Monday, October 12, 2009

State Responsibility in Taxation Matters

Daniel N Erasmus, Adjunct Professor, Thomas Jefferson School of Law, USA

State Responsibility in Taxation Matters

Hans Pijl in his interesting article, ‘State Responsibility in Taxation Matters’ states that international tax law is part of international law. The engagement of state responsibility in cases of breaches of tax-related treaties is an element of international tax law. The article gives an overview of the rules of state responsibility in international law.

The article takes further some of what I have taught on a 'rule of law' approach in applying international tax principles to facts in the greater international law arena.

In one interesting case, where US resident shareholders of a Barbados Co. invested into a company in South Africa, SARS (the tax authority) are refusing to refund overpaid tax, paid in error. The shareholders in the company are disinvesting, and SARS, by refusing to refund an overpayment of taxes (made by mistake by the company), will indirectly affect the US shareholders.

Once the company has exhausted its options in the court system in South Africa, assuming they do not win, the US shareholders may approach the State Department of the USA to exercise their discretion to invoke "diplomatic protection" on their behalf against the South African government and claim reparation and damages, for failure to repay the overpaid taxes (unjust enrichment) in terms on international law.

In another interesting case, APEH of Hungary are imposing harsh record keeping VAT provisions on marketing functions performed by a consumer product company to promote its product, applying old Hungarian tax rules that are contrary to EU law.

Under the international doctrine of "diplomatic protection", once this company has exhausted in Hungary its VAT dispute through the court system, and assuming it gets no positive result, its shareholders, at different levels, as there are a number of intermediate companies to the holding company, can approach the most sympathetic State to intervene on their behalf, and institute action against the State of Hungary for reparation and restitution for the VAT, penalties, interest and any other foreseeable damages caused, by virtue of the wrongful conduct of APEH enforcing the VAT provisions contrary to EU law.

Both South Africa and Hungary would be embarrassed having to face such an action, as the plaintiff would be another State.

For more information about this topic, or any international law and international tax law related issue, please do not hesitate to make contact with me at


Mark Hadassin said...

Mark Hadassin
Global Head of Tax at Babcock & Brown

Then asks:


Does the taking of "diplomatic protection" require a tax treaty between the State claiming the protection on behalf of the taxpayer and the State accused of wrongful conduct?

Are you aware of any State providing any guidelines on circumstances in which it will be prepared to pursue another State in such situations?


Prof. Daniel N Erasmus said...

Daniel N Erasmus, Adj Prof,
Adjunct Professor at Thomas Jefferson School of Law


I don't believe so. In the Hungary case the EU Treaty and the VAT Directives give rise to the underlying peremptory norms that states are obligated to follow in the international arena.

However, there is a whole body of customary international law outside of treaties that if breached, would give rise to similar opportunities.

For instance, look at the South Africa unjust enrichment example. There the claimants would be the US shareholders (through a quirk in developed international law) and not the Barbados Holding Company that owns the shares in the SA operating (now in liquidation) company. This is not driven by a treaty but the legal principle of unjust enrichment, alternatively, expropriation without proper compensation, or acting outside the scope of the tax legislation, causing damage to the US shareholders - despite losing a refund claim in the domestic SA courts all the way to the highest court.

The Barcelona Traction case was the first major international case pursuing state responsibility & diplomatic protection. The foreign office of the state in question would have to be approached with a fully motivated opinion setting out the facts and supporting law, demonstrating the international law breach, why it is a breach, the harm suffered, the reparations being sought, and a formal request to the state to exercise its discretion to take up the claim. There is commonwealth law to support the contention in cases where the state may be compelled to exercise its discretion in favour of the claimant, failing which the claimant will be able to take the foreign department on review for failing to exercise the discretion in favour of the claimant. Obviously soft negotiation works best in my experience. As a result we virtually never land up in court for our multi-national clients.

Hope that helps.


Daniel N Erasmus
Adjunct Professor

Marcin Zuk said...

Marcin Zuk has sent you a message.
Date: 10/15/2009
Subject: RE: State Responsibility in Taxation Matters
Dear Professor,

I am a registered tax advisor workin in Warsaw, Poland. I graduated in 2005 from the Faculty of Law, Jagiellonian University in Cracow, Poland. Since then I mainly deal with international tax issues and so far I wrote several articles in Polish tax magazines and one book published by C.H. Beck.

Indeed the problem rised in your post referring to the state responsibility in taxation matters is extremely interesting, especially if we take into account what is currently going on in Poland. 5 years after we entered EU our tax law was already screened from the angle of the comformity with EU tax law. As a result Polish Government faces the problem connected with certain amount of damages to be paid for the benefit of taxpayers.

By the way of example on February 12 2009 the ECJ passed a judgment (C-475/07) confirming that the Polish Excise Act violated EU law. On the basis of the directive electrical energy is subject to excise tax when it is supplied to the final purchaser (user). Under Polish law within the above mentioned period tax was due at the moment of production. This meant that the taxpayers were the power stations instead of distributors (under the directive).

The Government was trying to limit the scope of claims by introducing retroactively a concept of unjust enrichment into our domestic law. Therefore the power stations would not be entitled to receive the excise tax overpayment because they economically allocated the burden of excise tax to the customers. Consequently in the Government's view the power stations would be unjustly enriched.

Yet this concept has not entered into force and it is criticised as uncostitutional. This shows how important is to have a professional tax legislation.

I have to say that I met the concept of the diplomatic protection in taxation first time in my life, but it seems extremely interesting to me. I think I will make a deeper research in this respect.

Kind regards,

Marcin ┼╗uk
Tax advisor