Background
Before the Second World War, the only protection available to foreign investments was under customary international law. Due to the absence of a framework that offered protection to foreign investments coupled with the lack of an effective dispute resolution mechanism between foreign investors and States, host states resorted to espousal indiscriminately against foreign investment.
The League of Nations, established in 1920, strived for functional cooperation between states and codification of international law and the ICC offered a forum to settle disputes by way of arbitration. However, since there were no comprehensive treaties for the protection of investments, after the Second World War, several newly independent states expropriated foreign investments in exercise of their sovereign rights.
"Naturally, developing countries sought to protect their investments in developing states and developing countries in turn wanted to attract more capital. Thus, Bilateral Investment Protection Agreements ('BIPAs') were born."
Evolution of BIPAs
A BIPA is an agreement between two countries that seeks to protect and promote the investments made by investors of such countries by imposing conditions on the regulatory behaviour of the host State. The network of BIPAs developed extensively after the OECD provided legal materials and the 1962 Draft Convention on Protection of Foreign Assets on which developed countries based their BIPAs.
Key Characteristics of BIPAs
Modern BIPAs typically include provisions for:
- Protection against expropriation without compensation
- Guarantee of fair and equitable treatment
- Full protection and security for investments
- Free transfer of funds related to investments
- Most-favored-nation treatment
- Dispute resolution mechanisms
Tax Carve Outs: Concept and Importance
Tax carve outs represent specific exclusions or limitations within BIPAs regarding taxation matters. These provisions have become increasingly important as the intersection between investment protection and tax policy has grown more complex.
Types of Tax Carve Outs
There are generally two approaches to tax carve outs in BIPAs:
- Explicit Tax Exclusions: Clear provisions stating that the agreement does not apply to taxation measures
- Implicit Limitations: Provisions that indirectly limit the scope of investment protection in tax matters
Legal Framework and Precedents
The development of tax carve outs has been influenced by several key legal developments:
- OECD Model Tax Convention provisions
- UN Model Double Taxation Convention
- Arbitral tribunal decisions in tax-related investment disputes
- Domestic tax legislation in treaty partner countries
Contemporary Challenges
Modern tax carve outs face several challenges in the current international legal landscape:
Balancing Investment Protection and Tax Sovereignty
States must balance their obligation to protect foreign investments with their sovereign right to tax. This tension has become particularly acute in cases involving:
- Transfer pricing disputes
- Anti-avoidance measures
- Digital economy taxation
- Substance-over-form doctrines
Judicial Interpretation Issues
Arbitral tribunals have grappled with interpreting the scope and application of tax carve outs, leading to inconsistent jurisprudence across different cases.
Policy Considerations
When drafting or negotiating BIPAs with tax carve outs, several policy considerations should be taken into account:
Developing Country Perspectives
For developing countries, tax carve outs present both opportunities and challenges:
- Need to attract foreign investment while maintaining tax revenue
- Balancing investor protection with fiscal sovereignty
- Addressing capacity constraints in tax administration
- Managing potential disputes with multinational enterprises
Developed Country Interests
Developed countries typically focus on:
- Protecting their investors abroad
- Maintaining competitive tax policies
- Ensuring reciprocal treatment
- Coordinating with domestic tax authorities
Best Practices in Drafting
Effective tax carve outs should include:
- Clear definitions of what constitutes a "tax measure"
- Specific exclusions for certain types of taxation
- Mechanisms for coordination between investment and tax authorities
- Procedures for resolving tax-related investment disputes
- Provisions for regular review and updating
Future Directions
The evolution of tax carve outs in BIPAs is likely to be influenced by:
- Multilateral efforts to address base erosion and profit shifting
- Increasing focus on digital services taxation
- Environmental and social governance considerations in investment
- Regional integration and harmonization efforts
Conclusion
Tax carve outs in Bilateral Investment Protection Agreements represent a critical intersection between international investment law and tax policy. As globalization continues to evolve, these provisions will require careful calibration to ensure they serve their intended purpose of promoting investment while respecting states' sovereign taxing rights.
The ongoing development of jurisprudence and policy frameworks will be essential to creating a balanced approach that serves the interests of both investors and host states in the international investment landscape.