Starr Int'l Co. v. United States, Case No. 14–cv–01593 (CRC)

275 F.Supp.3d 228

STARR INTERNATIONAL COMPANY, INC., Plaintiff,

v.UNITED STATES of America, Defendant.

United States of America, Counterclaim–Plaintiff,

v.Starr International Company, Inc., Counterclaim–Defendant.

Case No. 14–cv–01593 (CRC)

United States District Court, District of Columbia.

Signed August 14, 2017

Rajiv Madan, Skadden, Arps, Slate, Meagher & Flom LLP, Andrew Todd Wise, Kevin M. Downing, Thomas Edward Zehnle, Miller & Chevalier, Chartered, Caroline S. Van Zile, Christopher P. Bowers, Skadden, Arps, Slate, Meagher & Flom LLP, Washington, DC, for Plaintiff.

Dennis Michael Donohue, Vassiliki Eliza Economides, William Edward Farrior, U.S. Department of Justice, Washington, DC, for Defendant.

MEMORANDUM OPINION

CHRISTOPHER R. COOPER, United States District Judge

Table of Contents

I. Background ...232

A. Statutory Background...232

B. Starr's History, Corporate Structure, and Previous Relocations...234

C. Starr's Move to Switzerland...235

D. Starr's Request for Treaty Benefits Under Article 22(6)...237

E. Administrative and Procedural History...238

II. Legal Standards ...239

III. Analysis ...240

A. The Proper Legal Standard for Awarding Treaty Benefits Under Article 22(6)...240

1. Starr's Third–Country–Resident Argument ...240

2. Starr Misunderstands the Technical Explanation's Conception of "Residency" ...241

3. If It Were Valid, Starr's Third–Country Rule Would Be a Mechanical Test; It Is Not ...243

4. Starr's Test Clashes With the Nature of Article 22's Discretionary Provision and Its Overriding Purpose ...244

5. Starr's Test Would Result In a Cramped Conception of Treaty Shopping ...245

B. The Competent Authority's Application of the Article 22(6) Standard...247

1. Whether Certain, Purportedly Key Evidence Required a Contrary Result ...247

2. Whether the Competent Authority's Analysis Rested on Irrelevant or Incorrect Determinations ...249

IV. Conclusion ...251

The bilateral tax treaty between the United States and Switzerland entitles Swiss-resident entities to a reduction in the tax rate applied to dividends they receive from U.S. sources, provided they meet one of a dozen or so objective criteria enumerated in the treaty. If none of the listed requirements are satisfied, the Internal Revenue Service may still authorize a lower rate if it determines that the Swiss entity was not established for a "principal purpose" of obtaining treaty benefits. These rules are designed to limit treaty benefits to applicants that have a sufficiently strong business or geographic connection to Switzerland.

Swiss-domiciled Starr International Company, Inc. ("Starr"), was once the largest shareholder of the insurance giant AIG. In 2007, Starr, which did not meet any of the treaty's objective criteria for benefits, petitioned the IRS for a discretionary reduction in the rate applied to some $191 million in dividends that Starr received from AIG during the 2007 tax year. After a lengthy period of discussions between the two sides, the IRS ultimately denied Starr's request for treaty benefits on the ground that Starr's historical selection of domiciles and its then-recent relocation to Switzerland were motivated as much by tax reasons as by independent business purposes. A "primary purpose" of the move, the IRS thus concluded, was to obtain treaty benefits.

Starr now challenges the IRS's denial of treaty benefits as arbitrary and capricious under the Administrative Procedure Act. Starr's primary contention is that the treaty's primary purpose test is designed to prevent the practice of "treaty shopping" and that the IRS applied an erroneous definition of that term in concluding that the company's relocation to Switzerland was largely tax-driven. Starr argues that "treaty shopping" is a precise legal term, covering only those instances where an on-paper resident of a country not party to the relevant tax treaty uses an entity that is an on-paper resident of a treaty country in order to obtain treaty benefits. Because Starr and its subsidiaries were on-paper Swiss residents and the majority of its voting shareholders were U.S. citizens at the relevant time, Starr says it could not have been "treaty shopping" under this definition. Starr's legalistic conception of "treaty shopping," however, cannot be squared with the text of the U.S.–Swiss treaty or its accompanying agency guidance. Instead, those authorities understand "treaty shopping" as encompassing situations where an entity establishes itself in a treaty jurisdiction with a "principal purpose" of obtaining treaty benefits. Because the IRS reasonably applied that standard in denying treaty benefits to Starr, the Court declines to set aside its determination.

I. Background

A. Statutory Background

When foreign corporations receive dividends from U.S. sources, that income is generally taxed at a 30% rate. 26 U.S.C. § 881(a)(1). To avoid double taxation and encourage cross-border investments, the United States has entered into numerous bilateral tax treaties with other nations. As a general matter, these treaties feature a reciprocal reduction in the tax rate on foreign-source income for domestic residents of the contracting countries. For example, the treaty at issue here, which the Court will refer to as the "U.S.–Swiss Treaty," reduces the tax on U.S.-source dividend income for Swiss residents from 30% to 5% or 15%, depending on the Swiss entity's percentage of ownership in the U.S. corporation. See Convention Between the United States of America and the Swiss Confederation for the Avoidance of Double Taxation with Respect to Taxes on Income art. 10(2), Oct. 2, 1996, S. Treaty Doc. No. 105–8, https://www.irs.gov/pub/irs-trty/swiss.pdf [hereinafter "Treaty"].

Bilateral tax treaties, including the U.S.–Swiss Treaty, thus aim to benefit residents of the two contracting states. But this "begs the question of who is to be treated as a resident of a Contracting State for the purpose of being granted treaty benefits." Dep't of the Treasury, Technical Explanation of the Convention Between the United States of America and the Swiss Confederation for the Avoidance of Double Taxation with Respect to Taxes on Income 59, http://www.irs.gov/pub/irs-trty/swistech.pdf [hereinafter "Technical Explanation"].¹ The U.S.–Swiss Treaty generally defines residency based on local tax liability: If a person "is liable to tax ... by reason of his domicile" or the like, that person is a resident of the taxing jurisdiction. Treaty art. 4(1)(a). However, "[t]he fact that a person is determined to be a resident of a Contracting State [under the treaty's definition] does not necessarily entitle that person to the benefits of the Convention." Technical Explanation 10. As the treaty framers recognized, if on-paper residency were enough to obtain treaty benefits, then it would be easy to skirt the system: Any company—no matter its actual jurisdictional or geographic ties, or the location or identity of its true beneficiaries—could simply establish itself or a subsidiary entity in one of the treaty nations, and obtain treaty benefits. That company, in other words, could easily engage in treaty shopping.

Enter "Limitation on Benefits" provisions. Common among bilateral tax treaties, and housed in Article 22 of the U.S.–Swiss Treaty, these provisions aim to deny treaty benefits to those who establish "legal entities ... in a Contracting State with a principal purpose to obtain [treaty] benefits." Technical Explanation 59. Of course, unlike determining on-paper residency, divining an entity's "principal purpose" for establishing itself in a particular jurisdiction is no easy task. Indeed, "it requires the tax administration to make a subjective determination of the taxpayer's intent." Technical Explanation 59. To ease "the administrative burdens of such an approach," id., Article 22 spells out a number of objective, mechanical tests meant to identify those treaty-country residents who are worthy recipients of treaty benefits. Generally, these mechanical tests seek to identify entities with legitimate, non-tax-related motives (such as business purposes) for their claimed state of residency: "The assumption underlying each of [Article 22's mechanical] tests is that a taxpayer that satisfies the requirements of any of the tests probably has a real business purpose for the structure it has adopted, or has a sufficiently strong nexus to the other Contracting State[.]" Technical Explanation 59. The idea is that, in order to obtain treaty benefits, the entity's "business purpose or connection [should] outweigh[ ] any purpose to obtain [treaty] benefits." Id.

Paragraph 1 of Article 22, for instance, provides that "a person that is a resident of a Contracting State and that derives income from the other Contracting State may only claim the benefits provided for in this Convention where such person" falls into one of seven categories. Treaty art. 22(1). Those categories include an "individual," id. art. 22(1)(a); an entity "engaged in the active conduct of a trade or business in the ... Contracting State" where it is a resident, if the income it derives is connected to that trade or business, id. art. 22(1)(c); and a "family foundation resident of Switzerland, unless the founder, or the majority of the beneficiaries, are persons who are not [individuals] entitled to [treaty] benefits ... or 50 percent or more of the income of the family foundation could benefit persons who are not [individuals] entitled to [treaty] benefits," id. art. 22(1)(g). These criteria are proxies for intent: The treaty drafters appreciated that individuals who actually live in Switzerland, who engage in an active trade or business in Switzerland, or who set up a Swiss family foundation in Switzerland (primarily to benefit Swiss individuals), probably are not residents of Switzerland because they want lower tax rates on their U.S.-source income.

The drafters also recognized, however, that certain entities with legitimate reasons for residing in a treaty nation might...