The tax authorities had issued an assessment according to which royalty payments from Colgate Palmolive España S.A (CP España) to Switzerland were not considered exempt from withholding taxes under the Spanish-Swiss DTA since the company in Switzerland was not the Beneficial Owner of the royalty-income.
The assessment was set aside by the National Court in a decision issued in November 2018.
The Supreme court were to clarify the conformity with the law of the judgement of the Audiencia Nacional, following in the wake of the order of admission which, in a similar manner to that proposed in appeal no. 5448/2018, ruled in favour of the taxpayer on 3 February last, asks the following questions.
a) to clarify the objective and temporal limits of the so-called dynamic interpretation of the DTAs signed by the Kingdom of Spain on the basis of the OECD Model Convention – as in this case the Spanish-Swiss DTA – when, despite the fact that the concept of beneficial owner is not provided for in article 12 of the DTA, this figure is applied in accordance with the Commentaries to the OECD Model Convention (drawn up at a date subsequent to the initial formalisation of the Convention), despite the fact that the beneficial owner was not introduced in Article 12 (relating to royalties) in subsequent amendments to the DTA, but was introduced in other provisions (Articles 10 and 11) for other concepts such as dividends or interest.
b) Whether dynamic interpretation, if possible, allows the applicator of the rule, including the Court in proceedings, to correct the actual meaning or literal tenor of the rules agreed in the Convention, which occupies a preferential place in our system of sources (Article 96 EC), in order to avoid treaty overriding or unilateral modification.
c) Clarify whether the Commentaries to the OECD Model Convention (here drawn up at a date subsequent to the signing of the Convention) constitute a source of law in their own right (Articles 117 EC and 1. 6 of the Civil Code), as they are not, as we have stated – STS of 19 October 2016, pronounced in appeal no. 2558/2015-, as they are not strictly speaking legal rules that are binding on the Courts of Justice and which, therefore, can be the basis for a ground for cassation in their hypothetical infringement and whether, consequently, the Courts can rely on their indications or opinions to stop applying a double taxation Convention and directly apply the national law, which results in a qualitatively higher taxation.
These questions coincide substantially, with slight variations in formulation, with those examined in appeal no. 5448/2018, which gave rise to the favourable judgment -for the taxpayer- of 3 February 2020. This leads us to specify the neuralgic points of the problem raised here, as far as they coincide, for the decision of the appeal in cassation and the formation of jurisprudential doctrine in this matter:
a) what is the dynamic interpretation of the Conventions and whether it is an expression that can find equivalents in our legal tradition; b) whether the OECD model agreements or their commentaries, by their origin and nature, are legal rules that the courts of justice must take into account when interpreting the rules agreed in the Conventions, in accordance with the provisions of Articles 94 and 96 of our EC; c) whether such commentaries, guidelines or interpretative models can take precedence over the hermeneutical rules, either those agreed between the signatory states or in other conventions and treaties, or those of their respective domestic legal systems, and by virtue of what source of legitimacy; d) whether this dynamic interpretation can be used to interpret an article of the Convention on the basis of the content of other subsequent rules of the same Convention, in any event not in force at the time of application of the withholdings required here; and e) whether Spain can unilaterally interpret, on the basis of this rule, the concept of royalties, as well as that of beneficial owner, in order to deny that it is present in the paying company.
Judgement of the Supreme Court
The court held in favour of Colgate and set aside the decision of the tax authorities.
“The provisions of paragraph 1 shall not apply if the beneficial owner of the interest, who is a resident of a Contracting State, carries on a business in the other Contracting State from which the interest arises through a fixed establishment situated in that other State and the debt-claim giving rise to the interest is effectively connected with that fixed establishment. In such a case the provisions of Article 7 shall apply”.
As already indicated, it should be stressed that the wording of Article 12 (royalties) did not include any reference to the concept of beneficial owner (despite having had the opportunity at the time of the amendment of the Convention).
Moreover, to date, the concept of “beneficial owner” has not been introduced in Article 12 either, despite the fact that there has been a second amendment of the Spain-Switzerland DTA through the Protocol made in Madrid on 27 July 2011 (BOE of 11 June 2013) – “Protocol of 2011”.
That is to say, without prejudice to the incorporation of the concept of “beneficial owner” in the 1977 and 1995 Model Conventions and the subsequent amendments made to the conventional text that came to reflect this and other modifications introduced in the Model Convention, the fact is that the literal wording of the sections that interest us here in Article 12 of the Spain-Switzerland DTA maintains, to date, its original wording. That is to say, the States have agreed to modify and adapt the CDI to the new standards set out in the Model, but only in those provisions expressly agreed by both States and among which the provision relating to royalties was not included […]”.
“By their very nature, the above considerations lead us to the need to annul and set aside the lower court judgment, on the grounds that it is based on an erroneous interpretation of the legal system and, resolving in its place the debate at first instance, uphold the contentious-administrative appeal, annulling the settlement and review agreements appealed against, with recognition of CD SPAIN’s application of the 5% withholding rate provided for in Article 12 of the Spain-Switzerland DTA, the only one possible in a grammatical, logical and systematic interpretation of the precept, based, among other things, on the fact that this provision does not provide for the beneficial owner clause, although it could have done so – there have been two reforms, the last in 2013, of Article 12 of the DTA – without the appeal to purely practical or technical rules, but not legal ones, such as those included in the model agreements and their commentaries, being able to serve to deliberately circumvent a true international agreement, which could only be done through the channels of reform that the instrument itself provides for, and after its incorporation into our domestic legal system.
To this end, there are two points in the reasoning of the judgment on which we should dwell, albeit briefly: a) firstly, it is astonishing that the beneficial ownership clause or principle should be considered as a kind of meta-legal rule or natural law that must always and at all costs be imposed on the convention itself and on a rational and legal interpretation of its precepts, regardless of its specific regulation and, therefore, of the sovereign will of the countries that enter into it.
The case can only be concluded by highlighting the obvious, that the DTA with Switzerland, which has been amended several times, and in some cases to include the beneficial owner principle – only for the purposes of dividends and interest, not royalties, which expressly excludes such a figure – is a source in law, which cannot be ignored by a Court of Justice, however “reasonable” such a solution may be in the opinion of the Administration, which is followed in everything by the Court, and however much an unknown “best doctrine” – which is not a source of law in Switzerland either – may be, in the opinion of the Administration, which the Court of First Instance follows in everything, and however much a “best doctrine” – which is not a source of law in the case of the DTA with Switzerland – may be, in the opinion of the Court of Justice, a source of law in itself.
-which is also not a source of law within the meaning of Article 1.1. of the Civil Code, supposedly endorses such a breach of the legal system; b) the second point is even more difficult to understand, and even less to agree with, since the Court of First Instance, after using all its dialectical energy to defend the application of such a principle – even taking into account the active silence of the IDC in this respect – which would lead directly to the application of the DTA with the United States, the final destination of the royalty payments – in the administrative argument – then abandons this criterion, claiming, again on the basis of the Inspectorate’s argument, that it is accepted without further ado: “it cannot be proved, without more specific evidence, that the entity of the group mentioned therein as the creditor of this income, Colgate Palmolive Company, is the recipient of this income under the conditions that would determine that it is the effective beneficiary’. Note that, as the Inspectorate states, ‘the flow followed by the royalty income, which could well have been channelled through (or located in) any jurisdiction […], is unknown’.
In short, the Audiencia Nacional seems to affirm that the application of the beneficial owner principle is obligatory and ineluctable, which would not be CP EUROPE but, on the basis of such a requirement, somewhat necessarily brought up, in open non-observance of the Spanish-Hellenic agreement, it is then stated that there would be as many hypothetical or theoretical beneficial owners as places or countries through which the royalty flow could have transited – a fact that is claimed to be unknown – which shows that the beneficial owner, according to the Administration, would not be the North American parent company that distributes the royalties, as the ultimate destination – an unusual assumption that the ruling accepts, despite contradicting the very concept of beneficial owner. This invention of the Administration seems to have the sole purpose of taxing the appellant in accordance with Spanish law, which is much more onerous for the interests of the appellant – a 24 or 25 per cent tax is imposed, depending on the year.”