STARR INTERNATIONAL COMPANY, INC. v UNITED STATES OF AMERICA

The factsStarr International Co Inc (“Starr”) was a company based in the Republic of Ireland owned by a US charitable foundation. Starr was a parent company to a number of international financial and insurance businesses. It was once the largest shareholder of American International Group, Inc. (“AIG”). In Ireland, Starr was paying a reduced rate of withholding tax on dividends under a bilateral income tax treaty between the United States (US) and Ireland. In 2006 Starr moved to Switzerland continuing to receiving dividends from its associate Company and sought to reduce its dividend tax rate by obtaining benefits under the US – Swiss Treaty. Under the agreement, companies were entitled to a reduction in withholding tax, provided one of a number of objective criteria was met. Because Starr did not meet any of those criteria, it relied on Article 22(6) of the Treaty, a provision that allows for discretionary tax relief. Article 22(6) states:A person that is not [otherwise] entitled to the benefits of this Convention… may, nevertheless, be granted the benefits of the Convention if the competent authority of the State in which the income arises so determines after consultation with the competent authority of the other Contracting State.The Internal Revenue Service (“IRS”) denied Starr’s request for treaty benefits under the limitation on benefit article 22, contained in the US – Swiss tax treaty. The IRS argued that the Starr’s change of domiciles and its recent relocation to Switzerland were motivated as much by tax reasons as by independent business purpose. A primary purpose of the move in accordance with the IRS was to obtain treaty benefits.Starr argued that treaty shopping is a precise legal term and covers only those instances where an on-paper resident of third country (not party to the relevant tax treaty) who uses legal entities established in a contracting state in order to obtain the benefits of a tax treaty. Because Starr were on-paper Swiss resident and the majority of its voting shareholders were US Citizens at the relevant time, it could not be a treaty shopping.It also argued that, as there were no provisions dealing specifically with companies owned by charitable entities, there was inadvertent oversight as many of the other US bilateral tax treaties contain special provisions granting relief to companies with such structures.The judgement The court sees nothing arbitrary or capricious in competent authorities finding that at least one of the principal purposes for moving Starr’s management, and therefore its residency to Switzerland was to obtain tax benefits under the US – Swiss Tax Treaty. By applying the correct legal standard to a host of indisputably relevant facts, the Competent Authority satisfied its obligations under the Administrative Procedure Act (“APA”) to “examine the relevant data and articulate a satisfactory explanation for its action including a rational connection between the facts found and the choice made.AnalysisThe significance of this case lies in its discussion of the principal purpose test for determining entitlement to treaty benefits. Action 6 of the OECD BEPS report contains a principal purpose test rule (PPT rule) for the purpose for determining entitlement to treaty benefits. This PPT rule is also included in the OECD Multilateral Instrument.The IRS denied Starr’s request for treaty benefits under the limitation on benefit article 22, contained in the US – Swiss tax treaty. The IRS denied the request on the ground that Starr’s historical selection of domiciles and its then-recent relocation to Switzerland were motivated as much by tax reasons as by independent business purpose. Starr incorporated in Panama and its management and control was in Bermuda, and then was re-located to Ireland and its movement of management out of Bermuda a relatively short time before the payment of dividends further suggests that Starr was seeking to obtain tax benefits. Subsequently Starr’s movement to Switzerland further suggests its intention of organizing in a treaty jurisdiction to avail itself of a reduced rate of withholding tax on US source dividends.In the request, Starr conceded that it was not entitled to benefits under any of Article 22’s mechanical tests. However, it sought discretionary relief under paragraph 6 primarily on the ground that its move to Switzerland was motivated by charitable considerations, not tax concerns. Starr’s argument was that the limitation on benefit provision was targeted against treaty shopping. These provisions, according to Starr, are covering only those instances where residents of third states establishing an entity in one of the contracting states in order to obtain treaty benefits. There were no third country residents involved as the corporation was genuinely resident in Switzerland and its ultimate owners were US residents. There was therefore no treaty shopping in accordance with Starr’s definition.Treaty shopping, it may often involve residents of third states, may also involve individuals or companies moving their residence in order to take advantage of that state’s treaty network. As the treaty drafters recognised, if on-paper residency was enough to obtain treaty benefits, then it would be easy to skirt the system. Any Company, no matter its actual jurisdictional or geographic ties, or the location or identity of its true beneficiaries, could simply establish itself or a subsidiary entity in one of the treaty states and obtain treaty benefits.Of course to identify an entity’s principal purpose to establish in particular jurisdiction is very subjective determination of the taxpayer’s intent. Such determination indeed it needs an effort from the tax administration. Article 22 of the convention lists a number of objective criteria seeking to identify entities with legitimate, non-tax related motives. The assumption underlying each of tests is that a taxpayer that satisfies the requirements of any of the tests probably has a real business and is entitled to treaty benefits.On Starr’s argument that the Treaty’s failure to specifically afford benefits to companies owned by charitable entities the Competent Authority stated that it could not reach “a definitive conclusion” on Starr’s position. The argument was apparently grounded in a comparison with other bilateral U.S. tax treaties, many of which do include specific provisions affording relief to companies with such structures.  The IRS further elaborated that “it is not possible for us to conclude whether [a Limitation on Benefits] provision like that found in the US – Netherlands Tax Treaty or the US – United Kingdom Tax Treaty, which . . . may have applied to permit [Starr] treaty benefits if included in the US – Swiss Treaty, was not included in the US – Swiss treaty intentionally or by casual omission.”This case may prove to be significant given the Multilateral Instrument which includes a principal purpose test. The implementation, operation and application of Article 7(1) of the ‘Multilateral Convention’, contains provisions related to the prevention of treaty abuse, including treaty shopping that correspond to changes proposed in the Base Erosion and Profit Shifting (BEPS) Action 6 Final Report.——————-Disclaimer: This article has been prepared as a general guide and for information purposes only. It is not a substitution for professional advice. One must not rely on it without receiving independent advice based on the particular facts of his/her own case. No responsibility can be accepted by the authors or the publishers for any loss.Taxatelier publishes tax case analysis articles every month.