The Implications Of a Cancelled Treaty

It has recently been reported that Argentina has unilaterally cancelled its 1997 double tax avoidance agreement (DTA) with Switzerland. Although the treaty was not ratified by the Argentinian parliament, it came into force on a provisional basis from 1st January 2001 through an additional protocol signed in 2000.

Interestingly, Argentina has called unambiguously for a Tax Information Exchange Agreement (TIEA) with Switzerland instead of a full DTA:

"Finally, in the abovementioned note, the Argentine government proposed to the Swiss government to enter into an Exchange of information Agreement for tax purposes (following the OECD model) and an Exchange of Information Agreement for customs matters (based on the World Customs Organization model) in order to increase collaboration between the tax and customs authorities of both jurisdictions."

This call for a more narrow TIEA suggests that Argentina was unwilling to renegotiate its DTA with Switzerland in order to include a typical Article 26 information exchange clause in this treaty. This unwillingness migth have been related to another detail reported about the treaty by Ernst and Young:

"It is important to note that, among the tax treaties signed by Argentina, the Treaty included some of the most beneficial clauses for foreign investors, such as an exemption from net worth tax for Swiss resident investors in Argentine companies, and reduced withholding taxes on royalty and interest payments from Argentine residents to Swiss residents."

Perhaps, the concessions granted in the DTA to Swiss-based investors (or those using the Swiss treaty provisions) were no longer seen as balancing the benefits gained by Argentina from the treaty. Which raises the questions: to what extent are developing countries benefitting from DTAs?.

In practice, DTAs between developing or emerging market countries and corporate tax havens such as Switzerland are generally problematic. Because DTAs frequently lead to drastic reductions of withholding taxes on royalty and interest payments, they create a strong incentive for multinational corporations to use fake or overpriced royalty and interest payments for profit shifting. When signing DTAs, developing and emerging market countries can end up losing possible revenues from both corporate profit taxes and withholding taxes on the transfer payments. This loss might be compensated by an increase of foreign direct investment, but research on whether or not DTAs lead to such an increase shows mixed results at best (for instance, here).

In the case of the now terminated DTA between Argentina and Switzerland, withholding taxes on royalty and interest payments were reduced, but not entirely abolished. However, the Swiss government indicated some time ago that it wanted to re-negotiate this treaty and further reduce, or possibly abolish, the remaining withholding taxes. Its most potent bargaining chip would have been the introduction of a tax information exchange clause (for more details, see pages 23-24, here). As Mark Herkenrath has shown in the Switzerland edition of TJN's Tax Justice Focus, Switzerland is only willing to include tax information exchange clauses in revised DTAs if the counterparty is willing to reduce or abolish its withholding tax rates.

Argentina's termination of the existing DTA looks like a very clear political statement: while Argentina clearly wants Switzerland to provide it with tax information exchange, it is not willing to accept the Swiss demand for a further reduction of withholding taxes in the framework of a revised DTA. This would explain why, according to the Ernst & Young summary mentioned above, Argentina has not only terminated the existing DTA, but is calling for a simple TIEA that does not cover withholding tax issues.

Argentina may be among the first country ever to challenge the idea (as promulgated by the G20 and the OECD) that it makes no difference whether notorious tax havens provide tax information exchange in the framework of revised DTAs or new TIEAs. This idea is simply wrong. DTA revisions give tax havens such as Switzerland formidable possibilities for raising counter-demands in the realm of withholding taxes. TIEA negotiations do not.

We are heartened to note that Argentina appears prepared to apply a cost-benefit approach to its existing DTA network. Iprofesional reports that the tax agency AFIP is restructuring in order to review its treaties to detect abuse, and to evaluate the overall fiscal impact of the treaties and their performance measured by their stated objectives (which are often related to attracting foreign investment).

We hope that other (developing) countries may follow suit since the Swiss government is not alone in trying to impose a quid pro quo on exchange for information exchange. The other havens which were the targets of the OECD’s drive to negotiate TIEAs have also been trying to get something in return, preferably a full DTA. Other OECD countries, notably the Netherlands, seem to be playing along with this game. Argentina’s stance is therefore very important in this context.

All of this confirms our view that we urgently need a multilateral framework for tax transparency, including effective, automatic information exchange and country-by-country- reporting.