THE TREATMENT OF TAXATION AS EXPROPRIATORY IN
INTERNATIONAL INVESTOR-STATE ARBITRATION
A state’s power to tax individuals and entities within its jurisdiction also empowers the state with the tools to
take and/or destroy investments within its reach. 1
By ALI LAZEM* and ILIAS BANTEKAS*
ABSTRACT
Domestic tax measures are treated by investment tribunals as a fundamental attribute of
sovereignty and constitute lex specialis in relation to the general rule on expropriation under
customary international law. Although both direct and indirect expropriation is possible
through the imposition of tax measures, in practice such a finding is rare and is further
restricted by joint tax vetoes and tax exclusion clauses in BITs and bilateral tax treaties. This
inclination in favour of host states is further confirmed by the requirement that the conduct
requirements for expropriation be satisfied, although the role of conduct requirements is to
differentiate between lawful and unlawful expropriation. The lex specialis character of tax
measures suggests, particularly as a result of cases such as Burlington, that investment
tribunals are unlikely to lower the threshold of state liability for expropriation arising from
tax measures and are in fact likely to view the substantial deprivation standard very strictly
and in a manner that requires a total deprivation of property.
Introduction
The regulation of tax in international investment law is hardly straightforward even if, as this
article demonstrates, the imposition of arbitrary and discriminatory taxes may amount to both
direct and indirect expropriation, as well as a violation of an applicable standard of investor
treatment. For one thing, the levying of taxes is an indispensable function of sovereignty, lest
states are unable to attain the requisite resources to uphold their sovereignty or survival. This
has given rise to a presumption in favour of the validity of tax-related measures under
international investment law.2 Moreover, the sovereign power to tax is subject to several
(consensual) limitations under international law, particularly trade liberalisation agreements,
whether in the form of regional free trade agreements (such as NAFTA)3 or global
arrangements such as those set up by the WTO. Whereas the restrictions on tariffs (taxes on
* LXL LLP (London).
** Professor of International Law, Brunel University School of Law.
1
Nearly 200 years ago, in the United States case of McCulloch v. Maryland (1819) 17 U.S. 327, the judge
presiding over the case, Chief Justice Marshall, correctly asserted that “… the power to tax involves the power
to destroy…”.
2
See El Paso Energy International Company v Argentine Republic, ICSID Case No. ARB/03/15, Award of 31
October 2011, para 290.
3
See, for example, Art 77 of the EC-Chile FTA which applies the national treatment principle in respect of
internal taxes to imported goods. Given that importers of goods engage in trade and not investment, a violation
of this provision does not give rise to international investment arbitration (IIA).
foreign goods upon entry) and internal taxes4 in the context of trade liberalisation treaties are
meant to inhibit any undue advantages to similar domestic products (essentially by making
the imported goods more expensive),5 the purpose in foreign investment law is to decrease
the economic value of the investment in such a manner that its operation is no longer
profitable to the investor. These two restrictions on the imposition of (arbitrary) taxes are
over-arching and it is not unusual for concerned states to initiate proceedings under the WTO,
subsequently followed by submission to investment arbitration.6 Exceptionally, some taxes
are far too favourable towards investors which in turn is viewed by other nations as a
facilitation of tax evasion and ultimately money laundering. Such tax practices are often
subject to multilateral sanctions and other countermeasures, as is the case with the tax
practices of tax heavens and countries maintaining fictitious fleets under so-called flags of
convenience. As will become evident in the course of this research the recent spate of
bilateral investment treaties (BITs) and free trade agreements (FTAs) specifically address the
authority of host states to impose internal taxes. The overall aim of all the aforementioned
restrictions is to maintain and enforce a level playing field between investors, imports and
local competitors and goods, while at the same time respecting the host states’ tax powers,
chiefly on the basis of mutuality.7
As a result of these considerations a variety of international legal regimes have arisen
concerning the determination as to the legitimacy and regulation of taxes. Trade
liberalisation, whether regional or global, is one, followed by international law on foreign
investment, particularly as regards the assessment of expropriation and the application of
appropriate standards of investor treatment.
An additional regime is that established under bilateral or multilateral tax treaties,
many of which now envisage a specialised arbitration procedure in respect of double
taxation8 or other specialised disputes, such as advance pricing agreements.9 Arbitration
lawyers would not rush to characterise these processes as akin to arbitration because of their
largely public nature as well as the absence of the type of party autonomy usually associated
4
Trade liberalisation encompasses tariff barriers and non-tariff barriers. As far as the former is concerned, the
term tariff is broad and includes practices such as duties, surcharges and export subsidies. Non-tariff barriers
include licensing requirements, quotas and arbitrary standards, among others.
5
In the 1970s developed countries were allowed to grant preferential tariffs to imports from least developed
nations, a system known as Generalised System of Preferences (GSP), which constituted an exception to the
most favoured nation (MFN) principle, itself a cornerstone of GATT and later the WTO. This was formalised in
1979 through an instrument known as the Enabling Clause, Articles 1, 5 and 7. See ʻDifferential and more
favourable treatment reciprocity and fuller participation of developing countriesʼ, Decision of 28 November
1979. This remains in force under Article 1(b)(iv) of the 1994 WTO Agreement.
6
WTO, Mexico – Tax Measures on Soft Drinks and Other Beverages, adopted on 24 March 2006; the same tax
measures were subject to investment arbitration between Cargill Incorporated v United Mexican States, ICSID
Case No. ARB(AF)/05/2, Award of 18 September 2009 and Archer Daniels Midland Company and Tate & Lyle
Ingredients Americas Inc. v United Mexican States (ICSID Case No ARB(AF)/05/05), Final Award of 21
November 2007.
7
Joint tax vetoes and tax exclusions [because relevant matters are ordinarily the subject matter of other bilateral
or multilateral tax treaties] constitute standard clauses in many contemporary BITs and FTAs. See A Kolo, Tax
“Veto” as a Special Jurisdictional and Substantive Issue in Investor-State Arbitration: Need for Reassessment?
(2008-2009) 32 Suffolk Transnat'l L. Rev 475.
8
For example, Art 25 OECD Model Tax Convention and Art 7 of the EC Convention on the Elimination of
Double Taxation in Connection with the Adjustment of Profits of Associated Enterprises was adopted in 1990
[EU Arbitration Convention], 90/436/EEC, OJ L 225 (20 August 1990). See I Bantekas, The Mutual Agreement
Procedure and Arbitration of Double Taxation Disputes, (2008) 1 Colombian YBIL 182.
9
The 2006 Protocol Amending the Convention between the USA and Germany for the Avoidance of Double
Taxation and the Prevention of Fiscal Evasion with Respect to Taxes on Income and Capital and to Certain
Other Taxes provides for mandatory arbitration in respect of certain cases in the mutual agreement procedure
(Art 25).
with international commercial arbitration. Nonetheless, they are not straightforward public
law procedures and in any event constitute an exception to the general rule whereby tax
disputes between a tax payer and the state are not susceptible to third party determination.
Inter-state resolution of tax disputes, the fourth variable identified in this research, is
generally non-contentious in the sense that states anticipate relevant issues through bilateral
tax agreements, which unlike regular treaties, involve a continuous process of inter-state
collaboration that is flexible and readily adapted to changing circumstances without in any
way implying that disputes do not arise. Typical disputes concern transfer pricing, division of
revenues from value added taxes, double taxation, source-based withholding tax on royalties
for intellectual property (such as trademarks and copyright) used in one country and paid to
enterprises or persons resident in another10 and others. No doubt, other inter-state disputes
can arise in connection to taxes, such as under sovereign financing agreements and regarding
the obligation of the borrowing nation to impose and collect unpopular taxes, but such
disputes will not normally culminate in contentious litigation or arbitration because the lender
can simply refuse to provide debt relief or further financing.
The fifth and final variable concerns the human rights dimension of tax, which
although individual in nature should be distinguished from the personal entitlement to
investment (or other) arbitration affordable to the victim of arbitrary or illegal tax; with the
exception of expropriation which is viewed as a deprivation of the right to property, IIA does
not perceive other violations against investors through the lens of human rights (e.g. violation
of the national treatment principle as discrimination) nor indeed are the available remedies
predicated on human rights considerations. Nonetheless, where an arbitrary and
discriminatory tax is considered by an international judicial entity as a violation of the right
to property the outcome is equal in legal nature (not necessarily its effects) to expropriation,
albeit the range of cases is limited because of the exclusion of states’ tax competence from
human rights scrutiny.11
The European Convention of Human Rights (ECHR) only makes reference to tax in
the context of the right to property in Article 1(2) of Protocol I to the ECHR and then merely
to affirm the tax sovereignty of states. The European Court of Human Rights (Eur Ct HR) has
generally been disinclined to encompass tax within the remit of fundamental freedoms under
the ECHR, even in situations where the national authorities viewed the tax in question as
unconstitutional.12 In Ferrazzini v Italy the Court held that “tax disputes fall outside the scope
of civil rights and obligations, despite the pecuniary effects which they necessarily produce
for the taxpayer”.13 Although the context and claim arising in Ferrazzini is clearly of a human
rights nature, namely the undue length of tax assessment proceedings leading to a deprivation
of the right to a fair trial, it is unlikely that an investment tribunal would have taken the same
stance had the case concerned a foreign investor claiming that the length of such a tax
assessment constituted unfair and inequitable treatment. Alas, the Eur Ct HR has reached
some decisions that have largely eroded Ferrazzini, for the same reasons that investment
10
See AD Christians, Tax Treaties for Investment and Aid to Sub-Saharan Africa, (2005) 71 Brooklyn LR 639.
See generally G Kofler, M Poiares Maduro and P Pistone (eds.), Human Rights and Taxation in Europe and
the World (IBFD, 2011).
12
The ECtHR has never suggested that the levying of religious tax (the so-called Kirchensteuer) violates Art 9
ECHR, whereas the German Federal Constitutional Court has tried to limit some of the unintended effects of
this unique tax. By way of illustration, in case BVerfg, 1BvR 3006/07 (2 July 2008) it found that a levy
ordinarily charged for abandoning the registers of a particular religion was unconstitutional. See also National &
Provincial Building Society, Leeds Permanent Building Society and Yorkshire Building Society v United
Kingdom, (1997) 25 EHRR 127, at para 80: “a contracting state… when framing and implementing policies in
the area of taxation, enjoys a wide margin of appreciation and the [ECtHR] will respect the legislature’s
assessment in such matters unless it is devoid of reasonable foundation”.
13
Ferrazzini v Italy (2002) 34 EHRR 45, para 29; confirmed in Jussila v Finland (2007) 45 EHRR 39.
11
tribunals find the conduct of national tax authorities (including legislators) offensive, whether
expropriatory or other.
The Court’s “lawfulness” test seeks to strike a fair balance between the state’s interest
in enforcing its tax laws and the protection of a person’s right to property. In the Yukos case
tax assessments made against the company in 2004 for the year 2000 fell outside a three-year
statutory time-bar set out in Article 113 of the Russian Tax Code,14 but because the tax
assessments for the year 2000 were subject to criminal proceedings a 14 July 2005 decision
by Russia’s Constitutional Court changed the interpretation of the rules on statutory timelimits to tax assessments subjected to criminal proceedings.15 The Russian authorities made
use of attachment, seizure and freezing orders for the enforcement of Yukos’s tax debt,16
leading to the auction of the company’s main production unit (OAO Yuganskneftegaz
(YNG)) in bankruptcy proceedings, ultimately sold at a low price to a sham bidder.17 The Eur
Ct HR found that the Russian authorities lacked flexibility in their enforcement of the tax
debt18 and “given the pace of the enforcement proceedings, the obligation to pay the full
enforcement fee and the authorities’ failure to take proper account of the consequences of
their actions”, it also held that that the “domestic authorities failed to strike a fair balance
between the legitimate aims sought and the measures employed.”19
Overall, investors (and their legal counsel) have thus far found no compelling reason
to employ human rights arguments or relevant claims in cases concerning tax before
investment tribunals even though as will become evident domestic tax measures are only
rarely viewed as giving rise to expropriation. This strategy is further justified by the fact that
if human rights arguments are introduced by investors they will equally have to be admitted
for the host states, which possess a much more compelling resonance particularly as regards
the obligation of the state to uphold and protect socio-economic rights that are contrary to its
FDI obligations. The potential of such claims is, however, significant,20 although they are not
well developed even in the field of commercial arbitration, but at least national courts are not
disinclined from employing constitutional and human rights arguments. At the very least, as
will be shown, several states unilaterally repudiate existing tax concessions by arguing that
they are unfair, particularly in economic terms. The human rights dimension of tax is well
beyond the scope of this article.
The subject matter of this article concerns the specific relationship between investors
and host states and the authority of the latter to impose taxes that violate the treatment
envisaged in applicable BITs, FTAs as well as the parties’ contractual arrangements. Equally,
it shall explore under what circumstances an internal tax measure may amount to a taking (or
expropriation) whether directly or indirectly on the basis of the jurisprudence of investment
tribunals under rules largely premised on customary international law. The article will
demonstrate that domestic tax measures are considered by investment tribunals as a
14
OAO Neftyanaya Kompaniya Yukos v Russia, ECtHR Application No 14902/04, Judgment of 17 January 2012
(Yukos v Russia), at paras 561 and 564.
15
Id, at para 565.
16
Id, at para 646.
17
Id, at paras 621 and 646.
18
Id, at para 656.
19
Id, at para 657.
20
By way of illustration, the European Court of Justice (ECJ) has been criticised for its failure to declare that
juridical double taxation should be prohibited as discriminatory, especially as regards its judgments in
Damseaux v Belgium, Case C-128/08, judgment (16 July 2009), para 27 and Kerckhaert and Morres, Case C194/06, judgment (14 November 2006), paras 19-24. The result in these cases is a violation of the right to
property, enshrined in Art 17 of the EU Charter of Fundamental Rights, by reason of confiscatory double
taxation to which the parties are subjected (in this case cross-border inheritance).
fundamental attribute of sovereignty and lex specialis that largely overrides the general rule
and requirements of expropriation under customary international law.
Before entering into this discussion it is perhaps prudent to examine the doctrine of
arbitrability as this applies to tax in IIA as well as the legal foundation for tax-related IIA
under international law.
A Quick Note on Tax-related Investment Arbitrability and Public Policy
Arbitrability is a concept encountered in the context of commercial arbitration whereby each
state may restrict the types of disputes which private parties may validly refer to arbitration
on the ground of public interest; as a result, disputes designated as non-arbitrable may only be
submitted to litigation. Lack of arbitrability will result in an award being set aside in the seat
of the arbitration (lex arbitri) or refused recognition and enforcement by the country where
enforcement is sought.21 Although arbitrability has been eroded significantly in the course of
the past twenty years22 tax disputes (other than investment-related) remain firmly grounded
within the remit of public authority and at best private disputes concerning tax contributions
in complex joint ventures may be submitted to arbitration in order to assess the appropriate
contribution of each participant.23 In equal manner, states in developed nations are
increasingly urging taxpayers to settle disputes with the state through statutory (mandatory)
arbitration, although the largely public nature of such tax arbitration negates many of the
benefits typically associated with party autonomy.24
Arbitrability, as such, does not exist in IIA. Any restrictions curtailing the investor’s
freedom to submit a particular dispute to arbitration will be definitively circumscribed by the
relevant BIT,25 the parties’ contract or an applicable investment statute with a standing offer
to arbitrate, irrespective of conflicting rules in other domestic laws, even if long-standing and
otherwise peremptory.26 In commercial arbitration, arbitrability and public policy
considerations may appear from thin air to the detriment of the parties’ right to legal certainty
and procedural fairness. The very fact that BITs and other multilateral treaties subject the
authority of the state to impose taxes to scrutiny as regards its impact on investor entitlements
(expropriation or treatment) leads to the obvious conclusion that states have consented to a
qualified erosion of this sovereign power, at least in the context of international investment
law. In fact, Article 17 of the UN Convention on Jurisdictional Immunities of States and their
Properties makes it clear that investment contracts constitute commercial transactions. 27 Even
21
Art V(2)(a) 1958 New York Convention on the Recognition and Enforcement of Foreign Arbitral Awards,
330 UNTS 38.
22
Particularly after Mitsubishi Motors Corp v Soler Chrysler Plymouth Inc, 473 US 614; see I Bantekas, The
Foundations of Arbitrability in International Commercial Arbitration, (2008) 27 Aust YBIL 193.
23
See WW Park, Arbitrability and Tax, in LA Mistelis and SL Brekoulakis (eds.), Arbitrability: International
and Comparative Perspectives (Kluwer, 2009) 179, at 181.
24
See, for example, Portuguese Law/Decree no 10/2011 on tax arbitration, in respect of which commentators
suggest that it has increased tax arbitration manifold.
25
See, for example, Ecuador v Occidental Exploration & Production Co. (OEPC), [2006] EWHC 345 (Comm),
where the court (not an investment tribunal) looked to the tax exclusion stipulations of Art X of the 1993 USEcuador BIT rather than Ecuadorian claims that tax was not arbitrable under its laws.
26
By way of illustration, South American rules of civil procedure require that all tax disputes be settled by
national judicial authorities and they therefore face a conflict between a “prohibition on submitting tax disputes
to arbitration and international commitments to be bound by arbitration when there is an arbitration clause in a
treaty”. See N Quiñones Cruz, International Tax Arbitration and the Sovereignty Objection: The South
American Perspective, (2008) Tax Notes International 533, at 540.
27
See R O'Keefe and CJ Tams (eds) The United Nations Convention on Jurisdictional Immunities of States and
Their Property: A Commentary (Oxford University Press, 2013) at 277.
so, the 1958 New York Convention remains important because where an investor seeks to
enforce an ICSID award in a non-ICSID member state this may only be achieved through the
channels of commercial arbitration whereby the enforcing state may indeed subject the award
to its arbitrability legislation. Similarly, an investor seeking to enforce an ICSID Additional
Facilities award can only achieve the same under the New York Convention, which is why
the Additional Facility rules require the seat of arbitration to be in a New York Convention
state.28 Nonetheless, a line should be drawn between the arbitrability of tax disputes and the
use of the New York Convention as a mechanism for tax collection.
Public policy considerations are not generally taken into consideration by investment
tribunals on the ground that internal law should not be used as justification to violate an
obligation under a BIT,29 in accordance with the rule set out in Article 27 of the 1969 Vienna
Convention on the Law of Treaties (VCLT). It is no wonder, therefore, that legitimate
(constitutionally-based) human rights claims by host states have been rejected by investment
tribunals.30 Given that tax policies are used to finance states’ human rights obligations, such
as healthcare and education or their ability to maintain internal and external security, public
policy considerations predicated on such grounds will equally fail in investment arbitral
proceedings, whereas the case is different in international commercial arbitration even if an
agreement to the contrary exists between the parties.31 Even so, an increasing number of
commercial arbitration statutes, many predicated on the UNCITRAL Model Law, stipulate
that where a state or an instrumentality thereof, is a party to international commercial
arbitration against a private entity it may not invoke the prerogatives of its own law in order
to avoid the obligations arising from the award.32
Whatever may be the case in the sphere of international commercial arbitration, it is
abundantly clear that states are bound by Articles 27 and 46 VCLT and customary
international law as regards the arbitrability (and lack of public policy restrictions) of those
tax disputes with foreign investors that amount to expropriation or which constitute a
violation of applicable standards of treatment.33
The Legal Basis of Tax-related Investment Arbitration in International Law
Prior to the introduction of IIA in international relations by the ICSID Convention and later
by other multilateral and bilateral agreements, it may be argued that a hybrid institution of tax
resolution existed under customary international law. The idea that internal tax measures
may violate agreed investment protection principles or be expropriatory in naturewas amply
28
Art 19, ICSID Additional Facility Rules.
Metalclad Corp v Mexico, ICSID Case No ARB(AF)/97/1, Award, 30 August 2000, para 70; Total SA v
Argentina, Case No ARB/04/1, Decision on Liability, 21 December 2010, para 40.
30
CMS Gas Transmission Co v Argentina, ICSID Case No ARB/01/8, Award, 12 May 2005, para 121, where
the tribunal rejected the claim that the severity of the Argentine crisis should allow the country to give priority
to its fundamental human rights obligations.
31
In BCB Holdings Ltd and The Belize Bank Ltd v Attorney General of Belize [2013] CCJ 5 (AJ) the Belize
Finance Minister had granted tax waivers in a unique deed but did not subject it to parliamentary approval.
Although the award was rendered free of any public policy claims, in BCB Holdings Ltd and The Belize Bank
Ltd v Attorney General of Belize (on behalf of the Government of Belize), LCIA Case No. 81169, Award of 29
August 2009, such claims were sustained at the phase of enforcement. See paras 3 and 61 of the CCJ judgment.
32
Art 2(2), Spanish Arbitration Act, Law no 60/2003 (as amended in 2011); Greek Law 3943/2011 on tax
evasion.
33
See Greek Supreme Special Court judgment 24/1993 which held that tax disputes with foreign investors are
beyond any doubt arbitrable.
29
recognised in the nineteenth century,34 despite some (exceptional) later judgments/awards to
the contrary,35 even if resolution of relevant disputes was ultimately achieved through
diplomatic protection or at the inter-state level. The absence of locus standi in no way reduces
the validity of the substantive rule, nor indeed the fact that expropriatory tax claims were few
in practice. It is on the basis of this legal framework that the matter was later encompassed in
investment-related treaties.
The contemporary legal basis for tax-related investment arbitration is largely treatybased, although exceptionally this may be achieved by means of agreement between the
parties or a standing offer in a domestic statute.36 In practice, the latter two are rare37 and so
our focus will be on treaty-based tax-related IIA. It goes without saying that a violation of a
tax stabilisation, discussed in more details in the last two sections of the paper, or tax freezing
clause in an investment contract triggers the arbitration clause in the contract as regards the
resolution of the ensuing tax dispute. The vast majority of BITs or FTAs (with investment
provisions, e.g. NAFTA) do not contain exclusions to the application of expropriation
provisions for tax-related claims except for the ability of the tax authorities of the BIT parties
to jointly veto the application of expropriation provisions to tax claims on a case-by-case
basis38 (joint tax veto). They do however widely include exclusions to the application of
national treatment and most-favoured-nation treatment in tax matters. The rationale
underlying such tax exclusions is to avoid conflict with existing bilateral tax regimes39 and in
order that states can retain maximum fiscal sovereignty, such as avoiding regulatory chill
from the threat of investor-state arbitration in respect of tax matters relating to national
treatment (and most-favoured-nation treatment (MFN)) and so that they can grant favourable
tax treatment to their nationals or nationals of select third states (which would breach national
treatment and MFN respectively but for the tax exclusions).40 This explains why investment
tribunals have found a violation of applicable standards of treatment and indirect
expropriation (in the form of measures with an equivalent effect)41 in BITs that are either
silent on such matters or otherwise contain tax exclusions.42 In fact, the draft Multilateral
34
County of Mobile v Kimball (1880) 102 US 691, at 703; see also Houck v Little River Drainage District
(1915) 239 U.S. 254, per Mr. Justice Hughes at 264, expressly stating that a state’s power to tax is ultra vires if
it is abusive and “as a result of its arbitrary character is mere confiscation of particular property”. Equally
confirmed in A Magnano Co v Hamilton, (1933) 292 US 40, at 44.
35
See, for example, Kügele v Polish State, Case No 34, (1932) Annual Digest 24, at 69, which rejected the
argument that an increase in taxes (a license fee in the case at hand) may be confiscatory, although the tribunal
did not necessarily reach the conclusion that this was generally impossible under all circumstances.
36
One should distinguish between jurisdiction and locus standi for IIA from the existence of expropriation as
such under international (including customary) law. That is why the tribunal in Link-Trading Joint Stock
Company v Department for Customs Control of the Republic of Moldova, UNCITRAL Arbitration, Final
Award, 18 April 2002, para 64, award iterated that tax is expropriatory where it violates a BIT or other treaty or
where the taxes themselves constitute abusive takings. See also T Wälde and A Kolo, Confiscatory Taxation
under Customary International Law and Modern Investment Treaties, (1999) 4 CEPMLP Journal.
37
Duke Energy International Peru Investments No 1 v Peru, ICSID Case No ARB/03/28 is the only case to the
best knowledge of the authors where a tax claim (based on a violation of the parties’ stabilisation clause) was
submitted on the basis of the parties’ contract rather than a BIT.
38
See for example Art 2103(6) NAFTA; Art 21.3(6) DR-CAFTA; Art 21(5) ECT; Art XII(4) Canada-Ecuador
BIT; Art 170(4)(b), Japan-Mexico BIT; Art 21(2) US Model BIT; Art 16, Canada Model BIT; Art 28,
Norwegian Model BIT.
39
This is explicit in Art 16(1) of the 2004 Canadian Model BIT and Art 3(4) of the 2008 German Model BIT
which excludes the application of national and MFN treatment to advantages provided in other bilateral tax
treaties; equally, Art 28(2), Norwegian Model BIT and Art 196(3), EC-Chile FTA.
40 UNCTAD, ‘Taxation’ (2000), Series on Issues in International Investment Agreements, Doc. No.
UNCTAD/ITE/IIT/16, 36 <http://unctad.org/en/docs/iteiit16_en.pdf> accessed 16 May 2014).
41
For example, Art 13(1), 2004 Canadian Model BIT; Art 1110(1) NAFTA; Art 9, EC-RSA FTA.
42
El Paso award, para 292.
Agreement on Investment (MAI) contained a definition of ‘taxation measures’ which
includes “any provision relating to taxes of the law of the contracting party or of a political
subdivision thereof or a local authority therein, or any administrative practices of the
contracting party relating to taxes” and taxes are taken to include “direct taxes, indirect taxes
and social security contributions.”43 The MAI Interpretive Notes recognised that some
taxation measures are capable of constituting an expropriation, although the general
presumption was that if they are “within the bounds of internationally recognised tax policies
and practices” they would not.44
Although most of the new generation of BITs and multilateral investment treaties
(MITs) contain explicit references to tax exclusions, joint tax vetoes prescribe the ambit of
this authority in the field of foreign investment (as well as other fields in the context of allembracing FTAs, such as competition and customs), very few specifically spell out that tax
measures may be expropriatory or in violation of other investor guarantees. Article 21(5)(a)
of the Energy Charter Treaty (ECT) is therefore a rarity. It states that the ECT expropriation
provision (Article 13) applies to taxes and hence relevant disputes may be submitted to IIA
under condition that the joint veto procedure is first exhausted. Subparagraph (b) then goes
on to say that a tax may indeed be expropriatory or discriminatory, in which case the full
impact of Article 13 is applicable (subject to the joint veto procedure). Some BITs list tax
measures among those that may give rise to expropriation. Exceptionally, the US-Egypt BIT
does so indicatively, stipulating that:
No investment or any part of an investment of a national or a company of either Party shall be expropriated or
nationalized by the other Party or a political or administrative subdivision thereof or subjected to any other
measure, direct or indirect (including, for example, the levying of taxation, the compulsory sale of all or part of
such an investment, or impairment or deprivation of management, control or economic value of such an
investment by the national or company concerned), if the effect of such other measure, or a series of such other
measures, would be tantamount to expropriation or nationalization 45 (emphasis added).
Most international investment treaties (IITs) whether bilateral or multilateral subject
their expropriation provisions to the host state’s regulatory measures in the field of tax.46 As a
result, investors may validly claim under the treaty that their assets have been taken, directly
or indirectly, by a particular tax law or measure. Whilst most IITs, as already explained,
contain tax exclusions to the privileges otherwise offered under the national treatment
principle, some exceptionally restrict the application of tax measures to expropriation by
including tax exclusions to the entire IIT and therefore capture expropriation within such
exclusion.47 In equal measure, although this is pretty much the norm, the majority of IITs
attempt to block the deliberation of tax in expropriation claims through joint tax vetoes.
Tax vetoes allow states to plan their fiscal and tax policies without undue disruption,
otherwise they would be reluctant to enter into investment agreements because these would
interfere with their tax planning and other bilateral tax obligations. It is not unlikely that in
the event of dispute the pertinent states find a political solution (even if the tax measure in
question is in fact an act of expropriation) which avoids the embarrassment of IIA. 48 Equally,
43
Art VIII(5)(b), Draft MAI.
OECD Negotiating Group on the Multilateral Agreement on Investment, ‘The Multilateral Agreement on
Investment- Draft Consolidated Text’ Doc. No. DAFFE/MAI(98)7/REV1 (22 April 1998), at 86; see also Art
6(2) of the Norwegian Model BIT.
45
Art III, US-Egypt BIT.
46
UNCTAD, Expropriation (UNCTAD Series on Issues in International Investment Agreements II, (2011),
Doc. UNCTAD/DIAE/IA/2011/7), at 133.
47
Art 5, 1999 Argentina-New Zealand BIT; Art 8, 1999 New Zealand-Chile BIT; Art 5, 1988 New ZealandChina BIT (with exchange of notes).
48
See William W. Park, ‘Arbitration and the Fisc: NAFTA’s “Tax Veto”’ (2001) 2 Chi. J. Int'l L., 231.
44
if not for the national treatment and MFN tax exclusions in most IITs, host states would be
constantly held to ransom over their tax policies and this is the position all states with a
foreign corporate presence would be in, from ‘developed’ capital exporting countries to
‘developing’ capital importing countries.
Tax as Expropriation
In the following sections we shall be discussing in what manner investment tribunals have
assessed internal tax measures as giving rise to expropriation, both direct and indirect. It will
become evident that although the tribunals are relying on relevant principles of customary
international law, they are compelled to balance their assessment of expropriatory conduct
with the sovereign entitlement to adopt tax measures. As a result, the standard generally
employed is higher in threshold as compared to general expropriation under international law.
Although it is beyond the purview of this article (largely because it is only relevant to
commercial arbitration and litigation before foreign courts), we take the view that whereas
tax measures fall within the jure imperii authority of states49 they also encompass a limited
commercial dimension when part of investment contracts. The situation in IIA arbitration is
clear, namely that tax-related investment disputes (giving rise to alleged expropriation or
violation of investment guarantees) are arbitrable. In the sphere of civil litigation and
commercial arbitration50 the situation is far from concise, but it is generally agreed that
foreign courts may not pass judgment on the tax measures of other states, but may only assess
whether the contract between the parties is consistent with those tax laws.51
Tax Measures and Expropriation
Expropriation provisions in IITs generally require host states to refrain from taking measures
tantamount to expropriation, whether direct or indirect (including measures equivalent to
expropriation) unless the expropriation (i) is carried out for a public purpose; (ii) is nondiscriminatory; (iii) takes place with due process of law ((i) to (iii) are together referred to as
the conduct requirements); and (iv) with prompt, adequate and effective compensation (the
compensation requirement). The majority of IITs do not define ‘measures’ that can give rise
to an expropriation but those that do define the term do so broadly, such as “any law,
regulation, procedure, requirement, or practice”52 of the host state. This broadness
encompasses ‘driven actions’ of the state53 that result in expropriation as well as ‘inactions’
(i.e. the refusal of the state to take action) with the inaction also capable of causing an
expropriation.54 Likewise, tax measures are merely ‘measures’ attributable to the host state
which relate to taxation. We have already referred to the draft MAI’s definition of ‘taxation
49
See H Lauterpacht, The Problems of Jurisdictional Immunities of Foreign States, (1951) 28 BYBIL 220 at
237.
50
In Sergei Paushok, CJSC Golden East Company and CJSC Vostokneftegaz Company v Mongolia (Award on
jurisdiction and liability) the arbitrators refused to assert jurisdiction for examining substantive tax disputes.
51
Yukos Capital SarL v OJSC Rosneft Oil Company [2011] EWHC 1461 (Comm) 122; Tullow Uganda Ltd v
Heritage Oil and Gas Ltd, Heritage Oil plc [2013] EWHC 1656 (Comm); Government of India v Taylor [1955]
AC 491 (HL) at 511.
52
Agreement between the Government of the Republic of Costa Rica and the Government of Canada for the
Promotion and Protection of Investments, signed 18 March 1998 (Canada-Costa Rica BIT).
53
Eudoro Armando Olguin v. Republic of Paraguay, ICSID Case No. ARB/98/5, Award of 26 July 2001 , at para
84.
54
CME Czech Republic BV (The Netherlands) v Czech Republic, Arbitration under the UNCITRAL Rules,
Partial Award of 13 September 2001, at para 607.
measures’ as “any provision relating to taxes of the law of the Contracting Party or of a
political subdivision thereof or a local authority therein, or any administrative practices of the
Contracting Party relating to taxes” and taxes are taken to include “direct taxes, indirect taxes
and social security contributions.”55
The tribunal in EnCana56 summarised what taxes, tax measures and tax laws amount
to under international investment law. The EnCana definition confirms that taxes include not
only direct taxes (including income tax, corporation tax, capital gains tax) but also indirect
taxes (such as excise duties and VAT).57 Other tribunals have confirmed this result by
rendering awards in disputes related to taxes other than direct taxes.58 The EnCana tribunal
defined tax measures as relating not only to the actual provisions of the law that impose
taxes, but all “aspects of the tax regime which go to determine how much tax is payable or
refundable…”59 while a taxation law “is one which imposes a liability on classes of persons
to pay money to the state for public purposes.”60 Measures under expropriation provisions are
taxation measures if they “are part of the regime for the imposition of a tax”61 and measures
providing relief for taxation are also tax measures to the same extent as measures that impose
taxes.62
Host states can flex their tax powers to expropriate investments both directly and
indirectly63 but whether an alleged expropriation is direct or indirect will depend on the
measures themselves (e.g. levy of new excessive/arbitrary tax or higher/arbitrary rate of
existing tax, passing of tax law, application of tax law by tax authorities and also by the
national courts),64 the circumstances of the case and crucially how the claim is framed by the
claimant. For example, if a claimant alleges that it has a right to tax refunds, it can streamline
its claim to restrict its investment to the tax refunds themselves or returns to investments or
Art VIII(5)(b), Draft MAI; social securities are likely to be interpreted by an arbitral tribunal as taxes –
Hellenic Electric Railways Ltd v Government of Greece, Ad Hoc Arbitration, Geneva, Award of 18 March
1930, in which the arbitral tribunal rejected the distinction between social security contributions and taxes.
56
EnCana Corporation v Republic of Ecuador, LCIA Case No. UN3481, Award and Partial Dissent of 3
February 2006 (EnCana, EnCana Award or EnCana Dissent).
57
EnCana award at para 142(2).
58
Antoine Goetz and Others v Republic of Burundi, ICSID Case No. ARB/95/3, Award of 10 February 1999
(Goetz I); Antoine Goetz and Others & et S.A. Affinage des Metaux v Republic of Burundi, ICSID Case No.
ARB/01/2, Award of 21 June 2012 (Goetz II); Archer Daniels Midland Company and Tate & Lyle Ingredients
Americas Inc. v United Mexican States (ICSID Case No ARB(AF)/05/05), Final Award (Redacted Version) of
21 November 2007 (Archer Daniels); Burlington Resources Inc. v Republic of Ecuador, ICSID Case No.
ARB/08/5, Decision on Jurisdiction of 2 June 2010 and Decision on Liability of 14 December 2012
(Burlington); Cargill Incorporated v United Mexican States, ICSID Case No. ARB(AF)/05/2, Award (Redacted
Version) of 18 September 2009 (Cargill); Corn Products International Inc. v United Mexican States, ICSID
Case No. ARB(AF)/04/01, Decision on Responsibility (Redacted Version) of 15 January 2008 (Corn Products);
El Paso Energy International Company v The Argentine Republic, ICSID Case No. ARB/03/15, Decision on
Jurisdiction of 27 April 2006 and Award of 31 October 2011 (El Paso); Marvin Roy Feldman Karpa v United
Mexican States, ICSID Case No. ARB(AF)/99/1, Award of 16 December 2002 (Feldman); Occidental
Exploration and Production Company v The Republic of Ecuador, LCIA Case No. UN 3467, Award of 1 July
2004 (Occidental).
59
EnCana award at para 142(3).
60
Id at para 142(4).
61
Id.
62
Id.
63
See generally EnCana award, paras 169-200.
64
On conduct of the courts, see section below on The Yukos Affair; see also generally RosInvest Co. UK
Limited v The Russian Federation, SCC Case No. V 079/2005, Award on Jurisdiction of 1 October 2007
(RosInvest Jurisdiction Award) and Final Award of 12 September 2010 (RosInvest); Quasar de Valores SICA V
S.A., ORGOR DE V AWRES SICA V S.A., GBI 9000 SICA V S.A., ALOS 34 S.L. v The Russian Federation, SCC
Case No. 24/2007, Award of 20 July 2012 (Quasar); and Yukos v Russia (E Ct HR).
55
claims to money65 and if the host state has refused to grant refunds that rightfully belong to
the claimant and has therefore taken and kept possession of said cash, this can amount to a
direct expropriation.66 This streamlining of a claim falls under the definition of partial
expropriation, whereunder particular rights that form an aspect of the entire investment are
expropriated, albeit the control, use and enjoyment of the investment as a whole need not be
affected,67 especially (as regards indirect expropriation) on account of a lack of substantial
deprivation of the entire investment. In most situations, however, alleged tax expropriations
will fall under the indirect heading, but the tribunal’s assertion in Feldman that tax can only
be indirect expropriation68 is too stringent a view in the opinion of the authors.
Arbitral jurisprudence on what constitutes an indirect expropriation has taken strides
in coming closer to a uniform definition, but inconsistencies do still exist and are likely to
remain for the foreseeable future and this is why a case-by-case analysis is, as Professor
Christie suggested some five decades ago, “probably the only method”69 to decide what kind
of interference constitutes an expropriation. Similarly, there are no hard-and-fast rules as to
when the power to tax results in a compensable taking under international law. Despite the
requirement of a case-by-case analysis,70 we can still, as will become evident in the course of
this article, determine discernible trends from the body of tax arbitration jurisprudence to
date, much of which undoubtedly reflects customary international law.
The issues before lawyers, arbitrators and academics when characterising a
governmental measure as indirect expropriation (including creeping expropriation and
equivalent measures) include the following: (i) form of state measure versus its impact; (ii)
intent behind the measure versus its effect; (iii) extent of deprivation of the use and benefits
of the investment (i.e. substantial or not); and (iv) legitimate and reasonable investmentbacked expectations of the investor. The next section will examine the treatment by tribunals
of tax in the context of the aforementioned as well as direct expropriation.
Characterisation of a Measure as Tax versus its Impact
Tribunals in tax arbitrations have recognised the necessity for host states to be afforded
flexibility in the creation, amendment and implementation of their tax laws and policies,
recognising that apparent wrongs by the state should not categorically be viewed as violations
of international law, thereby giving the state the benefit of the doubt in the implementation of
its tax policies.71 The reasoning behind such awards is that “taxation is in a special
65
EnCana award at para 182.
EnCana award at para 179. Similarly, if an investor is exempted from paying taxes (i.e. there is no need to go
through the refund route because the tax is not paid in the first place) and that tax advantage is revoked, the
revocation of the tax advantage can constitute an indirect expropriation.
67
R Dolzer and C Schreuer, Principles of International Investment Law (Oxford University Press, 2nd edition,
2012) at 119; see also Waste Management Inc v Mexico, ICSID Case No. ARB(AF)/00/3, Award of 30 April
2004 (Waste Management II), at para 141; Middle East Cement Shipping and Handling Co. S.A. v Egypt, ICSID
Case No. ARB/99/6, Award of 12 April 2002, in which the tribunal accepted that a licence granted to the
investor for the bulk importation and storage of cement was an investment (at para 101) under the Egypt-Greece
BIT, and that the revocation of the licence amounted to an expropriation of the licence (as an investment) (at
para 107).
68
Feldman at para 101.
69
GC Christie, ‘What Constitutes a Taking of Property Under International Law’, (1962) 38 Brit. Y.B. Int’l L.
307, 338.
70
Feldman award at para 102.
71
Feldman award at para 103; EnCana award at para 177; El Paso award at para 290; Link-Trading award at
para 68; in RosInvest, Russia argued that there is a presumption of legality for tax measures under international
law (RosInvest award at para 188) and that taxation measures are lawful from a public international law
66
category”72 (emphasis added) from an expropriation standpoint because the “universal state
prerogative”73 to tax would be impossible to utilise on account of “a guarantee against
expropriation”74 if taxes were easily assimilated to expropriation of property.75 Concurrently,
arbitral tribunals have made it clear that if tax powers are utilised to expropriate investment,
the form of government measure to expropriate (i.e. tax-related) will not automatically excuse
the state from liability.76
In the Archer Daniels case, the tribunal referred to taxation as an example of
measures that can be used to expropriate indirectly77 and a paradigm where the impact of a
measure prevails over its form. Archer Daniels was brought under NAFTA which contains a
tax veto clause in Article 2103(6). As already discussed, tax vetoes permit the arbitration of
alleged tax expropriations, subject to prior negotiations between the pertinent states and that
permission is in itself recognition of the expropriatory nature of the challenged tax measure.
In Cargill, the tribunal recognised the tax veto in NAFTA78 and stated that the United States
tax authorities “would not… agree that the [tax] was not an expropriation”79 thus paving the
way for arbitration under Article 1110 (expropriation).80 This further confirms that tax is
capable of being expropriatory and moreover tribunals will not be restricted from ruling as
such on the basis of the form of the measure used to allegedly expropriate.
Direct Tax Expropriation
Domestic tax measures may of course amount to direct expropriation where they involve the
direct taking of money or other assets. This is especially discernible in the context of tax
refunds because the money (property) is already in the hands of the state. If the money or
claims to money falls within the definition of investment under the terms of an applicable
BIT, then the expropriation is direct where the money is taken, or where there is an
intentional failure to return in the form of tax refunds. The first hurdle is for the claimant to
convince the tribunal that the taxed (or possibly taxable) funds constitute returns from an
investment and/or are investments as claims to money.
In EnCana, the claimant argued that through its subsidiaries it had been wrongly
denied of its right to tax refunds in breach of Ecuadorian law81 and that the breach amounted
to a direct expropriation. Under the Canada-Ecuador BIT through which the claim was made,
as with most BITs, an investment is broadly defined and in the case at hand encompassed
“any asset owned or controlled either directly, or indirectly through an investor of a third
state, by an investor of a contracting party in the territory of the other contracting party and
perspective, do not generally constitute expropriation and states have a wide margin of discretion in exercising
their tax powers (RosInvest award at para 476). The RosInvest tribunal agreed with Russia that tax authorities
may have a certain discretion and the right to change their positions regarding interpretation and application of
tax laws but are still subject to objectivity and fairness by an arbitral tribunal to determine whether such
measures are bona fide or not (RosInvest award at para 496).
72
EnCana award at para 177.
73
Id.
74
Id.
75
Id.
76
Feldman award at para 91; Occidental award at para 85; Archer Daniels award at para 238; EnCana award at
para 177; Burlington award at para 392.
77
Archer Daniels award at para 238.
78
Cargill award at para 16.
79
Cargill award at para 17.
80
Id.
81
EnCana award at para 179.
includes… (iii) money [and] claims to money”82 (emphasis added). The EnCana tribunal
determined that an investor’s claim to money can constitute an investment83 both in general
terms as well as specifically under the aforementioned BIT whose list of investments was
indicative rather than exhaustive. The tribunal was satisfied that Article I(g) of the CanadaEcuador BIT did not give rise to a restrictive genus by virtue of the words “in particular,
though not exclusively” which were inserted before the examples of investments, thus
making the definition very broad.84 Article VIII of the BIT (expropriation provision) states
that “investments or returns of investors of either contracting party shall not be…
expropriated…”85 (emphasis added). ‘Returns’ are defined in the BIT as “all amounts yielded
by an investment and in particular, though not exclusively, includes profits, interest, capital
gains, dividends, royalties, fees or other current income” (emphasis added).86 The EnCana
tribunal therefore decided that the BIT contained a very broad definition of investments as
well as returns and that tax refunds fell within its remit.87
Unlike EnCana, the claimant in Occidental failed to persuade the tribunal that an
entitlement to VAT refunds were investments in themselves88 under the definition of
investment in the US-Ecuador BIT (through which the claim was made) which includes,
similar to the Canada-Ecuador BIT, “a claim to money… associated with an investment”89
(emphasis added). The Occidental tribunal stipulated that “[h]owever broad the definition of
investment might be under the [US-Ecuador BIT] it would be quite extraordinary for a
company to invest in a refund claim.”90 This passage by the Occidental tribunal does not
implement the wide definition otherwise encompassing investments under the US-Ecuador
BIT whereby a claim to money should (or at least may) be interpreted as any money owed to
the investor. The tribunal was not completely antithetical to the idea of a claim to tax refunds
constituting a money claim;91 rather, it did not consider such claims to be investments in
themselves but solely in the context of the investment as a whole, in respect of which the
refunds represented merely a fraction and not a substantial deprivation of the investment.92
For this type of claim to succeed a tribunal must be open to the concept of partial
expropriation, as was the case with the EnCana tribunal but not its Occidental counterpart.
The arbitrators in EnCana found that the state’s refusal to refund the VAT in
retrospect, i.e. the denial of refunds previously granted “accrued in respect of past
transactions”,93 did fall under the BIT’s broad scope of “amounts yielded by an
investment.”94 Therefore, Ecuador’s retrospective denial of VAT refunds was only
susceptible as a claim for expropriation under the BIT.95
Ecuador’s Interpretative Law No. 2004-41 of 11 August 200496 (the Interpretative
Law) provided an interpretation of Article 69A of the country’s Internal Tax Revenue Law
(ITRL) which clearly stated that “petroleum is not a good that is fabricated” for the purposes
of Article 69A ITRL, thereby ruling out VAT refunds for inputs in oil exploration and
82
Art I(g), Canada-Ecuador BIT.
EnCana award at para 182.
84
EnCana award at para 182.
85
Art VIII(1), Canada-Ecuador BIT
86
Art I(j), Canada-Ecuador BIT; EnCana award, para 117.
87
EnCana award at para 182.
88
Occidental award at paras 81 and 86.
89
Art I(1)(a)(iii), US-Ecuador BIT.
90
Id.
91
Occidental award at para 86.
92
Id at para 89.
93
EnCana award at para 183.
94
EnCana award at para 183, citing Art I(j), Canada-Ecuador BIT which provides a definition of “returns”.
95
Id.
96
Id at para 95.
83
exploitation under Article 69A. The scope of the right to refunds that befell the tribunal
concerned the periods before and after the Interpretative Law was enacted because the
resolutions by which the refund was denied and which triggered the dispute related to trading
periods before the passing of the Interpretative Law.97 However, EnCana made a claim for
VAT refunds in the arbitration (through its statement of Claim) for its subsidiary AEC for
periods when tax was paid after the enactment of the Interpretative Law.98 In respect of tax
refunds claimed after the Interpretative Law was enacted, it was suggested by EnCana that
the law itself was unconstitutional (and thus expropriatory).99 Alas, the tribunal refused to
determine the matter, declaring instead that the constitutionality of Ecuador’s laws had to be
determined through the methods provided under the country’s constitution.100 As a result, the
Interpretative Law was presumed to be constitutional and the claim that tax refunds had been
expropriated after the enactment of the Interpretative Law were rejected.101 The authors fail
to see the rationale behind this line of thinking. The expropriatory nature of a government
under international law cannot (and should not) be measured against its constitutional
compatibility, but rather its compatibility with international law, given that in the majority of
cases a taking is consistent under domestic law.
The questions left to be determined by the EnCana tribunal were whether the
claimant’s Ecuadorian subsidiaries had a right to VAT refunds under Ecuadorian law for the
period before the ‘Interpretative Law’ was enacted,102 especially those periods covered by the
denying resolutions, and if so, whether that right had been expropriated by Ecuador.103 The
tribunal acted on the assumption that the claimant did have a right to VAT refunds under
Ecuadorian law on the basis of the Occidental ruling104 (for the purposes of the national
treatment and fair and equitable treatment claim), even though the Occidental decision was
not binding on the tribunal in EnCana.105 The arbitrators in EnCana also assumed that
Ecuador’s tax authority, the Sericio de Rentas Internas (SRI), made a policy decision “to do
everything within its power to deny refunds to the oil companies.”106 On the basis that the
claimant was entitled to tax refunds and given the assumption that the SRI purposefully
denied the refunds, the tribunal went on to analyse whether the denial of a right to VAT
refunds amounted to a direct taking.107 The EnCana tribunal adopted the position that when a
tax law does not by itself violate the rights afforded to investors, but rather a governmental
body is in breach of applicable tax legislation, including the tax authorities, this does not give
rise to an outright taking of property (or an indirect expropriation) unless it is accompanied
by a denial of due process (i.e. no access to Ecuadorian courts through legal or practical
means).108
97
Id at para 185.
Id.
99
Id at para 186.
100
Id at para 186.
101
Id at para 186 and 187.
102
Ecuador’s Interpretative Law No. 2004-41 of 11 August 2004 (Interpretative Law) contained an
interpretation of Art 69A of Ecuador’s Internal Tax Regime Law (ITRL) which had permitted refunds of VAT
paid in inputs for exported ‘fabricated’ goods. The Interpretative Law clearly stated that “petroleum is not a
good that is fabricated” for the purposes of Art 69A ITRL, thereby ruling out VAT refunds for inputs in oil
exploration and exploitation under Art 69A ITRL.
103
EnCana award at para 188.
104
Occidental award at paras 143 and 152.
105
EnCana award at para 189.
106
Id at para 190.
107
Id at para 191.
108
EnCana award at paras 192-195; the EnCana tribunal arrived at this decision by adopting the position of the
Waste Management award, whereby “the mere non-performance of a contractual obligation” (emphasis added)
98
The EnCana tribunal went on to note that a tax authority has the right under
international law to take a position (even if it is wrong in law) regarding tax claims by
individuals/companies as long as that position is made in good faith, the authority is ready to
defend its stance before the courts109 and the policy is not ordinarily reviewable under the
expropriation provisions in BITs “unless that policy in itself amounts to an actual and
effective repudiation of legal rights.”110 The legal right to tax refunds may not be repudiated,
according to the EnCana award, if: (i) the refusal is not merely wilful; (ii) the aggrieved party
has access to local courts and; (iii) the courts’ decisions are independent of the state and
cannot be overridden or repudiated by the state.111 In the case at hand, oil companies were
afforded the right to challenge the SRI’s decisions before Ecuadorian courts and in fact in
those instances that their application was successful the SRI complied with the relevant
judgments without delay.112 Moreover, the SRI’s director, who personally oversaw the VAT
refund issue and was in contact with Petroecuador’s President to determine whether or not
VAT refunds were included in the participation contracts through the so-called Factor X,113
acted in good faith and this was not denied by the claimant.114 Finally, the judgments
rendered by Ecuadorian courts were not bipartisan, or lacked independence or were in any
other way biased against oil companies.115 On these bases, EnCana’s claim that its VAT
payments were directly expropriated by Ecuador was rejected116 because the SRI’s policy on
VAT refunds “never rose to the level of repudiation of an Ecuadorian legal right.”117
The EnCana decision tells us that tax measures will not amount to direct
expropriation unless they are accompanied by a violation of the pertinent conduct
requirements, namely due process. This is of course a deviation from the usual rule that the
conduct requirements’ role is to differentiate between lawful and unlawful expropriation.
Although a violation of due process can help to prove that a state’s measures err on the side
of expropriation rather than non-compensable government takings, the fact that due process
(or all conduct requirements) is not violated does not and has not prevented tribunals from
finding an expropriation as having occurred, whereby such expropriation can be characterised
as lawful without, therefore, requiring the payment of compensation.118
does not equate to a taking of property or a measure tantamount to expropriation (Waste Management award at
para 174).
109
EnCana award at para 194.
110
Id at para 195.
111
Id at para 194.
112
Id at para 196.
113
Factor X was a formula in the participation contracts which set the participation percentages between
Petroecuador and the oil companies and outlined that any changes in the tax regime would result in adjustments
to the participation percentages to absorb the increase or decrease in taxes, maintaining the economic balance of
the contracts. (EnCana Award at para 31 and Occidental award at para 97). The EnCana and Occidental
contracts did not, however, contain provisions on VAT and its reimbursement (EnCana award at para 150 and
Occidental award at para 143).
114
Id; the Occidental tribunal emphasised that the SRI’s decisions appeared to be founded on reason and fact,
not prejudice or preference (Occidental award at para 163). The SRI tried to bring some resemblance of order to
the variety of contradictory practices, rules and regulations dealing with the VAT refund issue (Occidental
award at para 163).
115
EnCana award at para 196; in addition, Ecuador’s Tax Court and Supreme Court had differences of opinion
which suggested proper due process (at para 196).
116
Id at para 197.
117
Id.
118
Compañía de Desarrollo de Santa Elena, S.A. v The Republic of Costa Rica, ICSID Case No. ARB/96/1,
Final Award of 17 Feb. 2000 (Santa Elena), at para ; some tribunals and scholars have labelled expropriations
that lack compensation as unlawful while others have not. We are of the opinion that an expropriation that lacks
compensation is not de facto unlawful (unless it also violates the pertinent conduct requirements) and is
unlawful only when the host state has obviously expropriated investment and refused to compensate the
There could have been an interesting divergence between the EnCana and Occidental
awards had the tribunal in the Occidental case proceeded with the line of reasoning that tax
refunds were claims to money. The Occidental tribunal stipulated that the claim to money
would still have “to meet the standard required by international law” in order to be deemed
expropriatory.119 This means that it would have to meet the level of substantial deprivation, in
which case the absence of due process rights and guarantees would not have been
determinative factors. It goes without saying that on the basis of a substantial deprivation
analysis the retrospective denial of tax refunds constituted a substantial deprivation of the
claim to the money due. From the perspective of direct expropriation the tax money was not
returned by Ecuador’s treasury, which leads to the obvious conclusion that it was taken. The
Occidental tribunal did not venture any further into this line of thinking as presumably it
sufficed that Ecuador was clearly liable for its breach of the national treatment, and so unlike
EnCana, the Occidental tribunal was able to reject the tax expropriation claim.120
Intent vs effect
The ‘intent vs effect’ dichotomy is two-fold: on the one hand, some tribunals might require
proof that the host state intended to expropriate an investment in order to hold the host state
liable; on the other hand, so long as the investment has suffered the effect of expropriation,
the state’s good will shall not be a defence against liability. It is widely held “that the mere
post-facto explanation by a host state of its intention will in itself carry no decisive
weight,”121 albeit this has not prevented a divergence of views between arbitrators, lawyers
and academics. In Olguin122 the tribunal demanded “a teleologically driven action”123 as a
prerequisite for a finding of expropriatory liability, holding further that even glaring
omissions by the host state, absent intention, did not give rise to expropriation,124 thus
rendering the element of intention to expropriate a key factor for an assessment of liability.125
The Olguin reasoning has been preferred by some scholars because it prevents BITs from
serving as insurance policies against investment failures,126 a role they were not designed to
fulfil.127 Indeed, while it is true that BITs “are not insurance policies against bad business
judgments”,128 one of their purposes is to protect foreign investments from the effects of
expropriation and support for this can be found in the majority of BITs which protect
investors from indirect expropriation, i.e. measures with an “effect equivalent to …
investor. In all other situations litigation is required to determine the existence of expropriation and in such
circumstances it would be unfair to brand the action as unlawful if it has not violated the conduct requirements.
119
Occidental award at para 86.
120
T Wälde and A Kolo, Investor-State Disputes, ‘The Interface Between Treaty-Based International Investment
Protection and Fiscal Sovereignty’ (2007) 35(8/9) Intertax 424, 445.
121
Dolzer and Schreuer (n 67) p115.
122
Eudoro Armando Olguin v. Republic of Paraguay, ICSID Case No. ARB/98/5, Award of 26 July 2001 .
123
Id at para 84.
124
Id.
125
The tribunal in Sea-Land Service, Inc. v The Islamic Republic of Iran, Ports and Shipping Organisation,
Award No. 135-33-1 of 22 June 1984, 6 Iran-USCTR 149, came to a similar conclusion, requiring at the very
least proof of deliberate governmental interference in a company’s use and benefit of its investment. (6 IranUSCTR 149, 166); M Brunetti, The Iran-United States Claims Tribunal, NAFTA Chapter 11 and the Doctrine
of Indirect Expropriation, (2001) 2 Chi. J. Int’l L. 203, at 207.
126
Campbell McLachlan QC, Laurence Shore and Matthew Weiniger, International Investment Arbitration –
Substantive Principles, (OUP 2008) at 292.
127
Emilio Agustín Maffezini v. Kingdom of Spain, ICSID Case No. ARB/97/7, Award of 13 November 2000, at
para 64.
128
Id.
expropriation”129 (emphasis added). The effect of the measure(s) taking precedence over the
intent not only gives ‘effect’ to expropriation protections in BITs by disposing of
requirements for formal decrees which is especially important when creeping expropriations
occur in a manner that “seeks to cloak expropriative conduct with a veneer of legitimacy”130
but it is equally important in circumstances whereby deprivation by a host state of the use or
reasonably expected economic benefits of an investment are not obviously beneficial to the
state.131 The Metalclad132 definition of expropriation is by now paradigmatic and sums up
perfectly why the effect should always trump the state’s intent, whereby expropriation
“includes not only open, deliberate and acknowledged takings of property, such as outright
seizure or formal or obligatory transfer of title in favour of the host State, but also covert or
incidental interference with the use of property which has the effect of depriving the owner, in
whole or in significant part, of the use or reasonably-to-be-expected economic benefit of
property even if not necessarily to the obvious benefit of the host State133 (emphasis added).
The ‘intent vs effect’ debate in tax arbitration is a somewhat blurred avenue and the
crux of the blur is tax constituting a special category for the purposes of expropriation.
Relevant case law from tax arbitrations on this issue fall within two categories: (i)
expropriatory effect, albeit liability arises only if there is an intention to expropriate, as
substantiated by a breach of the conduct requirements; (ii) existence of intent, although
expropriation is deemed to arise only if the effect is a total or near-total deprivation of the
investment (over and above substantial deprivation), including investment in the narrow
sense of partial expropriation.
Intent and violation of the conduct requirements
The jurisprudence under this heading stems from the EnCana award. In EnCana (as
described above), the tribunal required that the denial of tax privileges: (i) be not merely
wilful; (ii) be accompanied by a right of access to local courts and; (iii) the courts’ decisions
be independent of the state and not susceptible to be overridden or repudiated by it.134 It is
clear that the tax monies due to be refunded to the claimant’s subsidiaries in EnCana were
directly expropriated by Ecuador but the tribunal deciding by a majority refused to uphold
state liability because there was no denial of justice in the limited sense that the claimant was
not denied access to the courts135 (i.e. the defunct decisions of the courts were not taken into
account).136 The EnCana award thus excludes liability for otherwise expropriatory taxation
129
Art 13(1), ECT; see also majority of UK BITs, such as Art 5(1), UK-Turkey BIT and Art 4(1) UK-Malaysia
BIT; similar can be found in various Swedish BITs such as Art 4(1), Sweden-Argentina BIT and Art 4(1)
Sweden-Russia BIT; see also Siemens A.G. v Argentina, ICSID Case No. ARB/02/8, Award of 6 February 2007,
at para 270.
130
Compañiá de Aguas del Aconquija S.A. and Vivendi Universal v. Argentine Republic, ICSID Case No.
ARB/97/3, Award of 20 August 2007 (Vivendi II), at para 7.5.20.
131
Metalclad Corporation v Mexico, ICSID Case No. ARB(AF)/97/1, Award of 30 August 2000, at para 103.
132
Id.
133
Id; Although the Metalclad definition of expropriation is within the context of NAFTA, expropriation
provisions in the international investment universe are all almost identical in form and/or effect and NAFTA
jurisprudence is assumed to reflect applicable standards under customary international law, as a result, among
others, of having been applied in non-NAFTA cases.
134
EnCana award at para 194.
135
EnCana award, Dissent, at para 6.
136
The decisions are said to be defunct on the basis that oil companies did have a legal right to tax refunds under
Ecuadorian law and Andean Community law as decided by the Occidental tribunal (Occidental award at paras
143 and 152) and for argument’s sake considered correct by the EnCana tribunal (EnCana award at para 189)
measures if the taxation measures in question are judged to be licit by the host state’s own
courts.137
Had the majority in EnCana based their findings on the more accepted “effects”
reasoning, as was the case with the award in Metalclad, regardless of culpa, the claimant
would have succeeded in its claim because it was recognised by the tribunal that the tax
money that ought to have been refunded was kept in its entirety, i.e. there was a total
deprivation (more than substantial deprivation) of the investment’s (tax) returns. Instead, the
EnCana majority added an additional hurdle to the finding of expropriation, namely that the
due process (access to courts and no executive interference with court judgments) and nondiscrimination (conduct) requirements must be breached for the host state to be liable for tax
expropriation. This is a deviation from the accepted norm that effect overrides intent, with the
opposite essentially preventing any findings of expropriatory conduct (i.e. presence of intent
but a lack of effect – see section on ‘Effect taking precedence over intent’ immediately
below). Although there is a presumption that tax measures constitute bona fide use of police
powers,138 where they entail a confiscatory character they are clearly expropriatory.139 The
function of the conduct requirements is to determine the existence of an unlawful
expropriation, not to assess whether an expropriation has actually taken place, i.e. the first
question must always be: “has there been an expropriation?” and if there has been an
expropriation then a violation of a conduct requirement will denote the existence of an
unlawful expropriation.
Effect taking precedence over intent [intent without requisite effect]
Most tax arbitrations dealing with expropriation claims have thus far recognised an intent to
expropriate140 or a discrimination against investors/investments (including unintended
discrimination),141 albeit intent or discrimination alone have not by themselves sufficed for
determining the existence of a tax expropriation142. This course of thinking is clearly
consistent with the general jurisprudence on expropriation. In our analysis of pertinent
awards, references to effects being non-expropriatory generally mean that there has not been
a substantial deprivation of one’s investment. This is discussed separately in ‘Level of
Deprivation’ below.
In Feldman, the claimant’s Mexican company, Corporación de Exportaciones
Mexicanas, S.A. de C.V. (CEMSA), was in the business of cigarette exports. CEMSA relied
heavily on receiving tax rebates for cigarettes it exported from Mexico and in fact its claim to
a right to receive rebates appeared to be the only significant asset of the company,143 without
which there would be no profits.144 The company was effectively precluded from receiving
and Ecuadorian courts had on occasion ruled that oil companies were due VAT refunds (Occidental award at
paras 141 and 143).
137
EnCana award, Dissent, para 7.
138
Quasar award at para 181; El Paso award at para 290; the Burlington tribunal however took the position that
there is no presumption of validity in favour of tax measures because the relevant BIT would state the same if
that was the true position (Burlington award at para 365).
139
§712 comment (g), Third Restatement of the Law of Foreign Relations of the United States 1987 (Third
Restatement); the Burlington tribunal also made a correlation between confiscatory taxation and expropriatory
taxation (Burlington award at para 394), as have Walde and Kolo (n 120) 441.
140
See Burlington award at para 455; Archer Daniels award at para 251; RosInvest award at para 621(a); Quasar
award at para 79 (referring to the tax assessments against Yukos being ‘shams’).
141
See Occidental award at paras 163 and 177 on arbitrariness/discrimination without intent.
142
Archer Daniels award at para 251.
143
Feldman award at para 118.
144
Id.
tax refunds initially by Mexican tax law which required invoices that “separately and
expressly” itemised the amount of tax paid,145 which is something only cigarette producers
had access to146 and finally by a change in the tax law which gave rebates for tax paid for
cigarettes available only to the ‘first sale’147 which meant that when resellers purchased
cigarettes from producers or distributors in Mexico, the producers would be entitled to the tax
refund on that ‘first sale’, and when the resellers subsequently resold cigarettes on the export
market, they would not be entitled to tax refunds. CEMSA was thereafter unable to engage in
the business of reselling and exporting Mexican cigarettes and was “deprived completely and
permanently of any potential economic benefits from that particular activity.”148 Despite this,
the expropriation claim was rejected with one of the grounds being that the effect of the tax
measures on the investment (i.e. CEMSA) was not expropriatory as the company was still
operational and could continue trading in non-cigarette export activities, such as alcoholic
beverages, with which it was concerned in the past and in respect of which tax rebates on
exports would continue to remain available.149 Therefore, although CEMSA’s cigarette
export business become untenable, the tax measures undertaken by the state to that effect did
not prevent the claimant from controlling his investment through which he could continue
other lines of business in Mexico.150 Here, again one sees the inclination noted in the
beginning of this article of the state’s tax sovereignty in the domestic sphere where it is not
discriminatory, even if the measure in question has a financial impact on the investor.151
The claimant in Cargill succumbed to a similar reasoning as that in the Feldman
award. Cargill traded in high-fructose corn syrup (HFCS) used in soft drinks that became
subjected by Mexican tax authorities to indirect taxes which had the effect of artificially
suppressing substantial demand for HFCS in Mexico.152 which was dominated almost entirely
by investors from the United States.153 There was no doubt that the HFCS tax measures were
aimed at HFCS suppliers/producers to the soft drinks industry whose detriment of being
driven out of the soft drink sweetener market benefited the majority-Mexican-owned154 cane
sugar industry,155 but it purposely targeted American investors to coerce them into lobbying
the United States government to comply with certain NAFTA obligations.156 Despite the
clear intent to deprive investors of their investments in the HFCS soft drink sweetener market
the tribunal decided that the damage done by the tax measures had to have an expropriatory
effect on the investment as a whole, not specific businesses of the investment.157
In equal manner, the tribunal in Burlington, whilst recognising that proof of intention
to expropriate helps to differentiate between permissible and confiscatory taxation158 - as well
145
Feldman award at para 15.
Id.
147
Id para 21.
148
Id at para 109.
149
Id at para 142.
150
Id.
151
The Mexican tax laws themselves were prima facie measures of bona fide general taxation (Id at para 113).
Crucially, Mexico was successful in arguing legitimate polices for the tax law, including the necessity to restrict
grey market cigarette exports (Id at paras 115-116 and 136) and illegal re-exportation of Mexican cigarettes
back into Mexico (Id at para 136). The application of the tax laws was, however, de facto discriminatory,
whereby they were not applied to like-situated Mexican exporters of cigarettes, resulting in Mexico being liable
for violating Art 1102 of NAFTA (national treatment) – see Id at paras 154-188).
152
Cargill award at para 109.
153
Id at paras 106 and 217.
154
Id at paras 106 and 217.
155
Id at paras 208 and 219.
156
Id at paras 208 and 220..
157
Cargill Award at para 368.
158
Burlington award at para 401.
146
as an intent to deprive and force abandonment of an investment or sell at a distress price
indicates the existence of expropriation159 - it determined that the effect of the tax measure
plays a primary role over and above such intent.160 Finding that “the State’s intent alone
cannot make up for the lack of effects amounting to a substantial deprivation of the
investment”161 the claimant did not succeed in convincing the tribunal that an expropriation
occurred162 as a result of a 99 per cent tax on oil profits above a certain threshold, despite the
tribunal finding that the tax was designed to force the investor to “abdicate its rights under the
[oil participation contracts].”163 The dispositive consideration for the Burlington tribunal was
therefore the “effects of the measures, rather than their underlying motivation”.164
The arbitral tribunal in Link-Trading did not expressly pitch intent against effect.
However, an analysis of the award does show that the tribunal focused more on the
importance of the effect by demanding that it was up to the claimant to demonstrate “the
causal link between the measures complained of and the deprivation of its business.”165
The tribunals in Feldman and Cargill also ventured into the “intent vs effect” debate,
finding in favour of the respondent state in each case whereby, despite discriminatory tax
treatment,166 the effects on the claimants’ investments (the investments being Mexican
subsidiaries) were not akin to expropriation.167
It has become standard practice for arbitral tribunals to require substantial deprivation
of investment in order to make a finding of state liability. The aforementioned cases, as well
as all other investor-state tax arbitrations (albeit subject to a finite number of exceptions such
as RosInvest and Quasar) have failed on the merits as a result of an absence of expropriatory
effect, namely a substantial deprivation, but what this means is analysed in the following
section.
Level of Deprivation
We established above that the effect of a host state’s measure(s) will in most situations take
precedence over its intent, but an expropriation will only be found to have actually occurred
(i.e. resulting in state liability) if the deprivation suffered by the claimant has reached a level
that the arbitral tribunal recognises as the benchmark for finding state liability. This liability
is assessed against the protection afforded in the relevant BIT or else what the tribunal deems
to be customary international law. The benchmark itself generally amounts to as substantial
deprivation, but has at various times also been referred to as radical deprivation168 and
substantial interference.169
A substantial deprivation occurs when, inter alia, there is (i) a substantial deprivation
of the economic value,170 economic use and enjoyment of investments;171 (ii) substantial
159
Id.
Id.
161
Id at para 455.
162
See section on Burlington case below.
163
Id at para 455.
164
Id at para 482.
165
Link-Trading award at para 87.
166
Feldman award at para 188; Cargill award at para 220.
167
Feldman award at para 152; Cargill award at para 368.
168
Técnicas Medioambientales Tecmed, S.A. v United Mexican States, ICSID Case No. ARB(AF)/00/2, Award
of 29 May 2003, at para 115; and M.C.I. Power Group L.C. and New Turbine Inc. v. Republic of Ecuador,
ICSID Case No. ARB/03/6, Award of 31 July 2007, at para 300.
169
M.C.I. Power Group L.C. and New Turbine Inc. v. Republic of Ecuador, id, at para 300.
170
Telenor Mobile Communications A.S. v Republic of Hungary, ICSID Case No. ARB/04/15, Award of 13
September 2006, at para 65.
160
interference with the use and enjoyment of the protected investment;172 or (iii) deprivation of
the fundamental rights of ownership which “is not merely ephemeral”173 and that makes the
“formal distinctions of ownership irrelevant.”174 Additionally, a substantial deprivation is a
deprivation of the investment “in whole or in significant part.”175
In Feldman, the claimant failed in his claim that the Mexican state expropriated his
investment because the tax authorities refused to refund excise duties paid by the claimant’s
company on exported cigarettes. One factor considered by the tribunal in rejecting the claim
for expropriation was that the claimant was not deprived of controlling his investment (a
Mexican company) and the state did not displace him as the controlling shareholder or
interfere in the investment’s internal operations.176 Moreover, by being in control of the
company, the claimant had the potential to pursue other non-cigarette business activities in
Mexico through the investment.177
This reasoning resonates across all pertinent awards. In Archer Daniels, the loss of
profits suffered by the claimants’ joint-venture company (ALMEX) from 1 January 2002
until 31 December 2006 due to the imposition of an indirect tax on HFCS (the sweetener tax),
including diminished profits from lost sales of HFCS in Mexico, “was not sufficiently
restrictive to conclude the tax had effects similar to an outright expropriation.”178 In addition,
the tax did not deprive the investors of the “fundamental rights of ownership or management
of their investment” because they were at all times in control of ALMEX’s production, sales
and distribution.179
In Cargill, the claimant’s HFCS business was not its only income stream. The
tribunal, therefore, required the sweetener tax to deprive the claimant from the investment in
the Mexican subsidiary, not only the subsidiary’s HFCS business. For that reason, the
sweetener tax’s effect on Cargill’s HFCS business in Mexico did not amount to a “radical
deprivation” of the claimant’s overall investment180 in its Mexican subsidiary. This is a
situation in which the tribunal may have found an expropriation under the partial
expropriation dictum had it been applied.
It is clear that investment tribunals are sceptical, or at least disinclined, to accept that
any loss to an investor arising from domestic tax measures amounts to expropriation. The
customary nature underlying this line of thinking is best reflected in the harmony between
BITs and bilateral tax agreements whereby states are clearly allowed to change and adapt
their tax policies with general application even if this may cause economic losses to a
particular class of commercial actors or investors. This conclusion is affirmed by the
consistent case law of investment tribunals. In Link-Trading, the arbitral tribunal did not find
the claimant had established a valid causal link between the amendment of the tax regime and
the slump in its business performance.181 Although the amended Moldovan tax regime could
have contributed to the claimant’s losses, this result in and by itself was insufficient to prove
171
Id; Tecmed Award at para 115.
M.C.I. Power Group award at para 300.
173
Tippetts award at Part III(1).
174
Waste Management award at para 143.
175
Metalclad award at para 103.
176
Feldman award at para 142.
177
Id.
178
Archer Daniels award at para 246.
179
Id at para 245.
180
Cargill award at para 368.
181
Link-Trading award at para 91; the downturn in the business and change in the tax regime coincided in part
with the Russian financial crisis of 1998, resulting in the sharp depreciation of the Moldovan currency against
the US dollar from September 1998 to September 1999. This was found by the tribunal to actually constitute a
stronger causal link to the company’s business misfortunes than the tax measures at hand (Link-Trading award
at para 90).
172
an expropriation as having occurred, and even if it were, it would have entailed that tax
expropriation was a concept without limits, as most tax measures have cost impacts on
businesses and consumers.182 The key, it seems, is not economic loss, even if substantial, but
loss of control over the investment. In Goetz II183 the arbitral tribunal opined that an investor
must be deprived not only of expected profits but that the deprivation must result in either a
loss of control of the investment or the rendering of the investment as purposeless.184 On that
basis the suspension of tax exemptions by Burundi (as well as other measures) were not
expropriatory because they did not lead to a loss of control of the investment (a company
based in Burundi) or the inability to use the investment.185
The power of states to adopt internal tax measures even if they have an impact upon
various classes of foreign investors is not in any way enhanced by fiscal or other crisesrelated arguments. If this were so, then given that all states have fiscal deficits and are
indebted in one way or another, they would view their ’crises’ as an open invitation to adopt
discriminatory and expropriatory tax measures. In any event, with the exception of the El
Paso case (which is not concerned with debt restructuring), none of the past or current cases
concerning creditor disputes arising from sovereign debt restructuring have involved claims
of tax expropriation as such.186 In El Paso, in the midst of its economic crisis between 19982002, Argentina took measures for contingency and recovery purposes, including the
enactment of Public Emergency Law No. 25,561 of 2 January 2002 187 (Public Emergency
Law). The Public Emergency Law devalued the Argentine peso by abolishing its parity with
the US dollar188 and authorised the Argentine government to impose withholding taxes on
hydrocarbon exports.189 El Paso complained that Argentina was responsible for expropriation
by taxation in three aspects: (i) by imposing withholding taxes;190 (ii) by not taking into
account inflation for tax depreciation purposes191 and; (iii) by limiting the range of tax
deductions that El Paso’s Argentine subsidiaries could make (if considering the devaluation
of the Peso as unreasonable).192
The last two claims were “based on the idea that a foreign investor has a right to
certain tax deductions.”193 In short, these ‘deduction claims’ centred on the calculation of
amounts that companies can deduct from their income and assets for tax assessment purposes.
Both arose as a result of the Public Emergency Law. The last claim was based on the
182
Link-Trading award at para 91.
Antoine Goetz and Others & et S.A. Affinage des Metaux v Republic of Burundi, ICSID Case No. ARB/01/2,
Award of 21 June 2012 (Goetz II).
184
Goetz II award at para 194.
185
Id at para 196.
186
See K Halverson Cross, Sovereign Arbitration, in RM Lastra and L Buchheit (eds), Sovereign Debt
Management (Oxford University Press, 2013), at 151. Exceptionally, the Cypriot government’s haircut to
private deposits in Cypriot banks was characterised at the time as an extraordinary tax to bailout the country’s
banking sector. Several mass claims are being organised and it is not unlikely that the tax on deposits constitute
a claim for tax expropriation, particularly as the Greece-Cyprus BIT of 1993 provides a very broad definition of
investments with many of the depositors being Greeks.
187
El Paso award at para 95.
188
Id.
189
Id; the Public Emergency Law also “… converted US dollar obligations into pesos at the rate of 1:1, a
measure known as “pesification”; … effected the conversion, on that basis, of dollar-denominated tariffs into
pesos; … eliminated adjustment clauses established in US dollars or other foreign currencies as well as
indexation clauses or mechanisms for public service contracts, including tariffs for the distribution of electricity
and natural gas; … [and] required electricity and gas companies to continue to perform their public contracts…”
(id).
190
Id at para 282.
191
Id at para 283.
192
Id at para 284.
193
Id at para 285.
183
devaluation of the peso, whereas the second claim was predicated on the onset of inflation as
a result of the devaluation of the peso, with inflation reaching 118 per cent in 2002.194 Under
Argentina’s Income Tax Law the value of a corporation’s fixed assets was depreciated
annually according to its estimated life expectancy.195 El Paso contended that Argentina’s
non-recognition of inflation for tax depreciation purposes was unreasonable and
confiscatory.196 Argentina stressed that Law No. 24,073 of 4 February 1992 “froze all
applicable indices and provisions for inflation adjustment purposes, including those related to
tax depreciation…”197 The laws relating to inflation and tax deprecation were in place since
1992 and El Paso was essentially complaining about “no change in the law.”198
The El Paso tribunal considered the export withholding taxes to be “reasonable
governmental regulation within the context of the [Argentinian] crisis”199 (emphasis
original). The withholding taxes that applied to hydrocarbon exports at rates between 4.76 per
cent and 16.67 per cent200 had only a limited impact on El Paso’s property rights201 and could
not constitute an expropriation, nor could they “have caused a forced sale constituting an
expropriation of El Paso’s shares in the Argentinean companies subjected to… [the] …
withholdings”.202 In addition, the withholding taxes were levied on extraordinary revenues
made by the oil exporting sector as a result of the devaluation of the peso and not as a result
of increased efficiency.203 Argentina’s expert witness explained that “it made total economic
sense to have a ‘compensated devaluation’ by relying on export taxes to raise revenues in the
sectors that had most benefited from the devaluation.”204 The El Paso tribunal agreed, noting
that it was logical to establish a tax on those extra substantial revenues. 205 Therefore, in El
Paso, the claimants once again failed to substantiate a deprivation of their investment by
taxation measures of the host state.
In EnCana, for the claimant’s indirect tax expropriation claim to succeed, the tribunal
required EnCana to prove that it had been deprived of its investment in its Ecuadorian
subsidiaries as a result of Ecuador’s refusal to grant VAT refunds to those subsidiaries.206
Despite the financial harm endured by EnCana as a result of its subsidiaries being denied tax
refunds, together with having to repay to Ecuador the money from tax refunds which were
already paid out to EnCana (via its subsidiaries), EnCana continued to function profitably and
was able to engage in its normal range of undertakings, i.e. extracting and exporting oil. 207
The EnCana tribunal emphasised that tax measures must be extraordinary, punitive in
amount or arbitrary in their incidence in order to be considered as indirect expropriation,208
because any other outcome would result in the “universal state prerogative [of taxation being]
194
Id at para 283.
Id at para 111.
196
Id at para 283.
197
Id at para 287.
198
Id at para 295, citing El Paso’s memorial at 366.
199
El Paso award at para 297.
200
Id at para 297.
201
Id at para 298.
202
Id.
203
Id at para 297.
204
El Paso award at para 297, citing Argentina’s expert witness, Nouriel Roubini (a leading economist) in
Argentina’s counter memorial at 153.
205
Id.
206
EnCana award at paras 172 and 178. This was unlike the direct tax expropriation claim in the same case, for
which the tribunal only required deprivation of ‘claims to money’, i.e. a deprivation of the cash paid for taxes,
rather than the much higher threshold of proving a substantial deprivation of the use, control and economic
benefits of the subsidiaries themselves.
207
EnCana award at para 174.
208
Id at para 177.
195
denied by a guarantee against expropriation”209 given that taxation always culminates in the
loss of profit or other income. The decision in EnCana was that the change in VAT laws or
their interpretation was not expropriatory because they did not bring EnCana’s subsidiaries to
a standstill or render the value “derived from their activities so marginal or unprofitable as
effectively to deprive them of their character as investments.”210 Therefore, the denial of tax
refunds in the “amount of 10 per cent of transactions associated with oil production and
export”211 did not constitute a substantial deprivation (denial of the benefits of investment in
whole or significant part) of EnCana’s investment212 and the indirect expropriation claim was
thus rejected.
In Occidental, the same grounds for rejecting EnCana’s indirect expropriation claims
applied, primarily that Ecuador’s tax measures did not “meet the standards required by
international law”213 in order to be considered expropriatory. Ecuador did not deprive OEPC
of the use or any reasonably expected economic benefit from its investment and equally the
tax measures did not affect a significant part of the investment. 214 The tribunal asserted that
had the requirements for a finding of expropriation been more lenient (i.e. less than
substantial deprivation), OEPC’s expropriation claim would nevertheless have failed,215
albeit the tribunal did not expand this point further. What it may imply however is that should
substantial deprivation encompass the denial of the benefits of an investment in whole or
significant part, and while it is impossible to put a universal figure on it (but let us assume
approximately 90 per cent of all available profits)216 a lesser level of deprivation, for example
at 50 per cent, would still not have amounted to expropriation because the denial of refunds
in Occidental were likely to have been in the region of 10 per cent of transactions associated
with oil production and export.217 Just as the existence of expropriation is best determined on
a case-by-case basis, so is substantial deprivation, which is “not… a mathematical exercise
but a question of reasonableness.”218
The Burlington arbitration
The authors have decided to highlight this case in order to demonstrate the complexities of
investment tax regimes and how they are applied in practice. One of the aims is to show that
investment tax measures are not necessarily of a forceful unilateral nature but may in fact
involve an offer by the host state and a significant degree of bargaining. States may
themselves posit convincing arguments as to why they think a previous tax regime has ran its
209
Id.
EnCana award at para 174.
211
Id at para 177.
212
Id.
213
Occidental award at para 86.
214
Id, para 89.
215
Id.
216
Companies will seldom invest in a country if 90 per cent of their profits will be taxed by the state because the
remaining 10 per cent profit margin would not be worth the investment risk and effort. In Burlington, Ecuador’s
denial of Burlington to 62.3 per cent and 73.9 per cent of the value of a barrel of oil was not considered to be a
substantial deprivation (see below).
217
In EnCana, the claims to refunds amounted to 10 per cent of transactions associated with oil production and
export (EnCana award at para 177) and the amount claimed by EnCana was US$78,347,323. The amount
awarded in Occidental (for violation of national treatment, fair and equitable treatment and full protection and
security) was US$73,181,369. The amount claimed in EnCana and that awarded in Occidental are very close.
Therefore, it is a safe assumption that the value of VAT refunds in Occidental would also have been in the
region of 10 per cent of transactions associated with oil production and export.
218
Burlington award, dissent at para 26.
210
life cycle and is now unfair to its and its peoples interests. Curiously, host states have
refrained from employing human rights arguments, but as already discussed this is probably
because they have been advised that such arguments find little, if any, favour with investment
tribunals. Had the Burlington award not involved tax measures it would no doubt have
amounted to expropriation and as a result it exemplifies the lex specialis character of tax
measures vis-a-vis the general rule of expropriation under customary international law.
Burlington219 was a claim brought under the US-Ecuador BIT by Burlington
Resources Inc. (Burlington) against Ecuador for the alleged expropriation by Ecuador of
Burlington’s investments in two oil exploration blocks, Block 7 and Block 21. Burlington
invested in the participation contracts for the oil blocks through its wholly-owned subsidiary,
Burlington Oriente.220 Burlington contracted into the participation contracts for Blocks 7 and
21221 as a minority contractor, holding 42.5 per cent of Block 7 and 46.25 per cent of Block
21, with the remainder in both blocks held by Perenco.222 Under the terms of participation
formula, the contractors were entitled to between 65 per cent and 76.2 per cent of oil
produced in Block 7 and between 60 per cent and 67.5 per cent of oil produced in Block 21,
with the relevant percentage depending on the daily average production of oil in barrels per
year.223
The dispute arose from Ecuador’s desire of a greater participation in oil revenues
when oil prices increased exponentially from the time most participation contracts in Ecuador
(not only for Blocks 7 and 21) were negotiated and executed. Ecuador maintained that the
contracts were based on an oil price projection of US$15/bbl (per barrel)224 with which the
contractors could cover their expenses and obtain a reasonable return on their investments.225
Burlington acquired interests in Blocks 7 and 21 in September 2001 when the price of oil was
US$20.15/bbl.226 Prices began to rise in 2002 and by June 2008 the price of Oriente crude
was US$121.66/bbl.227 Whilst oil prices fell to below US$30/bbl at the end of 2008 and the
beginning of 2009, they rose again and stabilised in the region of US$60-70/bbl in 20092010.228
Ecuador wanted an increased share in the revenues which, in its opinion were over
and above what may be described as unprecedented and unexpected increases in the price of
oil when the contracts were negotiated or executed. 7 contract)
According to Ecuador, the “unprecedented price increase affected the economic
equilibrium”229 of the contracts, which in turn (in Ecuador’s view) necessitated
readjustment,230 particularly since the state, as the owner of subsoil minerals, should be the
main beneficiary of extra revenues and other windfall profits from high oil prices.231 Ecuador
argued that the contractor’s share of production was based on “the oil price projections
219
Burlington Resources Inc. v Republic of Ecuador, ICSID Case No. ARB/08/5, Decision on Liability of 14
December 2012 (Burlington award).
220
Burlington award at paras 6 and 14.
221
Id at para 14.
222
Id at para 15; Perenco have brought their own claim against Ecuador for which the final award is still
pending: Perenco Ecuador Limited v Republic of Ecuador, ICSID Case No. ARB/08/6.
223
Id at paras 18 and 19.
224
Id at para 138.
225
Id; the price of oil at the time the Block 7 contract was executed on 23 March 2000 was US$25.11 per barrel
(Burlington award at para 291).
226
Id at para 23.
227
Id at para 24.
228
Id.
229
Burlington award at para 136.
230
Id at para 137.
231
Id.
estimated over the life of the contract”232 referred to as the ‘‘P’ factor’.233 However, the
arbitral tribunal did not find a link between the economies of the relevant participation
contracts and any price assumptions, emphasising “that the contractor was entitled to the
economic value of its oil participation share irrespective of the price of oil…”234 This was
especially clear when comparing the contracts for Burlington’s Blocks 7 and 21 with the
participation contract for an unrelated block by the name Tarapoa, which did contain an
economy of contracts provision, clearly providing that:
"If the price of crude oil in the Block exceeds USD 17 per barrel, the surplus of the benefit brought about by the
price increase in real terms (calculated at constant values of [1995]) will be distributed between the Parties in
equal shares.”235
A similar clause to the Tarapoa clause above was specifically discussed during Block 7 and
21 contract negotiations but rejected by the contractors.236 The non-inclusion of a price-based
oil revenue distribution clause “was not the product of inadvertence but a deliberate choice of
the contracting parties.”237
Ecuador unsuccessfully tried to negotiate the so-called economic disequilibrium with
the contractors,238 with Burlington outright refusing the requests for a change in distribution
of revenues.239 As a result, Ecuador enacted Law No. 2006-42 on 19 April 2006 (Law 42)
which amended Ecuador’s hydrocarbons legislation. Law 42 required oil companies to pay
the state “50 per cent of the amount, if any, by which the market price of oil [exceeded] the
price of oil at the time the [participation contracts] were executed” (referred to henceforth as
Law 42 (50 per cent)).240 Law 42 therefore gave Ecuador a greater share of revenues when
the market price of oil exceeded the price that existed on execution of the participation
contracts. Law 42 referred to oil revenues which exceeded the price of oil at the time the
participation contracts were executed as ‘extraordinary revenues’. The 50 per cent formula
was increased to 99 per cent on 18 October 2007 by Decree 662 (henceforth referred to as
Law 42 at 99 per cent). Under the threat of litigation from oil companies,241 Ecuador then
passed the Ley de Equidad Tributaria (LET) (Tax Equity Act) on 28 December 2008 in order
to open new negotiations with oil companies.242 If oil companies took advantage of the LET,
the state’s participation in extraordinary revenues would drop from 99 per cent to 70 per cent.
Burlington and Perenco refused to participate in the scheme envisaged under the LET.243
Burlington initiated arbitration proceedings against Ecuador on 21 April 2008.244 The
company, under protest, remitted to Ecuador Law 42 payments from the introduction of the
law in mid-2006 until May 2008. In June 2008, through a tax consortium set up with Perenco,
Burlington began making Law 42 payments to a segregated account in the United States
without sending the same to Ecuador.245 As a result, on 19 February 2009, Ecuador initiated
232
Id at para 279.
Id.
234
Id at para 281.
235
Clause 8.1 of the Tarapoa Contract (Burlington award at para 294).
236
Burlington award at para 299.
237
Id.
238
Id at para 139.
239
Id.
240
Id at para 32.
241
‘Ecuador: Diversification and Sustainable Growth in an Oil-Dependent Country’ (31 March 2010) World
Bank, LCR PREM Report No. 46551-EC, 29.
242
Burlington award at para 142.
243
Id.
244
Id.
245
Id at para 185.
233
coactiva proceedings (administrative proceedings) against the consortium246 (and therefore
Burlington)247 and began to seize Burlington’s share of oil production in March 2009.248 As
part of the coactiva proceedings, from March 2009 to mid-2010, Burlington’s share of oil
production was auctioned off to the sole bidder, Petroecuador (the Ecuadorian state-owned
oil company), at below market price.249 On 16 July 2009, Burlington and Perenco ceased
operation of Blocks 7 and 21 and on the same day Ecuador took possession of the blocks.250
Finally, Ecuador terminated the participation contracts for the blocks in July 2010 under what
was called a caducidad process251 (the caducidad process leads to a declaratoria de
caducidad del contracto (‘declaration of nullity of the contract’)).
Burlington brought its expropriation claim on the premise that Ecuador’s measures
individually and in the aggregate constituted an unlawful expropriation of its investment.252
The individual measures were the enactment of Law 42 at 50% and at 99% , the coactiva
proceedings that resulted in the seizure of Burlington’s share of oil production, the takeover
of Blocks 7 and 21 and the caducidad declarations (i.e. contract terminations).253 Here we
examine in brief summary the tribunal’s assessment of whether Law 42 at 50% and 99%
were expropriatory on their own accord. The tribunal examined the investment deprivation
caused by Law 42 at 50 per cent and at 99 per cent in real impact terms, i.e. “had Law 42
payments not been made, the corresponding amounts would have become additional income
for Burlington, to which the ordinary income tax and employment contributions would have
applied.”254 Having considered the former factors, the real impact of Law 42 at 50% was
calculated to be approximately 60 per cent of the actual Law 42 tax payments.255 Burlington
argued that Law 42 at 50 per cent had a devastating impact on its investment,256 having been
applied between April 2006 and October 2007. In 2006, Burlington made a net profit of
US$44.18 million.257 Law 42 at 50 per cent applied for three quarters of 2006, during which
time Burlington made a three-quarter of a year aggregate profit in the region of US$33.14
million, and Burlington’s profits thus diminished by around 40 per cent.258 In 2007 (during
which Law 42 at 50% was operable for 10 months), Burlington paid US$87.74 million in
Law 42 taxes259 (including two months at 99%) and its profits stood at US$30.95 million.260
Burlington would have earned approximately US$52.64 million extra revenue had it not been
subjected to Law 42 taxes (US$52.64 million was the real impact of the payments) and its
profits diminished by approximately 62.9 per cent in 2007.261 In addition, on a barrel of oil
basis, for Block 7 (Oriente crude), in July 2006, the market value was US$66.56, from which
Burlington would have received US$48.28 and made Law 42 and 50% payments of
US$18.36.262 On a Block 21 barrel of oil calculation (Napo crude), during which in July 2006
the market price was US$57.43/bbl, Burlington would have made Law 42 at 50% payments
246
Id at para 56.
Id at par 186.
248
Id.
249
Id.
250
Id.
251
Id.
252
Id at paras 254 and 337.
253
Id at para 337.
254
Burlington award at para 424.
255
Id at para 424.
256
Id at para 420.
257
Id at para 425.
258
Id.
259
Id at para 426.
260
Id.
261
Id.
262
Id at para 427.
247
of US$18.36/bbl the Ecuador. On the basis of these figures, the Burlington tribunal (by a
majority) did not consider that Law 42 at 50 per cent had substantially deprived Burlington of
the value of its investment.263 There was no substantial deprivation on the following three
bases: (i) the consortium submitted plans for further investments in Block 7, thereby
implicitly conceding, albeit indirectly, that Block 7 was economically viable with Law 42 at
50%; (ii) Burlington’s financial statements for Block 21 showed a positive figure, not a loss;
and (iii) there were bidders willing to acquire Burlington’s interest in Blocks 7 and 21 while
Law 42 at 50% was in effect.264 The purpose of Law 42 at 50% was found by the tribunal to
replicate in the participation contracts the price adjustment clause of the Tarapoa contract, i.e.
a sharing of windfall profits on a 50/50 basis between the state and the oil company resulting
from higher oil prices, not to force Burlington to abdicate its rights under the contracts.265
Burlington argued that Law 42 at 99% destroyed the value of its investment.266 Law
42 at 99%applied from November 2007 to March 2009 and therefore throughout 2008.267 In
2008, Burlington made US$203.09 million in Law 42 tax payments. Burlington’s accounts
did not show profits for 2008 but this appeared to the tribunal to the result of a high rate of
amortisation.268 It is easier to assess the impacts of Law 42 at 99% on a barrel of oil basis,
whereby Burlington was deprived of 62.3 per cent of a barrel of Oriente crude269 and 73.9 per
cent of a barrel of Napo crude.270 On a diminishment of revenue basis, Law 42 at 99%
reduced Burlington’s share in oil revenues in Block 7 by 58 per cent from (from 48.9 per cent
to 20.5 per cent) and in Block 21 by 70.2 per cent (57.4 per cent to 17.1 per cent).271
Although the tribunal found the records showed that Law 42 at 99% was intended to force
Burlington to abdicate its rights under the participation contracts, the state’s intent alone
could not make up for a lack of effects.272 On this basis, despite Burlington’s profits
diminishing considerably, that alone did not prove that the company’s investment in Ecuador
became worthless and unviable273 as the investment “preserved its capacity to generate a
commercial return.”274 The Law 42 tax at 99 per cent did therefore constitute a substantial
deprivation and was thus not found to be expropriatory by the majority tribunal.275
The dissenting arbitrator in the case, Orrego Vicuña, concluded that Law 42 at 50%
and 99% were expropriatory.276 In his opinion, no reasonable business person would
conclude that paying 50 per cent of revenue income, or more substantially, 99 per cent
thereof, would be profitable or valuable.277 For those reasons, finding a buyer would be nearimpossible because of the effect of the state’s tax measures on the viability of the business.278
The arbitrator found Law 42 (and especially at 99%) was beyond any standard of
reasonableness and the fact that Ecuador rolled the figure back to 70 per cent under the LET
263
Id at para 430.
Id at para 431.
265
Id at para 432.
266
Id at para 434.
267
Id at para 435.
268
Id at para 445; Amortisation refers to situations where the capital investment is accounted for/spread over 3-5
years instead of the year the investment was actually made.
269
Id at para 448.
270
Id at para 449.
271
Id at para 450.
272
Id at para 455.
273
Id at para 456.
274
Id.
275
Id at para 457.
276
Id, dissent at para 23.
277
Id, dissent at para 25.
278
Id.
264
was proof of unreasonableness in itself.279 According to the arbitrator, although not
unprecedented, a 50 per cent tax on income “is very substantial”.280 A 99 per cent tax, on the
other hand, was determined to be “not just an expropriation but a confiscation”.281 Although
the arbitrator did not expand on the difference between ‘expropriation’ and ‘confiscation’, it
is in our opinion reasonable to assume, on the basis that the arbitrator expressed that a 50 per
cent tax is substantial deprivation (and therefore expropriation), that he meant a 99 per cent
tax is total deprivation and, therefore, confiscation. Finally, the arbitrator very briefly touches
upon a human rights argument to make the case for substantial deprivation, stating that a 50
per cent tax means the individual or entity works half of its time for the state, and at 99 per
cent, nearly all of its time for the state (albeit that in the circumstances of the case Burlington
kept a certain minimum income).282 This raises a human rights issue of “freedom of the
individual in a democratic society.”283 This is profound, because a substantial deprivation can
be defined as the deprivation of the use, control and enjoyment of investment, all of which
are restricted under extreme taxation as was the case with Law 42 (99%).
The Yukos Affair
The authors have decided to highlight the rare circumstances in which claimants have
succeeded on the merits in proving state liability for tax expropriation.284 The cases
highlighted were both brought against the Russian Federation and both related to the
expropriation of Yukos.285
The investors in both cases were minority shareholders in Yukos and brought claims
against Russia for expropriating their investments in Yukos as a result of the treatment of
Yukos by the Russian state. The brief analysis here focuses on the treatment of Yukos by
Russia rather than the claimants in the specific cases as they and their investments (shares in
Yukos) were not directly targeted by the Russian state but indirectly suffered as a result of the
state’s treatment of Yukos.286
In a nutshell, Yukos was once Russia’s biggest oil company287 and the largest
taxpayer in the state288 until it was subjected to tax audits and reassessments for the years
279
Id, dissent at para 26.
Id, dissent at para 27.
281
Id.
282
Id.
283
Id.
284
There have been, at the time of writing and in the best knowledge of the authors, only the RosInvest and
Quasar claims which have resulted in the finding of state liability for tax expropriation. The authors are aware
of the Revere case (Revere Copper Brass Inc. v Overseas Private Investment Corporation, AAA Case No. 16 10
0137 76, Award of 24 August 1978), in which the claimant investor succeeded in its compensation claim for tax
expropriation by Jamaica. However, the claim was brought against political risk insurers (Overseas Private
Investment Corporation – OPIC) rather than the host state, and because it is not conclusive that the claim would
not have succeeded if it was brought against the Jamaican state as opposed to an insurance company, we are not
including it within our assessment of tax expropriation in investor-state arbitration.
285
A further three arbitrations against Russia for the expropriation of Yukos, the proceedings for which have
been consolidated into one, are at the time of writing pending final awards: Hulley Enterprises Limited (Cyprus)
v Russian Federation, ECT Arbitration, PCA Case No. AA 226; Yukos Universal Limited (Isle of Man) v
Russian Federation, ECT Arbitration, PCA Case No. AA 227; and Veteran Petroleum Limited (Cyprus) v
Russian Federation, ECT Arbitration, PCA Case No. AA 228.
286
The RosInvest and Quasar arbitral awards themselves, in most part, also focus on the treatment of Yukos as
opposed to the investors.
287
‘Yukos Ten Years On’ (The Yukos Library, 2013) < http://www.theyukoslibrary.com/en/the-yukos-affairten-years-on/> accessed 10 January 2014.
288
Quasar at para 102.
280
2000 to 2004 by the Russian Tax Ministry. The tax assessments were used as an excuse for
the state to freeze certain critical assets of the company which made paying the tax debts
insurmountable tasks. As a result of being unable to pay the tax debts, the state seized
Yukos’s shares in its subsidiaries and auctioned off those companies (one of which was worth
between US$15 billion and US$57.7 billion289 and accounted for 60% of Yukos’s total oil
production290 and was auctioned off for US$9.8 billion to settle the year 2000 tax
reassessment of US$3.5 billion) to settle the tax debts. YNG was sold at auction to
BaikalFinansGroup (BFG), a company with no physical presence at its registered address and
incorporated only days before the auction, and which was bought by the Russian state-owned
oil company Rosneft three days after the auction for US$360, together with the voting shares
in YNG, before the YNG payment price had to be paid.291 Rosneft did not buy at auction
itself so that the debacle had a veneer of legitimacy.292
To put some perspective on the tax assessments, together with taxes already paid by
Yukos for the years 2000 to 2003, the assessments amounted to more than 90% of Yukos’
annual consolidated gross revenues for those years.293 From an alternative perspective,
Yukos’s net income from the year 2000 to the third quarter of 2003 was US$13 billion, and
with the last of Russia’s tax assessments included, the total tax assessments with fines and
surcharges for 2000 to 2004 amounted to more than US$24 billion.294
Both arbitral tribunals found the investors’ investments were expropriated as a result
of Russia’s treatment of Yukos. The Yukos affair is an apt and recent example of the power
to tax being used to destroy. Russia based its reasons for the extra tax liabilities on the basis
of its apparent discovery that Yukos sold oil to its subsidiary trading companies based in low
tax Russian jurisdictions who then sold the oil to third party purchasers at market price, thus
avoiding higher rates of tax. Russia labelled the trading companies as ‘shams’ and the intragroup transactions as ‘sham transactions’.295 Yukos, however, had complied with the written
word of the tax law.296 As a result of the Tax Ministry’s stance, Yukos became liable for: (i)
VAT-related levies, fines and interest at US$13.5 billion297 (for VAT the trading companies
had actually paid for on exported oil and for which they were due refunds for because there is
0% tax on exports – the Tax Ministry also did not allow Yukos to benefit from the VAT
refund requests submitted by the trading companies nor did it allow Yukos to submit its own
refund documentation even though it was now viewed as the seller/exporter);298 and (ii) by
declaring the trading companies as shams, Russia assessed Yukos as being liable for US$9.4
billion (including US$1.5 billion in repeat offender fines) of profit tax – tax which the trading
companies had for years filed tax returns and paid billions thereto.299
289
OAO Yuganskneftegaz (YNG) was: (i) valued by the Quasar claimants as at least US$15 billion (Id at para
84); (ii) sold at auction for US$9.4 billion which was just over half of its appraisal value by Russia’s own
advisors (Id at para 163); (iii) valued before its auction by investment bankers at US$22 billion (RosInvest
Jurisdiction Award at para 2, quoting the claimant’s Request for Arbitration); and (iv) valued by Russian-stateowned oil company Rosneft, YNG’s ultimate post-auction owner, at US$57.7 billion (Quasar Award at para
84).
290
Quasar award at para 162.
291
RosInvest award at para 76.
292
See RosInvest award at paras 70-76; and Quasar award at para 104, quoting the claimants’ Statement of
Claim.
293
RosInvest jurisdiction award at para 2, quoting the claimant’s Request for Arbitration.
294
Quasar award at para 47, quoting the claimants’ Statement of Claim.
295
Quasar award at para 66.
296
RosInvest award at para 460.
297
RosInvest award at para 426.
298
RosInvest award at paras 424-425.
299
RosInvest award at para 4, quoting the Claimant’s Post-Hearing Reply Brief; Quasar Award at para 75.
Yukos was prevented from discharging the tax assessments at several stages in an
overall scheme by the Russian state to expropriate the company. The settlement of the tax
assessments was prevented at several stages (e.g. through freezing orders) and the freezing
orders also resulted in Yukos defaulting on a US$1 billion securitised loan from a banking
consortium (the SocGen consortium).300 With the Russian state-owned oil company, Rosneft,
assuming the SocGen consortium’s debt, it and the Tax Ministry (i.e. together as the Russian
state), became Yukos’ main creditors, controlling 94 per cent of votes at the first creditor’s
meeting in July 2006.301 With Rosneft already owning the YNG asset, Yukos’ main creditors
decided to liquidate Yukos’ remaining assets,302 resulting (together with the purchase of
YNG) in Russia ultimately owning 93 per cent of Yukos’ assets.303 The choices of Yukos’
main creditors were, according to the Quasar tribunal “clearly… part of an overall
confiscatory scheme.”304
The tax assessments began with a three week audit of Yukos’ tax affairs in 2003.
Earlier that year, the Russian Tax Ministry’s specialised top level division that was instituted
for large oil companies completed a six month audit of Yukos and found only minor tax
liabilities305 which Yukos paid in full.306 The three week audit, on the other hand, which was
preceded by the arrest and imprisonment of some of Yukos’ senior executives (including its
CEO, Mikhail Khodorkovsky) and staff lawyers and external counsel, found liabilities in the
amount of US$3.5 billion in taxes for 2000.307 Between 2 September 2004 and 9 December
2004, Tax Ministry reassessments for Yukos’ 2000 to 2003 tax years were issued, which,
together with Yukos’ 2004 tax liability, amounted to US$20.6 billion in taxes, fines and
punitive interest.308 The fines faced by Yukos were actually double fines for the 2001 to 2003
tax reassessments because Yukos was considered to be a repeat offender309 (the normal fine
was 20%).310 Such doubling of fines, which in themselves amounted to US$3.8 billion of tax
liability, were not used in any comparable cases.311 Other comparable taxpayers in Russia
who made use of trading companies in low tax regions “were not subjected to ruinous tax
consequences.”312 Although the Tax Ministry made new assessments against other oil
companies for using the same tax planning strategies, the assessments and fines were not at
the same confiscatory level as applied to Yukos.313 In addition, other oil companies were able
to settle their debts on reasonable terms, whereas in the case of Yukos, its assets were
transferred to the state.314
300
Quasar award at para 134.
Id at para 142.
302
Id at para 144.
303
The creditors decided to liquidate rather than accept Yukos’ proposals to deal with remaining tax debts by
selling some US$15.7 billion of assets and using the remaining assets to generate approximately US$3 billion
per year to pay off any outstanding tax debt, as well as using funds held in the Netherlands to pay off other
creditors such as the SocGen consortium (Quasar award at para 143).
304
Quasar award at para 147.
305
RosInvest award at para 494.
306
Quasar award at para 47.
307
Quasar award at para 47, quoting claimants’ Statement of Claim.
308
RosInvest award at para 4, quoting the Claimant’s Post-Hearing Reply Brief; and ‘Timeline’ (The Yukos
Library) < http://www.theyukoslibrary.com/en/library/timeline/> accessed 16 May 2014. (The Yukos Library:
Timeline).
309
RosInvest Award at paras 69-70.
310
Id at para 444.
311
Id at para 453.
312
Id award at para 539, quoting Prof. Peter Maggs’ Report I at 173.
313
Id at para 537.
314
Id.
301
The central theme of the Yukos arbitrations was why Russia treated Yukos as it did if
the true intention was a bona fide assessment and collection of taxes (as Russia had argued
them to be).315 The claimant in RosInvest did not claim that the retroactive tax assessments
caused a substantial deprivation,316 but the tax elements were considered by the tribunal
together with the other actions attributable to the state that formed part of the creeping
expropriation, including the conduct of the Russian courts in the context of denial of
justice.317 The tribunal in Quasar however was “concerned with whether Yukos’ tax
delinquency was actually a pretext for the seizing of Yukos’ assets and the transfer of them to
Rosneft or one of its affiliates.”318
The RosInvest tribunal found that the interpretation of Russian law whereby a goodfaith/bad-faith doctrine was developed in relation to Yukos’ use of the low tax regions, i.e.
that the tax benefits available in the low tax regions were rules of good faith that were
exploited by Yukos, was a novel application of Russian law not used with other comparable
taxpayers.319 This same interpretation was used to wrongly label Yukos and its trading
companies as shams without economic substance.320 Russia also developed a proportionality
principle that the tax benefits which companies derive from using low tax regions must
correspond to their investment in those regions.321 The RosInvest tribunal found this not to be
part of any law.322 The tribunal also decided the interpretation of VAT law (see above on
VAT-related levies and fines).323 For those reasons, as well as the fact that the doubling of
fines were not used in comparable cases,324 the RosInvest tribunal found that the tax measures
taken by Russia were not bona fide and were discriminatory. 325 In totality, the RosInvest
tribunal ruled that: (i) the VAT assessments and fines were extraordinary and not bona fide
and not non-discriminatory taxation measures;326 (ii) Yukos used ambiguous legislation that
allowed the use of low tax regions to its advantage but done so in an open and transparent
way and the application of so-called good faith and proportionality principles by the Tax
Ministry to make Yukos liable for profits of the trading companies was not bona fide and was
in fact discriminatory treatment, especially in view of other companies using the same
methods and not being treated as Yukos was;327 (iii) the repeat offender fines for US$3.8
billion for Yukos’ conduct that pre-dated the findings that it was a first-time offender was
part of a cumulative effort in destroying Yukos;328 (iv) the YNG auction and purchase of
YNG by BFG was a front for Rosneft that was organised in a manner to ensure state control
of Yukos’ prized asset – “in short the Tribunal is convinced that the auction of YNG was
rigged”;329 and (v) the bankruptcy auctions, although not foul of Russian law, were initiated
and conducted by SocGen bank in association with Rosneft which therefore fitted in with
“the obvious general pattern and obvious intention of the totality scheme to deprive Yukos of
its assets”330 (emphasis added). Russia’s intent was therefore to expropriate Yukos, and that
315
Quasar award at para 41.
RosInvest award at para 262.
317
RosInvest award at para 273.
318
Quasar award at para 160.
319
RosInvest award at para 449.
320
Id.
321
Quasar award at para 54.
322
RosInvest award at para 450.
323
Id at para 452.
324
Id at para 453.
325
Id at para 454.
326
Id at para 620(a).
327
Id at para 620(b).
328
Id at para 620(c).
329
Id at para 620(d).
330
Id at para 620(e).
316
intent was also made obvious by the discrimination against the company, whereas no other
company was subjected to the same relentless attacks as Yukos was despite using almost
identical ‘tax avoidance’ measures.331 Russia’s intent was put into effect by the tax measures
and consequent auctions and liquidation proceedings, whereby Yukos’ assets were
expropriated by removing them from the company and from certain individuals’ control332
(mainly its then-CEO, Mikhail Khodorkovsky, and Platon Lebedev who was the president of
Group Menatep (now GML) which had a controlling interest in Yukos). The RosInvest
tribunal determined that Yukos was substantially/totally deprived of its assets and the taking
of Yukos’ assets as a result of the tax measures constituted an expropriation of the RosInvest
claimant’s shares in Yukos.333 The cumulative effect of Russia’s tax measures were judged as
being an unlawful expropriation of Yukos’ assets.334 The RosInvest decision clearly shows
that Yukos was expropriated with intent and effect through measures kicked-started by the
Russian Tax Ministry.
The Quasar tribunal determined that the Tax Ministry’s tax assessments were, rather
than being the consequences of sham transactions, actually sham tax assessments.335 The
Quasar tribunal also decided that Russia was hostile towards Yukos by invalidating the
trading companies’ exports but still making Yukos liable for VAT in excess of US$13.5
billion on the basis of being the true seller, and then not allowing Yukos (as the true seller) to
apply for the VAT refunds, effectively the state tried to have it both ways.336 Also, by not
giving Yukos a moment to catch its breath and dispose of its assets in an orderly fashion to
cover the tax assessments, the Tax Ministry did not act like a legitimately operating tax
authority would.337 This included the Tax Ministry’s refusal to wait for three years before
acting on the writ of execution (it acted immediately, giving Yukos five days to pay its tax
debts). Although tax authorities should seek to collect monies expeditiously, that aim should
be balanced with rational care and the right of the taxpayer.338 Such rationality was accorded
to Rosneft when it became liable for YNG’s tax debts with a scheduled quarterly payment
over five years agreed to by the Tax Ministry.339 The failure of the Tax Ministry to work with
or even respond to Yukos’ multiple settlement requests was “disturbing to say the least”340
and if the real intent was to collect legitimately-owed taxes, Russia could have come to a
satisfactory conclusion that did not involve the liquidation of Yukos.341 The quick sale of an
asset the size of YNG and the lack of investigation by Russia before dismantling a company
of Yukos’ magnitude342 proved the intent and effect of the tax assessments was to subjugate
Yukos rather than to collect taxes.343 Therefore, the real goal behind the tax assessments
against Yukos was a ploy to expropriate Yukos and not to legitimately collect taxes.344 The
tribunal found the VAT assessments made against Yukos for $13.5 billion and the subsequent
disapproval for Yukos to apply for VAT refunds were “confiscatory to a degree which comes
331
Id at para 621.
Id at para 621.
333
RosInvest Award at paras 624- 625.
334
Id at para 633.
335
Quasar award at para 79.
336
Quasar Award at para 80.
337
Quasar Award at para 170.
338
Id at para 174.
339
Id at para 175.
340
Id at para 103.
341
Id; an investigation would have been required to decide whether Yukos could actually pay its tax debts over a
period of time – which, with the increase in oil prices, such a scenario would have been plausible (Id).
342
Id.
343
Id.
344
Id at para 177.
332
close to validating the claims [of expropriation] in their entirety on this basis alone”.345 The
Quasar tribunal ultimately determined that Russia expropriated Yukos.346
The RosInvest and Quasar cases can be distinguished from all those cases discussed
in this article and is decisive proof of the authors’ view first written above that arbitral
tribunals require a total deprivation of investment (over and above substantial deprivation) to
find tax measures to be expropriatory. Clearly, the expropriation of Yukos could not have
occurred without intent through tax measures which were discriminatory and extraordinary,
and of course therefore not bona fide measures of general taxation which is permitted under
international law. Intent, therefore, will in most cases automatically be a requisite part of a
total deprivation of investment.
Unilateral repudiation of tax concessions
Some of the cases discussed thus far have involved a unilateral repudiation of contractuallyagreed tax concessions by the host state. The balance employed by investment tribunals is
clearly inclined towards the prevalence of tax sovereignty, save for circumstances where the
repudiation is such that deprives the investment of any economic value or otherwise
constitutes a taking. In theory, it is not clear whether this prevalence of qualified tax
sovereignty is the result of a unique rule attributable to the fundamental nature of sovereignty
(lato sensu) under customary law, or rather a distinct exception to the rule whereby states
must not only honour their agreements but they cannot invoke domestic laws as justification
for violating their international obligations. The better view is that the attributes of
sovereignty, including economic self-determination, dictate that, save for expropriation there
are no restrictions on the state to legislate as regards its domestic fiscal policy. 347 This
conclusion is drawn from the fact that despite the otherwise binding (contractual) nature of
tax stabilisation clauses these have been struck down by courts in liberal democracies on the
ground that they effectively inhibit the constitutional ability of the state to legislate in certain
areas.348 Not surprisingly, arbitral tribunals have categorically denied the right to executive
necessity in respect of developing nations in disputes with companies from their developed
counterparts, arguing that international law (i.e. the institution of stabilisation clauses)
overrides any domestic laws, namely the unfettered power of government to legislate.349
Although this tension is hard to reconcile, it seems that contemporary investment tribunals
345
Quasar Award at para 82.
Id at para 186.
347
See also USA v Winstar Corp et al, 518 US 839 (1996) where the US Supreme Court held that an agreement
by the government to compensate a contracting party as a result of a legislative change by no means suggests a
surrender of sovereignty.
348
Watson's Bay and South Shore Ferry Co Ltd v Whitfield [1919] 27 CLR 268, 277; Redericktiebolaget
Amphitrite v King [1921] 2 KB 500, 503. These cases support the so-called doctrine of executive necessity. The
idea is that that contracts or promises made by the government are unenforceable in the public interest if they
fetter the future competence and powers of the executive. This has not however precluded British courts from
ruling that changes in local taxation laws abroad affecting foreign investors are arbitrable – potentially giving
rise to indirect or creeping expropriation. See Ecuador v Occidental Exploration & Production Co. (OEPC)
[2006] EWHC 345 (Comm).
349
See AGIP v Congo (1982) 21 ILM 726 and Texas Overseas Petroleum/California Asiatic Oil Co.(TOPCO) v
Libya (1978) 17 ILM 3, 12. An extract from the arbitral award in Copper Revere and Brass Inc v OPIC (1978)
17 ILM 1343, para 44, is instructive:
“Inevitably, in order to meet the aspirations of its people, the Government may for certain periods of time impose limits on the sovereign
346
powers of the State, just as it does when it embarks on international financing by issuing long term government bonds on foreign markets.
Under international law the commitments made in favour of foreign nationals are binding notwithstanding the power of Parliament and other
governmental organs under the domestic Constitution to override or nullify such commitments.”
have distanced themselves from the pro-investor nationalisation awards of the 1970s and
1980s and without expressly referring to the doctrine of executive necessity, in practice they
view tax measures as largely falling within its remit.
In a recent case entertained by the Caribbean Court of Justice (CCJ), a last instance
court for Caribbean island-states, a newly-elected Belize government repudiated a tax
concession granted to a group of companies by means of a settlement deed negotiated by its
predecessor. The concession was adhered to by the parties for a period of two years
notwithstanding the fact that it had not been approved by the Belize legislature, was
confidential (hence non-transparent) and was manifestly contrary to the country’s tax laws.
The successor government repudiated the concession and the private parties initiated arbitral
proceedings which rendered an award for damages which they subsequently sought to
enforce in Belize. The issue of enforcement ultimately reached the Caribbean Court of Justice
which was asked to assess the government’s claim that the violation of fundamental
constitutional rules and the interests of the people of Belize dictate that the award in question
violates Caribbean and international public policy. The Court upheld these claims, arguing
that public policy should be assessed by reference to “the values, aspirations, mores,
institutions and conception of cardinal principles of law of the people of Belize” as well as
international public policy. The tax concession could only be considered illegal if it was
found to breach “fundamental principles of justice or the rule of law and represented an
unacceptable violation of those principles”. The Court did not expressly say that such tax
concessions were repugnant per se or that they gave rise to a legitimate human rights defence,
but in the opinion of the authors this is certainly implicit. What the Court did emphasize
however, is that tax concessions, even those subject to conduct-based estoppel such as the
one at hand, are procedurally unfair or illegitimate because they violate fundamental
principles of constitutional legal order and to “disregard these values is to attack the
foundations upon which the rule of law and democracy are constructed”.350
This conclusion that tax measures possess a strong constitutional foundation is
significant because many of the existing tax concessions in the developing world, particularly
in mining and natural resources, have come about as a result of advice received by the World
Bank (WB) whereby it was urged that in order to attract investors the host states’ should
apply a profit-based tax regime.351 According to this, host states should not expect returns
immediately but wait until the investor has recouped his capital and other expenses – which
in the case of mining are significant –and the investment starts to generate profits for the
investor. As a result, states were urged not to demand royalties (in any case they should not
exceed 2 per cent), import or export taxes and make special allowances for corporate tax.352
A number of countries, especially in Africa, subscribed to these rather generous tax
concessions, which in conjunction with poor drafting, corruption and lack of expert advice,
effectively culminated in the generation of immense profits with little, if any, benefits to the
impoverished local populations.
A scholar that conducted extensive research on post-WB tax concessions in three
resource-rich sub-Saharan nations found that they received only a miniscule amount of
revenues, whether in the form of direct taxes or revenues, as compared to the investors. 353 In
350
BCB Holdings Ltd and Belize Bank Ltd v Attorney-General of Belize, [2013] CCJ 5 (AJ)
A variant of this tax regime is now a standard contractual term for oil and gas production operations, namely
the production sharing agreement (PSA), whereby the investor typically recovers capital and operating costs in
the form of a share in crude production at the beginning of its cycle. Once the investor’s costs are reimbursed
the remainder of the output (profit oil) is shared among the state and the investor in accordance with an
individually agreed formula, which typically encompasses all other applicable taxes.
352
World Bank, The Strategy for African Mining (World Bank, 1992), at 29ff.
353
R Nshala, Dispossession through Liberalisation: How Sub-Saharan African Nations Lost Sovereignty over
Mineral Resources, SJD thesis, Harvard Law School (2012), at 360-370.
351
the case of Zambia, for example, the royalty rate was set at 0.6 per cent of the gross value of
the minerals produced. Investors were exempted from payment in the first five years and in
any event this was deductible against their income tax. Even so, royalty payments were
agreed to be deferred when the investors’ cash operating margins fell below zero. Although
one may perhaps presume that profit would be made from corporate tax which was set at 25
per cent, investors were in fact allowed to deduct up to 100 per cent of their capital
expenditures, in addition to price participation payments and were freed from customs and
excise duties for items related to their production activities. Moreover, investors are allowed
to carry losses forward for ten and twenty years on the basis of first-in-first-out. Despite the
obligation to pay some other minor taxes, mining investors in Zambia were exempted from
paying any withholding tax on dividends, royalties and management fees to shareholders or
affiliates. Equally, there were no restrictions in place as regards transfer pricing which has
allowed investors to offset losses incurred by other affiliates across the world with huge
profits in Zambia and elsewhere. Estimates clearly show that Zambia’s profits from its mines
were manifold, even with a much smaller production, prior to their privatisation at the advice
of the WB.
Tax repudiation does not only concern a fair reassessment of existing tax regimes, as
would be the case for a revision of the aforementioned Zambian paradigm, but also disputes
as to the investor’s tax compliance. In many cases host states claim that the investor
intentionally overstates his expenses and costs in order to decrease his taxable profits. This
may be achieved “lawfully” as is the case with dubious transfer pricing accountancy or
conversely by concealing the true budget. In both cases, not only is the level of tax payments
unfair, in addition to the state suffering a loss, but moreover the shareholders of the company
manipulating its profits equally incur a loss of profit. In 2009 arbitral proceedings were
commenced by the Karachaganak Petroleum Operating Company (KPOM), an oil and gas
joint venture in Kazakhstan’s largest field, requesting among others the reimbursement of
retrospective crude export duty payments. The Kazakh government, through its state-owned
oil company (KMG) retorted that following independent auditing KPOM was unable to
account for a sum close to $400 million declared as major expenditures. The dispute was
ultimately settled before the tribunal was ever constituted and the terms of the settlement saw
KMG acquire a 10 per cent equity in KPOM, half of which was financed by a KPOM loan,
while the other half in the form of an undisclosed settlement arising from the two arbitral
claims and counterclaims (i.e. export duty payments and overstated expenses).354
State practice concerning unilateral tax repudiations (short of expropriation) is of a
twofold nature. On the one hand, countries may expressly enact new tax legislation affecting
businesses on their territory or subject to their laws, whereas on the other they may engage in
overt or concealed statements or agreements355 and/or seek to settle disputes before an award
is rendered. The latter may entail a degree of resource nationalism, as is the case with
Ecuador or indeed the Nyerere doctrine in the aftermath of colonisation, but in the vast
majority of cases there is no claim by the host state of an intent to nationalise nor is there any
use of self-determination arguments, even if it is ultimately claimed that existing tax
concessions are unfair.356 By way of illustration, Kazakhstan enacted a sweeping tax code in
354
S Perry, Kazakhstan Settles Billion-Dollar Oil Claims, Global Arbitration Review (16 December 2011).
Especially, concessions or production sharing agreements (PSAs) governed by private law, in which case the
confidentiality clause prevents the agreement from parliamentary scrutiny and approval.
356
See generally, TM Franck, Fairness in International Law and Institutions (Oxford University Press, 1998), at
25-46, where he focuses on the procedural legitimacy of international rules by reference to four distinct
properties of the rule. These are its coherence, determinacy, symbolic validation through ritual and pedigree and
its adherence to a normative hierarchy. Franck’s idea of procedural legitimacy, through the interaction of these
properties, concerns the degree to which the rule will be obeyed by states and not if it is necessarily perceived as
fair by individual stakeholders.
355
2009 which replaced existing royalties with a natural resource extraction tax calculated on the
basis of recoverable reserves and global crude prices in any given year. Whatever its impact
on investors it was argued that it is fair for producing nations to impose tax in correlation
with global market prices. Although the Kazakh government initially stipulated that the
changes will not affect investments guaranteed by tax stabilisation clauses, senior officials
continue to describe these clauses as unfair, but stop short of making any direct claims of
unilateral repudiation.357
This state practice is speculative and uncertain and hence difficult to quantify.
However, given our observations throughout this article, particularly on the basis of available
investment awards, where a host state violates the terms of a tax stabilisation clause
investment tribunals would have a hard job balancing between breach of contract and tax
sovereignty. The damage would have to be sustained but it would no doubt be mitigated,
perhaps even considerably, by the following factors: a) the duration of the contract and the
profit accrued to the investor at the time of the breach; b) the unfair nature of the tax
concession, if any; c) the absence of negotiating parity between the parties when the contract
was signed, if any; d) relevant international standards and practice and; e) the good faith of
the host state, reflected either in its prior consultation with the affected investors or the efforts
taken to mitigate as far as possible any negative impacts. Such an outcome in favour of the
host state would be undeniable in the absence of a stabilisation clause and hence the breach of
a clearly unfair stabilisation clause with the adoption of tax measures consistent with
international practice would hold significant sway with investment tribunals.
Several tribunals have made it clear that a state can be liable for tax expropriation if
there is a breach of legitimate expectations, the basis of which is a stabilisation clause. The
rationale inherent in this connection between stabilisation clauses and legitimate expectations
is addressed in the following sections through the “eyes” of relevant awards.
Tax Arbitration: Legitimate and Reasonable Expectations of the Investor
In Feldman, under Mexico’s IEPS law, the presentation of detailed invoices to receive tax
refunds had been a condition since 1 January 1987 and continued throughout the time the
claimant, Feldman, invested in Mexico in April 1990 until 1 January 1998 when the law was
amended to allow tax rebates only to the first sale of cigarettes in Mexico.358 Therefore, the
invoice requirement was always written law and although it was not always applied359 it was
not expropriatory and constituted a reasonable legal requirement backed up by rational policy
– i.e. the Mexican tax authorities could straightforwardly, accurately and without
overstatement, analyse and process the tax amounts for which rebates were sought.360 Indeed,
without the invoices, the claimant was unable to know and declare precisely the amounts of
tax rebates CEMSA would be owed361 and had on some occasions used formulas to estimate
the tax refund amounts accepted in 1992, but were grossly overstated in later years.362 The
fact that the tax law’s invoice requirement was always law since Feldman’s investment in
Mexico albeit without ever having been enforced could not give him a legitimate expectation
that enforcement of the tax laws would not change. As noted by the tribunal, “tax authorities
357
R Kennedy, Resource Nationalisation Trends in Kazakhstan, 2004-2009, Russ-Casp Working Paper (March
2010), at 7-8.
358
Feldman Award at para 119.
359
Ibid.
360
Ibid at para 129.
361
Ibid at para 130.
362
Ibid at para 131.
in most countries do not act in a consistent and predictable way.”363 Therefore, a line of
conduct by tax authorities (i.e. their enforcement or non-enforcement of tax laws) cannot give
an investor a legitimate expectation that such conduct would continue and there can be no
expropriation on those grounds.
In EnCana, part of the indirect expropriation claim was based on a legitimate
expectation to receive VAT refunds. The EnCana tribunal recognised that a tax expropriation
can occur if specific commitments have been made by the host state as regards tax
measures,364 such as a tax stabilisation clause.365 Without a commitment being made by a
host state to an investor/investments, the host state is entitled to change its tax laws as it sees
fit, with the investor having “neither the right nor any legitimate expectation that the tax
regime will not change, perhaps to its disadvantage, during the period of investment”366
(authors’ emphasis). There was no such commitment made by Ecuador in EnCana.
Therefore, if the economic benefit from the investment is reduced by taxation, in the absence
of a specific commitment made by the host state to the investor, tax measures will not be
expropriatory.
Similarly, in Cargill, the tribunal rejected the notion that an investor could have
reasonable investment-backed expectations that the tax law will remain stable unless such
expectations arise from contract or quasi-contractual bases.367
In Link Trading, the tribunal determined that tax measures which violate obligations
given by the state to an investment can be abusive368 and in turn abusive tax measures can
amount to expropriation.369 In that case, however, the tribunal agreed with Moldova’s
position on the 10-year guarantee, concluding that Moldova did not make any specific
obligations to maintain the customs and tax regimes applicable to the claimant’s customers
buying in the FEZ.370 The claimant could not, therefore, have had a legitimate expectation
that the tax regime would not change and so there was no expropriation on that basis.
In El Paso, El Paso claimed that “[i]nvestors have a reasonable and legitimate
expectation to be able to adjust their fixed assets for tax purposes in periods of high
inflation.”371 This argument was rejected by the tribunal because there is no duty on a state to
adapt its tax regime in foreign investors’ best interests.372 Therefore, the calculation of taxes
which is merely unfavourable to a foreign investor does not equate to expropriation.373
In Occidental II, the arbitration concerning Ecuador’s Law 42 that resulted in the
Burlington arbitration, was found by the tribunal to be in breach of the participation contracts
and therefore flouted the claimants’ legitimate expectations. In that arbitration, however, Law
42 was not considered to be a tax.374
The analysis of the above tax arbitrations has shown that arbitral tribunals are willing
to find a state liable for expropriation if a legitimate expectation has been breached, but
investors cannot have legitimate expectations that the tax regime, both in terms of tax laws
363
Ibid at para 113.
EnCana Award at para 173.
365
Ibid.
366
EnCana Award at para 173.
367
Cargill Award at para 290 (this point arose in the disposition of the fair and equitable treatment claim – the
decision was not repeated in the expropriation section of the award).
368
Link-Trading Award at para 64.
369
Ibid.
370
Link-Trading Award at para 86.
371
El Paso Award at para 295, quoting El Paso’s Memorial at 362.
372
Ibid
373
Ibid.
374
Occidental II at para 527; it would have been a very interesting discussion in this thesis if Law 42 was
considered to be a tax in Occidental II, especially as regards legitimate expectations, which was not discussed in
Burlington.
364
and enforcement of those laws, will not change, unless there is a contractual/quasi-contractual
obligation thereto. Hence, the state’s power to tax, including its power to amend and create
new tax laws, supersedes investors’ expectations that are based on anything other than
contract/legal obligations given by the state to the investor/investment. In the alternative, an
arbitral tribunal could still require a substantial deprivation of an entire investment even
though contract rights have been repudiated.375 The issue of investors’ legitimate expectations
has in some respects found greater credence in the context of minimum standard of treatment,
namely the fair and equitable treatment standard (FET).376 In the recent Micula award377 the
tribunal clearly emphasised that in the context of FET, absent a stabilisation clause, investors
must expect legislation to change.378 Like the national treatment standard, FET does not
require a substantial deprivation of investment, and therefore claimants could potentially have
a greater chance of success for breach of legitimate expectations in relation to the tax regime
applicable to them under the FET standard. In fact, stabilisation clauses aside, a shift in the
tax regime applicable to investments can result in a violation of FET if the investments were
made on the basis of receiving tax incentives (and others) under a legislative regime for a
specific period of time.379 A repudiation of or a substantial change to those incentives will
violate FET if: (i) the state has made a promise or assurance; (ii) the promise or assurance is
relied on by investors as a matter of fact; and (iii) such reliance was reasonable.380 As the
tribunal in Micula stated:
“it cannot be fair and equitable for a state to offer advantages to investors with the purpose of attracting
investment in an otherwise unattractive region… and then maintain the formal shell of the [incentive] regime
but eviscerate it of all (or substantially all) content.” 381
Conclusion
Available case law and state practice clearly demonstrate that the application of domestic tax
measures affecting investments in the host state constitute lex specialis to the general
framework of expropriation under customary international law. Unlike other national
measures clad with the attire of formal law and contrary to the rule whereby states cannot
invoke their domestic legislation to evade their international obligations, tax measures are
viewed as intrinsic to (or inseparable from) the fundamental attributes of sovereignty, in
much the same manner as self-defence (mutatis mutandis). Despite its reverence this is
nonetheless a qualified sovereignty, stopping short of expropriation, whether direct or
indirect. In the EnCana case, for example, a direct expropriation claim would have otherwise
been successful, albeit the tribunal required the violation of particular conduct requirements,
although the role of conduct requirements is to differentiate between lawful and unlawful
expropriation. The lex specialis character of tax measures is further confirmed in the
Burlington award, which no doubt constituted a substantial deprivation as no major oil
company would likely invest hundreds of millions of dollars to pay a 99 per cent tax in order
to make a mere $30 million a year, or only 37.7 per cent of the value of a barrel of oil. If the
375
Burlington award at para 453.
See El Paso award at paras 350-364; Ioan Micula, Viorel Micula, S.C. European Food S.A, S.C. Starmill
S.R.L. and S.C. Multipack S.R.L. v Romania, ICSID Case No. ARB/05/20, award of 11 December 2013, at paras
527-529.
377
Ibid.
378
Ibid at para 666.
379
Ibid at para 677-686.
380
Ibid at para 668.
381
Ibid at para 687.
376
Burlington case concerned measures other than tax, the finding of the tribunal should have
been in favour of tax expropriation on the basis of a breach of legitimate expectations.
Investment tribunals are unlikely to lower the threshold of state liability for
expropriation arising from tax measures and are in fact likely to view the substantial
deprivation standard very strictly and in a manner that requires a total deprivation of
property. This is clearly evident in the Yukos cases, where the host state engaged in a total
deprivation of the investor’s profits and in fact the tax assessments were so vast that they
went above and beyond Yukos’ net income for the relevant periods of tax assessments. A
finding of liability for tax expropriation will always be embarrassing for the host state as it
communicates utter disregard for investors and constitutes an abuse of the tax power. It is for
this reason that tribunals are prepared to give the benefit of the doubt to the host state, as in
EnCana. No such leeway is afforded to host states in respect of tax measures that violate the
national treatment principle. Unlike tax expropriation, violation of the national treatment
principle provides few difficulties for investment tribunals because where there is a like
investor/investment, if the foreign investor/investment is treated less preferentially than the
host state’s investor/investment this alone suffices for liability to arise. There need not be an
abuse of power by the state, whether nationality-based discrimination is present or not. This
is evident from the vast number of tax arbitrations which succeeded on the merits in the
national treatment claims but failed on expropriation for the same tax measures.382
Finally, state practice confirms the position adopted by investment tribunals,
particularly the affirmation of the state’s power to tax as enshrined in bilateral tax treaties
without being disputed or in any other way distorted in BITs. States are aware of the qualified
limits of this sovereign power and with the exception of very few cases where tax
expropriation was blatant in all other cases, whether leading to arbitration or not, host states
demonstrated an inclination to retain the investment productive and profitable and there was
no serious counterclaim (at a political level) by the investor’s state of nationality that the host
state is not entitled to amend its domestic tax regime. No doubt, a change of tax regime in
breach of a stabilisation clause will incur liability for the host state. Perhaps, the next phase of
argumentation by host states will involve human rights claims, including economic selfdetermination, particularly in respect of tax concessions entered into under terms that were
coercive, corrupt or largely unfair to the host state. Whatever the case, the lex specialis
character of domestic tax measures in the field of international investment law will remain
valid for the foreseeable future.
382
Archer Daniels, Cargill, Corn Products, Feldman, and Occidental.