator of the sales factor, there is a special rule that distinguishes two types of items: (1) the in-State flight revenue is calculated as the total flight revenue multiplied by the abovementioned ‘flight departures ratio’; 101 Ibid, at pp. 10-18.

102 In the MTC’s airline industry formula, the departure ratio is formulated as ‘Departures of aircraft from locations in this State weighted as to the cost and value of aircraft by type compared to total departures similarly weighted’, which is not quite clear. In combination with the explanatory example attached in the MTC’s airline industry formula, it clearly means that different types of aircrafts’ departure ratio should apply to the aircrafts’ valuation in the property factor differently.

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and (2) the non-flight revenues attributed to the State is attributed to the geographic State.

As to the property factor, the denominator of the property factor shall be the average value of all of the taxpayer’s real and tangible personal property owned or rented and used during the income year. The airline formula provides a special rule for the numerator of the property factor. In principle, the property factor shall include the taxpayer’s real and tangible personal property owned or rented and used in this State during the income year.

However, the property factor of the MTC’s airline industry formula treats ‘aircrafts ready for flight’ differently. The ‘aircraft ready for flight’ shall be still included in the numerator of the property factor at ‘the flight departures ratio’.

4.3 Other Transportation Industry Formulas In US 4.3.1 The Railroad Industry In addition to the airline industry, the MTC Regulation IV further provides special formulas for the railroad industry and the trucking industry. The rationale for these two transportation industry formulas is to provide a fair apportionment result for the mobile transportation activities, especially when these transportation activities are conducted across States.

For the railroad industry, its weighting factors are calculated by the special ratios. This is also because the railroad industry has mobile features, and some States even adopt the single-factor revenue miles formula.103 MTC Regulation IV Section 18(f) provides a three-factor formula with special ratios.

According to MTC Regulation IV Section 18(f), the railroad industry formula,104 the property factor has some special items. As to ‘mobile or movable property’ such as passenger cars, freight cars, locomotives and freight containers, the included value in the numerator should be multiplied by the ratio of (in-State locomotive miles)/(everywhere locomotive miles) and (in-State car miles)/(everywhere car miles) respectively.

103 10-9.

104

For the overview explanation, see Hellerstein and Hellerstein (n 85)., 10.03 [2][a], p.

Ibid.

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The payroll factor numerator has special rules for payroll for enginemen and trainmen performing services on interstate trains. The value of their compensation in the numerator should be calculated as the ratio of (their services performed in this State)/(their services performed everywhere) because their services on the interstate trains are performed both within the State and outside the State. The ratio is to decide the extent that the services are performed within the State.

The sales factor of the railroad industry formula distinguishes ‘sales from hauling freight, mail, express’ and ‘sales from passengers’. The taxpayer’s receipts from hauling freight, mail, express and passengers purely in-State, i.e. originating and terminating within the same State, shall be totally included in the numerator of the sales factor. However, receipts from hauling freight, mail, and express while passing through/into/out of the State, should be included in the numerator at the ratio of (in-State miles traveled of such movement )/(total miles traveled of such movement from origin to destination).

Moreover, the taxpayer’s receipts from transportation of passengers passing through/out/into the State shall be included in the numerator of the sales factor at the ratio of (inState passenger miles)/(total passenger miles).

4.3.2 The Trucking Industry For the trucking industry, MTC Regulation IV Section 18(g) also provides a special formula.105 The trucking industry formula has three weighting factors: property, payroll, and sales. Similar to the railroad industry formula, the trucking industry formula distinguishes the mobile property and nonmobile property. Mobile Property means all motor vehicles, including trailers, engaged directly in the movement of tangible personal property. The value of the taxpayer’s mobile property included in the numerator of the property factor, must be calculated at the ratio of (inState mobile property miles )/(the total mobile property miles).

The payroll factor of the trucking industry formula also distinguishes personnel performing services both within and outside of the State (the cross-border personnel) and personnel performing services exclusively within the State (in-State personnel). As to the compensations paid to inState personnel, the value can be fully included in the numerator of the 105

Ibid, 10.03 [3].

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payroll factor. However, the value of compensation paid to the cross-border personnel must be calculated at the ratio of (in-State service performed based on mobile property miles )/(everywhere service performed based on mobile property miles).

As to the sales factor, the trucking industry formula is very similar to the railroad industry formula. The taxpayer’s receipts of hauling freight, mail, and express originating and terminating within the State, i.e. the intra-State sales, is fully included in the numerator of the sales factor; whereas the mobile property miles traveled by such movements must be calculated at the ratio of (in-State mobile property miles traveled by such movements)/(the total mobile property miles traveled by such movements everywhere).

These special ratios of the trucking industry and the railroad industry have one feature in common: The special ratios are applicable to the mobile items, and these ratios are decided by the type of mileage in each transportation industry.

4.4 Surface Travel, Flow-Through and Pass-Through are Less Relevant Proxies In State taxation cases regarding transportation industries, there are discussions about ‘surface travel’ and ‘pass-through’ jurisdiction. The core question is whether such pass-through transportation activities constitute nexus and justify apportionment of tax base.

For the airline industry, there exists consensus that over-flights106 should not constitute nexus nor justify apportionment, because the mere fact of flying through does not avail to the public services or market of the jurisdiction, and this does not justify exercise of taxing right.

As to the shipping industry, there are still diverse approaches107 regarding voyage on the high sea or voyage outside the water jurisdiction. Some States adopt the voyage days formula, so there will be ‘nowhere income’ from voyage on the high sea or nontaxable waters; other States adopt ‘the port 106 Hellerstein and Hellerstein (n 85). 10.03[6][b][i] Treatment of overflight or flyover time or mileage.

107 ibid. 10.03[5][a] Specialized Statutory and Regulatory Provisions

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day formula’, so voyage on nontaxable waters will not be considered anyway.

As to land transportation and pipeline transportation, the answer is a bit more controversial. For example, prior to 2009, Illinois adopted108 ‘passthrough miles’ for motor carriers (land transportation) and the court also supported this formula. This is because motor carriers do have physical contact with the jurisdiction while ‘passing through’, even they do not stop for picking up or delivering.

Just as Justice Black’s remarks on ‘a physic basis’ in the case Northwest Airlines, Inc. v. Minnesota109: ‘A State has a different relation to rolling stock of railroads than it has to airplanes. Rolling stock is useless without surface rights and continuous structures on every inch of land over which it operates.

Surface rights the railroad has acquired from the State or under its law. There is a physical basis within the State for the taxation of rolling stock which is lacking in the case of airplanes.’ It seems true that land transportation activities do create some more connections to the pass-through jurisdiction than air transportation, and in some cases nexus and apportionment by the passthrough jurisdiction is justified.

However, even from the perspective public benefits provision, when there is no stopping point to deliver or collect foods or passengers, in the pass-through jurisdiction, I am doubting if taxpayers of land transportation, could fulfill the factor presence nexus threshold, because they have no customers’ market (the sales factor) nor no service performing (the labour factor) in the pass-through jurisdiction. The only possible factor presence threshold would be the asset factor; but it would be hard to argue that vehicles could be attributed to the pass-through jurisdiction. As to the ground accommodating the rail tracks, highways, and pipelines, it is true that taxpayers make use of them by passing through, but I would argue that, without the related sales factor and the labour factor, it is hard to argue that, the ground accommodating the rail tracks, highways, and pipelines represent taxpayers’ capacity to mobilise these facilities.

Therefore, in my view, transportation industry formulas should focus on the departure and arrival jurisdictions, and not on the pass-through 108 ibid. 10.03[3][b][v] Pass-through miles.

109 Comments on the case, PHILIP M ZINN, ‘The Requirements of’ Substantial Nexus’ and’ Fairly Related’ Under the Commerce Clause’, The State and Local Tax Lawyer. Symposium Edition (JSTOR 2007)., p.66

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jurisdiction.

4.5 The Final Remarks of the transportation industry formulas in US State Taxation In the context of State taxation in the US, the transportation industries need special rules for apportionment. It is not only because the standard formula is based on a manufacturing industry’s model, but also because these transportation industries by their nature involve a lot of cross-border services provision. The State formula aims to decide the taxability within the State, and thus there must be some indicators to estimate the reasonably attributable extent of these activities.

In these MTC transportation industry formulas, various proxies in the form of a ratio are used for different industries to estimate their in-State activities.

The airline formula takes the flights departure as a proxy; the railroad formula and the trucking industry take the mileage as the main proxy. Since the State formula is unilaterally applied to the taxpayers, these ratios are necessary to limit the States’ powers to apportion the tax base.

5. Comparison and Discussions: Tax Neutral Transportation Formulas should Reflect the Fluid Source of Departure and Arrival After comparing all-or-nothing approaches in the traditional tax regime and formulary apportionment approaches, we can draw several common implications, despite the existence of diverse approaches of allocating taxing rights on the international transportation industry.

First of all, both the traditional international tax regime and the US’s State taxation formulary apportionment system are aware of the difficulty of ascertaining the source of income earned in the international transportation industry. In other words, the source is ‘fluid’. Their responses are different: the traditional international tax regime embraces administrative convenience and all-or-nothing rationale, so different tax model conventions all seek a single proxy, either ‘place of effective management’ or ‘residence’. For formulary apportionment system, there have been various formulas, using 286

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time or distance as the factor in the formula to transcribe the inherent mobile feature. There is also no consensus yet between States in US how such formula should be designed.

In Section 3, I have demonstrated that in the field of international tax law regime, the approach of allocating taxing rights of the international transportation industry, is following the traditional all-or-nothing rationale and heavily relying on the POEM or residence criterion, As a result, one single State will have the exclusive taxing right. Such approach is not based on any solid theory, but administrative convenience. Although it seems easier to use such formalistic criterion, it may divide the real economic transportation activities and result of attributing the taxing right. Such approach is not compatible with the reform spirit of the Base Erosion and Profit Shifting Project.

On the contrary, from the above-mentioned examples in Section 4, regarding transportation industry formulas developed by MTC and States in the US, it is common to apply an extra ratio to the weighting factor(s).

Some are based on the spatial criterion (such as MTC’s railroad and trucking industry formula and mileage factor) and some are based on time criterion (such as the port-days formula or voyage days formula).

The second reflection is that, the all-or-nothing rationale and formulary apportionment are not compatible, and adopting a hybrid approach can create more complexities. The main advantage of ‘administrative convenience’ actually disappears. For the current CCCTB Directive Proposal, it has a hybrid approach. As to the corporate tax, the CCCTB adopts a formulary apportionment system as its general setting; but its ‘carving-out’ approach for the transportation industry seems to be influenced by OECD’s approach mainly for the purpose of administrative convenience. This is only one side of the story about taxing the transportation industry. Formulary apportionment actually can also be an alternative to tax cross-border income earned transportation activities and has been used in practice, either in Hong Kong, Australia or at the State level in US. Since the CCCTB Directive Proposal has chosen formulary apportionment as the tax reform direction, it would be unreasonable to leave a backdoor for the transportation industry.

As the third reflection, due to the transportation industry’s mobile feature, it is reasonable to adopt the sales factor, which equally weights 287

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the dimension of both arrival and departure as ‘the destination’, because both arrival and departure represents taxpayers’ response to the clients.

Due to the inherent mobile feature of transportation activities, the income earned will inevitably the departure, voyage and arrival jurisdictions. From the perspective of benefit principle, the departure jurisdiction and the arrival jurisdiction provide main customer markets for MNE taxpayers. Therefore, both departure and the arrival jurisdiction should be understood as source as well as ‘the destination’ in the context of the sales factor, because the sales factor represents ‘the response to clients’ market’, and both departure and arrival jurisdictions are the transportation industry’s ‘clients’ market’.

To sum up, the failures of the traditional international tax regime as well as Base Erosion and Profit Shifting problems are not limited to ‘digital economy’. In fact, there have been similar BEPS problems in the international transportation industry. Digital economy makes the old problems even more serious, and EU’s reform effort CCCTB is an ambitious and comprehensive attempt. While putting so much effort designing a EU-level formulary apportionment, completely carving-out the transportation industry from the CCCTB’s application scope would negatively offset the benefits of the tax reform. In conclusion, the current text of the provision on the transportation industry under the CCCTB Directive Proposal is counter progressive and unreasonable, and an amendment is necessary.

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Sean Portellli The scope of the ‘pure’ VAT exemptions and their interpretation by the CJEU, with particular reference to the services referred to in article 135(1)(g) of Directive 2006/112EC, as well as the provisions’ transposition into Maltese law.

Sean Portelli graduated from the University of Malta with a secondclass Bachelor of Laws (Hons) degree, and is currently reading for the Master of Advocacy at the same university. He is mainly interested in the financial and technological fields of law. Sean Portelli was elected to serve as Treasurer of the Malta Law Students’ Society (GħSL) during the 2019/20 term of office.

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This article analyses the exemptions provided for by the VAT Directive, these being categorised into two separate groups, concerning Articles 132 through to 134, as well as Articles 135 through to 137 of the VAT Directive, respectively. Moreover, in order to fully understand the applicability of the exemption provided for by the VAT Directive, the work examines the exemptions from the perspective of the Court of Justice of the European Union.

Simultaneously, the work shall methodically scrutinise the caselaw of the Court of Justice of the European Union concerning Article 135(1)(g) of the VAT Directive, whilst further examining the transposition of the same into the Maltese legislative framework, under the VAT Act.

1. Introduction

I

t is indisputable to state that Value Added Tax (‘VAT’), is a general tax imposed upon consumption, that is indirectly applied by means of taxing the supply of goods or services for consideration, at every stage of production and distribution.1 The general nature of VAT indicates that every form of economic activity is to be included within its remit, without showing discrimination as to the nature of the taxable person that is involved in the supply of goods and services.

2. The Exemptions Prescribed by the VAT Directive From a practical point of view, the justification of VAT exemptions may be brought about through three distinct methods. Firstly, certain exemptions may be implemented so as to build upon VAT’s advancement. Secondly, certain goods and services deserve to be tax exempt. Thirdly, distinct categories of goods and services may prove too burdensome to tax. The application of an exemption carries, with it, certain consequences. In fact, any input tax which is attributed to an exempt supply cannot be deducted.2 1 Council Directive (EU) 2006/112 of 28 November 2006 on the common system of value added tax (2006) OJ l347/1 2 Ben Terra and Julie Kajus, ‘A Guide to the European VAT Directives, Volume 1’ (2006,

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The VAT Directive3 categorises exemptions without deduction into two separate groups. The first group concerns activities which are exempted in the interest of the general public, whilst the second group concerns other forms of exempted activities.4 The first group is covered by Articles 132 through to 134 of the VAT Directive, and it is comprised of, amongst others, medical, educative, sport, cultural, and social services. Such transactions are generally carried out by public bodies; however, the exemption also covers a number of the same transactions performed in the interest of the general public by either the private sector, or by the voluntary sector. 5 The second group is covered by Articles 135 through to 137 of the VAT Directive, and it allows for exemptions which include amongst others, insurance and reinsurance transactions, the leasing and letting of immovable property, banking and financial transactions, as well as investment funds.6 Such exemptions concern a varied array of transactions, which are mostly related to money and finance.7

3. The Exemptions from the Lens of the Court of Justice of the European Union In order to fully understand the applicability of the VAT Directive’s exemptions, it is fundamental to refer to the interpretations made, in the vast body of case-law of the Court of Justice of the European Union (the ‘CJEU’).

Furthermore, due to the fact that exemptions are an exception to the general VAT rule that all supplies of goods or services are subject to VAT, they shall be interpreted very strictly. As a matter of fact, excluding what is included in the VAT Directive, there are no thorough definitions of the services covered, IBFD Publications) 3 Council Directive (EU) 2006/112 of 28 November 2006 on the common system of value added tax (2006) OJ l347/1 4 Ibid 5 European Commission, ‘Exemptions without the right to deduct’ <https://ec.europa.eu/taxation_customs/business/vat/eu-vat-rules-topic/exemptions/exemptions-without-right-deduct_en#fin_insur_services> accessed 19 April 2019 6 Ben Terra and Julie Kajus, ‘A Guide to the European VAT Directives, Volume 1’ (2006, IBFD Publications) 7 European Commission, ‘Exemptions without the right to deduct’ <https://ec.europa.eu/taxation_customs/business/vat/eu-vat-rules-topic/exemptions/exemptions-without-right-deduct_en#fin_insur_services> accessed 19 April 2019

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nor are there any unambiguous references made to definitions used in other sets of Community legislation or by any regulatory bodies.

This lack of meticulousness has plagued tax authorities and commercial activities with problems in interpreting both the scope and the application of such exemptions. This phenomenon is illustrated in the growing body of CJEU case-law. Moreover, the CJEU has often been requested to fill in such voids, as well as to clarify the correct understanding of the current exemptions in the VAT Directive.

Thus, an analysis of the CJEU’s interpretation on the exemptions provided in the VAT Directive, should essentially consider both the exemptions related to activities conducted in the public interest, as well as any exemptions related to money and finance, which shall be specifically dealt with later on.

As aforementioned, activities in the interest of the general public, including, amongst others, the supply of organs, blood, and milk, as well as hospital and medical care, including other closely related activities are exempt from VAT. The Court, in De Fruytier,8 was tasked with determining whether Nathalie De Fruytier’s activity, in transporting human organs is exempt from VAT under Article 132(1)(d) of the Directive, as the Directive exempts the supply of human organs, blood and milk from VAT. The Court held that ‘the terms used to specify the exemptions in Article 132 of Directive 2006/112 are to be interpreted strictly, since they constitute exceptions to the general principle’9 which requires VAT to be charged on the supply of goods and services for consideration. The Court further held that ‘the requirement of strict interpretation does not mean that the terms used to specify the exemptions referred to in Article 132 should be construed in such a way as to deprive the exemptions of their intended effect’.10 The Court thus held that physically transporting the goods concerned from one location to another for hospitals or laboratories does not fit the notion of the supply of goods as prescribed by the VAT Directive, since the person transporting the goods is not disposing of them as the owner, and therefore, such an activity cannot qualify for the VAT exemption under Article 8 Case C-86/09, Future Health Technologies Limited v The Commission for Her Majesty’s Revenue and Customs [2010] 9 Ibid 10 Ibid

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132(1)(d).

One may note that the Court has taken an active role in formulating guiding principles as a means to interpret the exemptions provided by the VAT Directive. The second group of exemptions has also been heavily dealt with by the Court.

In Velvet & Steel, the Court had to determine whether Article 135(1)(c) of the VAT Directive included within its scope non-pecuniary obligations, such as the requirement to refurbish a property. The Court held that the exemption concerned the assumption of obligations, as well as the negotiation, assumption and management of credit guarantees, and any other form of security for consideration. Furthermore, the Court held that such transactions are essentially financial services. In light of this, the Court held that the assumption of an obligation to have a building renovated is not to be considered as a financial service in accordance with Article 135(1)(c) of the VAT Directive, and thus, it falls outside the remit of the provision.

The Court further held that such an interpretation is reinforced by the purpose for which financial transactions are exempted from VAT, and such purpose is tied with lessening the burdens associated with the determination of the tax base, and of the amount of deductible VAT, as well as to prevent an increase in costs. Therefore, the Court decided that subjecting the assumption of an obligation to have property renovated to VAT does not create complications which require the transaction to be exempted, and thus such an obligation is subject to VAT.

4. The CJEU’s Interpretation of Article 135(1)(g) of the VAT Directive The EU’s common VAT system has, since the Sixth VAT Directives’ adoption, virtually exempted the most common categories of financial services, notably insurance and the management of investment funds. Such exemptions are linked with the general fact that the process of taxing financial services is burdensome, technical and extremely complex.11 Thus, this work shall give 11 Accompanying document to the Proposal for a Council Directive amending Directive 2006/112/EC on the common system of value added tax, as regards the treatment of insurance

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specific attention to Article 135(1)(g) of the VAT Directive concerning the exemption from VAT of transactions related to the ‘management of special investment funds’.12 Fiscale Eenheid13 centred around a management company providing portfolio management and property management services. The management company took the position that these services qualified for the VAT exemption, which was met by disagreement with Netherlands tax authorities, and thus, the case was submitted to the CJEU. The Dutch authorities questioned whether an investment vehicle which solely invests in real estate, could also meet the requirements of a qualifying investment fund for the purpose of the exemption, as opposed to a UCITS fund. The Dutch authorities further questioned whether property management qualifies as exempt fund management. The CJEU held that, if subjected to specific State supervision, real estate investment funds can qualify for the VAT exemption, however property management does not.

The CJEU did not, however, define what the term ‘specific State supervision’ entailed.

The ruling in Fiscale Eenheid is significant as it could either increase or reduce the VAT expenses of managing investment funds or pools. The Court ruled that investment funds, real estate funds, and other non-UCITS funds are entitled to the exemption provided under Article 135(1)(g) if they are subjected to specific State supervision.

In GfBk Gesellschaft,14 the CJEU established that investment advisory services also fall within the remit of the VAT exemption provided in Article 135(1)(g) of the VAT Directive. The case concerned a German investment manager, GfBk Gesellschaft, which provided fund management advise as a service to the fund manager for consideration. However, the German tax authorities believed that the advisory services provided by GfBk Gesellschaft did not fall under the remit of the exemption for fund management.

In its judgement, the CJEU held that management services which are and financial services [2008] SEC (2007) 1554 12 Council Directive (EU) 2006/112 of 28 November 2006 on the common system of value added tax (2006) OJ l347/1 13 Case C‑595/13, Staatssecretaris van Financiën v Fiscale Eenheid X NV cs [2015] 14 Case C‑275/11, GfBk Gesellschaft für Börsenkommunikation mbH v Finanzamt Bayreuth [2013]

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provided by a third-party manager fall within the scope of the exemptions provided by the VAT Directive, as the management of special investment funds is determined in accordance with the nature of the services provided, and not by the person that is either supplying or receiving the service.

Thus, in order to determine whether the advisory services provided, fall within the scope of ‘management of special investment funds’15, the CJEU held that one must determine whether the said advisory service is ‘intrinsically connected to the activity characteristic of an [Investment Management Company], so that it has the effect of performing the specific and essential functions of management of a special investment fund’.16 The CJEU held that advisory services which concern investments in transferable securities provided by a third party to an investment management company fall within the remit of Article 135(1)(g) of the VAT Directive.

In GfBk Gesellschaft, the CJEU also made reference to the Abbey National17 case, in which the Court had stretched the exemption to functions for managing collective investment undertakings such as those which are provided for under the UCITS Directive. However, in GfBk Gesellschaft, the Court’s decision went further, and added that the exemption also applies to investment advisory services, albeit the fact that they are not considered as core services under the UCITS Directive.18 The case in Wheels Common Investment Fund19 concerned the VAT Directive’s treatment of management fees that are charged to a pension fund.

The facts of the case centred on pension schemes provided to a category of former employees. Fund managers were appointed so as to manage the fund’s assets. The CJEU was asked whether assets of a retirement pension scheme, and the investment fund through which they are collectively pooled, fit the requirements of the exemption under Article 135(1)(g) of the 15 Council Directive (EU) 2006/112 of 28 November 2006 on the common system of value added tax (2006) OJ l347/1 16 Case C‑275/11, GfBk Gesellschaft für Börsenkommunikation mbH v Finanzamt Bayreuth [2013] 17 Case C-169/04, Abbey National plc, Inscape Investment Fund v Commissioners of Customs & Excise [2006] 18 Case C‑275/11, GfBk Gesellschaft für Börsenkommunikation mbH v Finanzamt Bayreuth [2013] 19 Case C-424/11, Wheels Common Investment Fund Trustees Ltd and others v Commissioners for Her Majesty’s Revenue and Customs [2013]

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VAT Directive.20 The CJEU remarked that under the VAT Directive, Member States are given discretion to determine the meaning of the term special investment funds, however the Member State is restricted from choosing which category of fund is entitled to the exemption and which category is not.21 The power given to the Member State in this scenario is that of defining within its respective laws, the funds that fit into the remit of Article 135(1)(g).

Thus, in Wheels Common Investment Fund, the CJEU took it upon itself to determine whether an investment fund under which assets of a retirement pension scheme are pooled, match funds which are indistinguishable from, or comparable to special investment funds. In its deliberation, the Court held that special investment funds are funds which are comprised of undertakings for collective investments in transferable securities as provided for by the UCITS Directive.22 Nevertheless, an investment fund under which the assets of a retirement pension scheme are collectively pooled must not be considered to be a collective investment scheme under the UCITS Directive.

Thus, such a fund cannot be considered to be equal or identical to fund which constitute special investment funds.

The CJEU, in its judgement, held that such a scheme, is a measure through which the employer complies with his obligation towards his employees, and thus, the fund pooling assets of the retirement pension scheme is not a special investment fund, and therefore is not VAT exempt.23 Reference should also be made to the case of ATP PensionService24, in which ATP provided services to pension funds. In its judgement, the CJEU had to determine whether a defined contribution pension scheme was to be regarded as a special investment fund in line with Article 135(1)(g) of the VAT Directive, and if such was the case, the CJEU had to also determine whether the services ATP provided should be considered as management.

The CJEU provided that Member State discretion to define special investment funds, under Article 135(1)(g) was restricted by the principle of 20 Ibid 21 Ibid 22 Ibid 23 Case C-424/11, Wheels Common Investment Fund Trustees Ltd and others v Commissioners for Her Majestyâ&#x20AC;&#x2122;s Revenue and Customs [2013] 24 Case Câ&#x20AC;&#x2018;464/12, ATP PensionService A/S v Skatteministeriet [2014]

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fiscal neutrality.25 Furthermore, the CJEU held that the defining element of a special investment fund is asset pooling, which in turn, allows for the diversification of the beneficiaries risks.

ATP PensionService was contrasted with the decision in Wheels Common Investment Fund, under which the CJEU decided that a common investment fund which collectively pooled assets of a defined benefit pension scheme was not to be considered as a special investment fund, meaning that any supplied management services were not exempt from VAT. Moreover, the CJEU further provided that the VAT Directive did not dismiss the management of special investment funds from being separated into individual services, each of which having the ability to fall within the remit of the VAT exemption.

Finally, in its judgement, the CJEU concluded that: pension funds such as those at issue in the main proceedings may fall within the scope of that provision if they are funded by the persons to whom the retirement benefit is to be paid, if the funds are invested using a risk-spreading principle, and if the pension customers bear the investment risk.26 The above case law is of paramount importance in the interpretation of Article 135(1)(g) of the VAT Directive, as it allows for increased workability in dealing with the VAT treatment of funds.

5. The Transposition of Article 135(1)(g) into Maltese Law The exemptions provided under the Value Added Tax Act (the â&#x20AC;&#x2DC;VAT Actâ&#x20AC;&#x2122;) are exceptions to the general principle that all supplies of goods or services are subject to VAT and, as the CJEU has reaffirmed, in multiple instances, such exemptions must be construed strictly. This infers that the exemption at hand is to solely apply to what it was intended to apply towards.

Malta has implemented Article 135(1)(g) of the VAT Directive into the VAT Act, under Item 3(6) of Part 2 of the Fifth Schedule, as an exemption without 25 26

Ibid, para 42 Ibid

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credit. The effect of this is that goods and services purchased by consumers are untaxed, and thus, no VAT is charged on the value of the supply, and in turn, the supplier is not eligible to claim back any input VAT sustained in providing that supply, as businesses carrying out VAT exempt transactions are not eligible to recuperate input VAT. The VAT Act provides that ‘the supply of services consisting of the management of any investment scheme, provided that these services are limited to those activities that are specific to and essential for the core activity of the scheme’.27 Moreover, the VAT Act, also determines, for the purposes of the exemption, what fits the requirement of an ‘investment scheme’, and what category of service fits the requirement of ‘management services’.

The VAT Act provides for four categories of ‘investment scheme’, notably, ‘collective investment schemes’, ‘retirement schemes’, ‘securitisation vehicles’, as well as ‘authorised reinsurance special purpose vehicles’. Thus, the concept of ‘investment scheme’ requires one to look at the legislation tied to the various schemes which fall under the exemption. For instance, let us consider ‘collective investment schemes’. In this case, the VAT Act makes reference to its definition under the Investment Services Act. Thus, if the ‘investment scheme’ satisfies the required conditions for a ‘collective investment scheme’, under the Investment Services Act, it will qualify for the VAT exemption under the VAT Act. This applies to the other listed forms of investment schemes under the VAT Act. Moreover, both the VAT Act and the VAT Directive fail to define the term ‘management’. However, it is implied, under the VAT Act, that ‘management’ includes within its remit, services, linked to the core activity of the scheme.28

27 ule 28

Value Added Tax Act, Chapter 406 of the Laws of Malta, Item 3(6), Part 2, Fifth SchedIbid, Item 3(6), Part 2, Fifth Schedule

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6. Conclusion Thus, as demonstrated above, the exemptions provided by the VAT Directive establish independent notions of EU law which aim to harmonise the various systems of VAT by attempting to lessen any deviations from the general rule that VAT is a wide-ranging tax imposed upon consumption, that is applied indirectly by taxing the supply of goods or services for consideration at every stage of production and distribution.

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