Report No. 260

E. Articles 11 and 12. Taxation and Compliance with Laws of Host State

(i) Analysis and comment:

4.5.1 The 2015 Model has a general exclusion that states the treaty does not apply to any taxation measure (Article 2.6(iv)). The 2015 Model also asserts the supremacy of the Host State in determining whether or not any conduct on its part is a subject matter of taxation and therefore excluded from the scope of the treaty. Taxation also appears in Article 6.3 that lists accepted interventions by the Host State to restrict the general right of an investor to freely transfer funds relating to an investment. As per Article 6.3(vi), a party may condition or prevent a transfer of funds by the investor through a good faith application of its laws on taxation.

4.5.2 Articles 11 and 12 deal with the investor's obligation to comply with the Host State's laws. Article 11 adopts the tax responsibility model79 by requiring investors and their investments to comply with taxation provisions, including by making timely payment of their tax liabilities.80 Article 12 is broader, requiring investors and investments to comply with the laws of the Host State, and then lists the various types of laws. It also requires investors and investments to "strive... to contribute to the development objectives of the Host State", particularly by recognizing rights of local communities and indigenous peoples.

79 UNCTAD Series on issues in international investment agreements, Taxation, p. 45, available at: http://unctad.org/en/Docs/iteiit16_en.pdf

80 The requirement for investors to make timely payments of their tax liabilities is closely linked to the clarity in the tax demand. See, for example, Shefali Anand and Kenan Machado (2015), 'India's Minimum Alternate Tax', The Wall Street Journal, available at:
http://blogs.wsj.com/briefly/2015/04/17/indias-minimum-alternate-tax-the-short-answer/

4.5.3 The 2003 Model also contained a similar provision on "Applicable Laws" (Article 12.1), but the 2015 Model deviates in that compliance with these provisions is mandatory for the investor to claim the benefit of the treaty provisions (Article 8.3). When issuing a notice of dispute under Article 14.3(iii) the investor must furnish a self-certified statement "demonstrating compliance with Articles 9, 10, 11 and 12", and any breach can adversely impact the compensation recoverable by the investor (Article 14.10(ii)) or expose it to a potential counter claim from the Host State (Article 14.11(i)).

4.5.4 This leads to an interpretation where even minor non-compliance with any law could lead to the investor being denied the benefit of the treaty. It is suggested that Articles 11 and 12 may be redrafted to firstly, specify a general requirement of compliance with laws; and secondly, lay down an exhaustive list of areas in which noncompliance of laws would attract the consequences under Article 14.10 and 14.11.

Further, the obligation to "contribute to the development objectives of the Host State" given under Article 12.2 is slightly vague, and may not be sustainable unless the state clearly articulates and documents its development objectives in a form known to the investor. It is suggested that such a provision may be treated as a general requirement, rather than one linked to Article 14.

4.5.5 A tribunal must take into account any breach of laws while awarding compensation under Article 14, but it is unclear if the tribunal must determine whether the investor has complied with the Host State's laws and can therefore claim treaty benefits. This interpretation would significantly enlarge the scope of the tribunal's responsibilities. Therefore, instead of requiring the investor to demonstrate compliance with laws, it may be sufficient to allow the Host State to raise this issue in its response/counter-claim and to prove the same before the tribunal. The IISD Model provides guidance in this regard.81

81 While the IISD model also requires investments to be subject to the laws and regulations of the Host State (Article 11), no general consequences of non-compliance have been provided. In contrast, that model identifies certain specific obligations relating to pre-investment impact assessment; anti-corruption obligations; post-establishment obligations; and corporate governance norms and separately provides for the consequences of non-compliance of each requirement.

For instance in the context of post establishment obligations and corporate governance norms the IISD model specifies that there should have been a "persistent failure to comply" (rather than an isolated incident) and the tribunal hearing such dispute should consider whether the breach, if proven, is "materially relevant to the issues before it", and if so, what mitigating or off-setting effects this may have on the merits of a claim or on any award of damages (Article 18).

The IISD Model is available at:
https://www.iisd.org/pdf/2005/investment_model_int_agreement.pdf

4.5.6 The 2015 Model imposes specific obligations on investors, and it is suggested that the Host State should be equally required to make information publicly available, including information relating to laws and regulations, administrative procedures, rulings, judicial decisions, and international agreements, as well as draft or proposed rules.82

82 For discussion on transparency in BITs, see UNCTAD, Transparency, UNCTAD/DIAE/IA/ 2011/6, available at:
http://unctad.org/en/PublicationsLibrary/unctaddiaeia2011d6_en.pdf