Treaty Shopping: The Fine Line Between Aggressive Tax Planning and Anti-Abuse Investigations
What is the objective of a company undertaking a tax planning strategy? At first glance, the answer appears simple: reducing its overall tax burden. In reality, however, this simplicity masks a far more complex situation. In today's complex regulatory environment, achieving this objective requires careful strategic decisions and a thorough assessment of tax rules. This complexity increases further when the company operates internationally. Increasingly, companies are reorganising their corporate structures and relocating their headquarters (particularly the parent company) to other countries to exploit differences between tax systems and achieve tax savings. Such a strategy may appear entirely legitimate, particularly in light of increasing market globalisation and capital mobility. However, if not planned correctly, it can lead to challenges from the tax authorities. One of the main issues concerns the phenomenon of treaty shopping, a much-debated practice because it lies in a grey area between the legitimate use of double taxation treaties and aggressive tax planning. Treaty shopping involves the use of conduit companies, often located in countries with favourable tax regimes or with an extensive tax treaty network, which enable multinationals to obtain:
reductions or exemptions from withholding tax on dividends, interest and royalties;
double non-taxation or very low taxation;
the deferral of taxation in the countries where the income is actually generated.
This combination can lead to outcomes that are inconsistent with the purpose of the treaties, which is to avoid double taxation, not to create situations of double non-taxation.
The spread of treaty shopping has prompted states and international organisations to strengthen anti-abuse measures, in order to protect tax sovereignty and combat the erosion of the tax base. To this end, the multilateral agreement implementing the BEPS measures was introduced in 2018. In line with these principles, it is noted that the Italian Revenue Agency, in most cases, does not so much challenge a formal breach of the law as the lack of genuine economic substance consistent with the tax benefits obtained. Tax authorities often argue that these conduit companies perform little or no genuine business activity other than distributing dividends or managing the cash received; one example is loans to shareholders, which are unlikely ever to be repaid. In essence, these are shell companies that transfer wealth to the beneficial owner, who is located in a country that would not otherwise have been able to benefit from the “conduit” arrangements.
Alongside this need for protection, however, the tax authorities have at times adopted a very aggressive stance, using these grounds to justify particularly stringent tax assessments. In several cases, the Italian Revenue Agency has based its assessments on the theory of treaty shopping, challenging not only the use of treaty benefits but also the economic structure of the parent companies receiving dividends. A significant example is Decision No. 3001, issued on 6 June 2018 by the Lombardy Regional Tax Commission.
In that case, the Agency argued that the mere absence of valid economic reasons for holding shareholdings, combined with the possibility of benefiting from a preferential tax regime (for dividends received from a foreign company), was indicative of tax abuse. The Administration therefore sought to apply anti-avoidance presumptions, requiring the taxpayer to demonstrate the economic genuineness of the corporate structures involved.
The Lombardy Regional Tax Commission, upholding the taxpayer’s appeal, reiterated a fundamental principle: “anti-abuse provisions must be substantiated by the tax authorities with convincing arguments and appropriate evidence”, even though the taxpayer still bears the burden of proving the valid economic reasons for the transaction.
Even without delving into the technical aspects, it is evident that the qualification of cross-border arrangements raises highly complex legal issues and fuelling the debate between lawful tax planning and abuse of the law. Furthermore, in addition to the difficulties already mentioned, there are procedural asymmetries in the application of the benefits provided for under the conventions. It is not uncommon for one State to adopt unilateral provisions which are then rejected by the other, preventing the correct application of the treaty. In Italy, for example, to obtain exemption from withholding tax, certification of the requirements is required via “Form E”, which is not accepted by the Luxembourg authorities.
In conclusion, within an increasingly complex regulatory framework that is often subject to controversial interpretations, the legislation risks being used, during audits, not so much as a tool for the correct application of the law, but rather as a basis for particularly aggressive tax assessments. In this context, tax planning must be approached carefully and strategically, as structures that are not properly put in place can lead to tax assessments and penalties with significant economic consequences. For this reason, relying on professionals with in-depth knowledge of international treaties and strategies to counter often disproportionate or legally unfounded claims by the tax authorities becomes essential to effectively safeguard the taxpayer’s position.
