The acquisition of treaty-shopping benefits consists in the use of the benefits of a given double taxation agreement by an entity established in the territory of a State which is not a party to that agreement and is therefore not covered by its entity.
A person who is not resident in any of the States, parties to a given double taxation agreement, may obtain the tax benefits provided for in that agreement if its provisions are applied to financial transactions carried out by that person.201 However, in order for that situation to take place, a person wishing to acquire tax benefits resulting from the provisions of the tax agreement must establish a subsidiary in the territory at least one from States which are parties to the Agreement.
The economic intention of the applicant to acquire the tax advantages resulting from the contract, rather than the fact that a subsidiary is established in a country (territory), is therefore crucial for the qualification of a specific action as ‘attracting a contractual advantage’, which is, as a rule, legally permissible.
Of course, most international tax planning mechanisms have certain contractual advantages. The very fact that subsidiaries are established in countries which are parties to favourable double taxation agreements, which are motivated by the desire to benefit from these favourable contractual provisions, regardless of the method adopted, is a form of acquiring contractual advantages.
The acquisition of contractual advantages is, regardless of the method chosen, widely regarded as circumventing the law, at least in an axiological sense. Under the current Polish legal order, tax law cannot be circumvented in formal terms, since this concept is not normative and such action is not legally prohibited, which is equivalent to its legal nature. In principle, the acquisition of contractual advantages can take the form of four Methods203, where numerous combinations of elements taken from different methods are possible, this makes it significantly difficult to identify economic interlinkages and the economic sense of financial flows between the parent company and its subsidiaries. The basic methods of acquiring contractual advantages which distinguish between doctrines are:
- • method of using subsidiaries, daughters established in both countries, sides of the respective double taxation agreement,
- • the method of the ‘equivalent’ loan to the company – the daughter and the collection of interest-free interest,
- • indirect loan method,
- • method of using a foreign subsidiary.
The essence of each of the above methods is the same and boils down to the "entry" into the tax-friendly rights of foreign entities resulting from the provisions of the double taxation agreement of the binding State of residence of those entities.
In principle, the acquisition of contractual advantages applies primarily to passive income subject to favourable taxation under a given tax agreement. Of course, most international tax planning mechanisms have certain contractual advantages.
The very fact that subsidiaries are established in countries which are parties to favourable double taxation agreements, which are motivated by the desire to benefit from these favourable contractual provisions, regardless of the method adopted, is a form of acquiring contractual advantages.
first the method of acquiring contractual advantages is the method of using subsidiaries established in both countries, the parties to the respective double taxation agreement, appearing in the literature under the English name ‘direct conduit method’205 and based on the assumption and use two companies — daughters established in countries which are parties to a double taxation agreement, which exempts from taxation a certain income paid206 from sources located in one of those countries to persons established in the other of those countries.
A foreign company wishing to benefit from the tax benefits of such an agreement assumes companies – daughters in the countries related to that agreement, and then transfers ownership of all shares in one of these companies to the other of them, resulting in the obligation to pay dividends by first of companies — daughters second the company – the daughter.207 According to the tax agreement binding the state of residence of the companies, these dividends will be tax-free.
second method of acquiring contractual benefits, most commonly referred to as the English ‘stepping-stone method’209, It comes down to the granting by the company, the mother of the so-called ‘equivalent’ loan to the company, to a daughter located in a tax haven where the state of residence of the company, of the daughter is bound by a double taxation agreement with another country applying harmful tax competition, which provides for an exemption from the withholding tax of interest paid between residents of those countries.210 Foreign unit established in the territory of the State third, in order to benefit from the provisions of this agreement, establish a company – a daughter in the territory of one of the parties to this agreement. Having granted loans to entities established in the second country associated with this favourable double taxation agreement, the parent company transfers all rights related to these loans to its company – daughter.
The next step in acquiring the contractual advantage in this version is the granting by the company, the mother of the so-called ‘equivalent’ loan to its company, to the daughter of the same amount as the loans granted by the company, the mother of residents second the State party to the above favourable tax agreement.212 Since all rights relating to this loan have previously been transferred to the company, the daughter, including the right to interest, the daughter, will receive withholding tax free interest on that loan and subject to taxation in the country of its residence.
However, the tax liability of the company – the daughter can be ‘balanced’ by deducting the interest that it pays to its company – to its mother for the loan it received.213 The fact that the two loans amount to identical amounts makes the resulting tax obligations fully ‘balance’.
As a result, the company – the mother – derives from its company – the daughter's unpaid interest. In the case of the above method of acquiring contractual benefits, it is also possible to establish a company – a daughter in the second State party to a favourable tax agreement and granting it a loan.
The further scheme of financial flows between the company – the mother and its companies – is the same, and the only difference is to replace independent entities in a country applying harmful tax competition wholly owned by a wholly owned subsidiary, which allows for the widest possible control of the capital transferred and for increased financial security of the entire group participating in that mechanism.
third the method within the ‘treaty-shopping’ phenomenon (indirect loan method) is of an auxiliary nature to previous methods.
It uses a loan granted by a company established in a country whose legal system is considered to be harmful to its tax company, a daughter located in the territory of a State which is a party to an agreement to prevent double taxation, which exempts interest paid at source between resident entities of the countries of that agreement.215 The necessary assumption for this method is the high level of taxation of passive income in the State bound by that tax agreement.
At that time, a company established in a jurisdiction considered to be applying harmful tax competition in order to obtain income from the sources in that jurisdiction second the State would have to pay a high income tax in accordance with its legislation in the absence of a double taxation agreement concluded between that State and the State of its residence.
In order to overcome these inconveniences, the above company establishes a company – a daughter in first from countries – parties to this agreement, and then the company invests in second Contracting States for which it will collect untaxed income (interest, dividends, royalties).216 This revenue will be transferred to a company – a mother established in a harmful country for tax purposes, while a company – a daughter will deduct interest paid to her mother from interest received from second Contracting States for their investments.
As a result, the company – the mother will receive untaxed interest, and the entire capital group participating in this mechanism will make tax savings.
The last method of acquiring contractual advantages consists in the use of a foreign subsidiary which is established in a country which is a party to a favourable double taxation agreement, which provides for an exemption or unconditional reduction of the withholding tax on passive income paid between resident entities of the countries concerned.217 Company – daughter investing in the contracting State acquires the right to obtain non-taxable income from its territory for the investments made there (may be interest, dividends and royalties).218 The capital thus acquired after tax on favourable terms is then left at the disposal of the company – the mother, the group or the company – its daughter.