Star International versus the United States of America
Tax Treaty Shopping? Star International vs. United States of America
- The case involved a dispute over tax refund and US-Swiss tax treaty.
- IRS denied Starr International a full refund based upon alleged tax treaty shopping.
- The company appealed twice and was advised by US Circuit Court to file another appeal based upon the proper definition of “principle purpose.”
In 2007, Starr International filed suit against the United States. There was a $38 million tax refund to the company in dispute and, from the IRS’s perspective, the issue was tax treaty shopping. The company had recently moved to Switzerland and wanted to take advantage of provisions of the US-Switzerland tax treaty to reduce their tax rate to 15 percent from 30 percent on a dividend payment from a US corporation. The dividend payment was subject to the 30 percent withholding rate because it was US-sourced fixed or determinable, annual or periodic (FDAP) income paid to foreign persons.
The company wanted the withholding to be reduced to 15 percent as provided by the 1996 US-Swiss tax treaty Article 22(6) and petitioned the US competent authority, the IRS, for discretionary relief. The IRS denied the petition because the company did not automatically qualify for tax relief under the treaty’s “limitations on benefits” provisions, designed to detect and prevent treaty shopping on the part of taxpayers.
Under Article 22(6) [of the US-Swiss tax treaty of 1996], the competent authority of the treaty country in which the taxpayer’s income arises:
“will base a determination under this paragraph on whether the establishment, acquisition, or maintenance of the person seeking benefits under the Convention [tax treaty], or the conduct of such person’s operations, has or had as one of its principal purposes the obtaining of benefits under the Convention. Thus, persons that establish operations in one of the States with a principal purpose of obtaining the benefits of the Convention ordinarily will not be granted relief under paragraph 6. Id. at 72. This “principal purpose” test provides the standard for evaluating whether a taxpayer is entitled to relief under Article 22(6).”
In a Joint Appendix, the IRS indicated it found “troubling” certain facts and circumstances, including Starr’s initial incorporation and legal structuring in Panama; its subsequent relocation to Ireland to enjoy the benefits of the US-Ireland tax treaty in anticipation of receiving other corporate dividends; the relatively short time the company stayed in Ireland before relocating again to Switzerland as the current dividend in question was to be paid.
The IRS denied the tax refund requested because these circumstances lead directly to the conclusion that the principal purpose of relocating to Switzerland was to obtain the benefits of the US-Swiss tax treaty. In their opinion, the IRS stated they could not conclude “that obtaining treaty benefits was not at least one of the primary purposes for moving the company’s management, and therefore its residency, to Switzerland” in violation of Article 22(6).
Starr International’s initial appeal asked the IRS to grant the company treaty benefits by negotiating with competent authorities in Switzerland to settle the tax withholding issue, which would be the practice in such a dispute. The US District Judge denied the appeal, stating the case raised a nonjusticiable political question because it encroached on the executive branch’s diplomacy rights. However, the D.C. Circuit Court ruled that the District Judge was incorrect about the political question doctrine because “A district court decision will not have an impact on the consultation between the US and Swiss competent authorities.”
After having been denied the tax refund based upon the political question doctrine, Starr International amended the complaint to claim the denial of treaty benefits violated the Administrative Procedure Act (APA) because it was arbitrary and capricious. However, the US Circuit Court argued that the APA was the appropriate remedy only in cases where there is no other remedy available. Since the initial appeal was overturned because of the political question doctrine not applicable in this case, the taxpayer did have a remedy: successfully claim the tax refund.
What was the “principle purpose” of the move to Switzerland?
Furthermore, the US Circuit Court ruled that the initial denial of the tax refund was incorrect in its interpretation of the “principal purpose” provision in the US-Swiss Tax Treaty. The court ruled that the IRS had ignored the term “principal” and decided that “purpose” was merely an indication that the company wished to consider the tax consequences of a move to Switzerland, which is not enough of a reason to deny the tax refund to the company.
There was, in fact, substantial evidence that Starr International’s real principal purpose for the Swiss move was to protect its assets from AIG Inc., a company from which Starr received substantial dividend income as AIG’s largest shareholder, with 290 million shares of stock. Relations between the two companies soured when Starr’s CEO, who had been an executive at AIG, left the company and moved to Starr. AIG sought to gain control of Starr’s board of directors and the 290 million shares. Starr’s legal counsel advised the move to Switzerland could help protect those assets, and company control, due to Swiss law requiring AIG to get 51 percent of shareholders to vote out the existing board. This ”principle purpose” was well outside any tax treaty or the desire for a $38 million tax refund.
The final determination as to whether Starr International will be awarded the tax refund is still pending.