When the European Commission (the “Commission”) issued its anti-tax avoidance package on 28 January 2016, it included a recommendation to EU Member States on the implementation of measures against tax treaty abuse (the “Recommendation”). The Recommendation encourages Member States to include certain provisions in their double tax treaties. The Recommendation is not legally binding on Member States and accordingly may be of limited relevance.

However, a few months ago the Commission issued a much stronger message to Member States on double tax treaties in the form of infringement proceedings issued against the Netherlands with respect to a limitation on benefits provision (“LOB”) included in the Dutch double tax treaty with Japan. In this update, we examine both developments.

The infringement proceedings

In November 2015, the Commission commenced infringement proceedings against the Netherlands in respect of the LOB in the Japan / Netherlands double tax treaty. Under the terms of the LOB included in the Japan / Netherlands treaty, a Dutch resident company that is 100% owned by Dutch resident individuals can qualify for treaty relief, whereas, a Dutch resident company that is 100% owned by residents of EU Member States other than the Netherlands may not qualify for relief. The Commission’s position is that a Member State concluding a treaty with a third country cannot agree better treatment for companies held by shareholders resident in its own territory than for comparable companies held by shareholders who are resident elsewhere in the EU.

The Commission has asked the Netherlands to amend the LOB included in the Japanese double tax treaty. In the absence of a satisfactory response from the Dutch, the Commission may refer the complaint to the Court of Justice of EU (“CJEU”) and in some cases such proceedings can result in financial sanctions for the Member State involved. The Dutch had two months to respond to the Commission. That timeline elapsed in January 2016 and to date, no official response has been published by the Dutch Government, nor has the Commission issued any public update with respect to any further steps it has taken. It will take some time for the matter to be finally resolved. In the meantime, the threat of potential infringement proceedings will no doubt influence Member States in their future treaty negotiations and implementation of the recommendations made by the OECD under Action 6 of the base erosion and profit shifting (“BEPS”) project.

Bearing in mind the bilateral nature of double tax treaties, the involvement of the Commission raises a number of novel issues. For example, if the CJEU ultimately decides that equivalent treatment must be afforded to Dutch companies that are owned by residents of other Member States, how can the Netherlands force Japan to agree to such an arrangement? Should the application of the treaty in such cases be regarded as a Japanese, rather than a Dutch or EU, matter? If Japan refuses to amend the LOB, what is the practical outcome? Would the Netherlands rescind the treaty to avoid or mitigate fines? What impact would a decision of the CJEU have on double tax treaties agreed by other Member States (including treaties with the US that contain LOB clauses)? Would Dutch companies that are owned by residents of other Member States be entitled to be compensated for Japanese withholding taxes suffered by reason of their inability to satisfy the LOB? Against whom would they have a claim?

The timing of the proceedings is notable. As far back as 1992, the potential discriminatory effect of LOBs had been highlighted to the Commission in the Ruding Report. So why has the Commission decided to act now? Perhaps it has one eye on the implementation of the recommendations made under Action 6 of the BEPS project. It is also reflective of the Commission’s increasing willingness to use the enforcement tools at its disposal in the area of direct tax, an area that remains a matter of competence for Member States. For how long this trend will continue is unclear.

The Recommendation

The Recommendation comprises two components:

  • first, if Member States include a principal purpose test (“PPT”) in their double tax treaties, the Commission recommends that the language of the PPT should be drafted so that it does not deny treaty benefit in cases where it can be established that the transaction or arrangement in respect of which treaty relief is sought “reflects a genuine economic activity” – the Commission’s view is that incorporating this additional language in a PPT results in the provision being EU law compliant; and
  • second, the Commission encourages Member States to include the revised permanent establishment (“PE”) definition agreed under Action 7 of the BEPS project in their double tax treaties.

The first recommendation is perhaps more interesting for what it doesn’t say than for what it does say. It does not expressly require Member States to include a PPT in the double tax treaties they agree. Nor does it expressly preclude or discourage Member States from including LOB provisions in their double tax treaties. It simply recommends that if a PPT is included in a double tax treaty agreed by a Member State, it should incorporate the additional language noted above.

On the other hand, two other documents issued by the Commission on the same day as the Recommendation, a Commission Staff Working Document and a Communication from the Commission to the European Parliament and the Council explicitly state that the Commission considers LOB clauses to be detrimental to the Single Market and problematic for the Capital Markets Union. It is difficult to understand why the Recommendation itself does not expressly reflect that view and as such appears to be somewhat diluted. Perhaps the Commission considers that the Dutch infringement proceedings sufficiently express their position.

The second recommendation follows on from a proposal made by the European Council (“Council”) in December 2015. At that time the Council issued a draft directive covering many of the items now included in the draft Anti-Tax Avoidance Directive. That draft included a provision requiring Member States to adopt a minimum threshold for recognising PEs in accordance with the recommendations made under Action 7 of BEPS. No such provision was included in the draft Anti-Tax Avoidance Directive issued on 28 January and the Commission Staff Working Document acknowledges that the “matters do not lend themselves easily to be addressed in a legally binding instrument such as a Directive, which is why they are included in a Recommendation”.

As noted above, the Recommendation is not legally binding. It remains to be seen whether any Member State will have regard to its provisions when negotiating double tax treaties.


The recent EU developments affecting double tax treaties in many ways reflect the EU’s approach on direct tax matters. Legally such matters remain within the national competence of EU Member States and accordingly, legislative proposals require unanimous approval. Given that requirement, it is not unusual for those proposals to fail (eg, the financial transaction tax and the 2011 common consolidated corporate tax base proposal). The Commission is acutely aware of the difficulties inherent in a system that requires unanimity before legislative proposals can become effective and recognised this in an official document as far back as 2001.

As also recognised by the Commission in 2001, other methods are available to them to achieve progress in removing perceived tax obstacles and distortions to the internal market, methods such as infringement proceedings and State aid. More recently, we have seen increased enthusiasm (on the Commission’s part) for those other methods. The infringement proceedings against the Netherlands are a case in point and likely will be much more influential on the behaviour of Member States in their future double tax treaty negotiations than the Recommendation.

It is increasingly apparent that the Commission is seeking to play a greater role in the area of direct taxation. Are Member States prepared for the implications of this and will they be willing to concede national competence in this area?

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