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Starr International Co., Inc. v. United States

United States District Court, District of Columbia

August 14, 2017

STARR INTERNATIONAL COMPANY, INC., Plaintiff,
v.
UNITED STATES OF AMERICA, Defendant. UNITED STATES OF AMERICA, Counterclaim-Plaintiff,
v.
STARR INTERNATIONAL COMPANY, INC., Counterclaim-Defendant.

          MEMORANDUM OPINION

          CHRISTOPHER R. COOPER, UNITED STATES DISTRICT JUDGE.

         Table of Contents

         I. Background ........................................................................................................................ 3

         A. Statutory Background ................................................................................................... 3

         B. Starr's History, Corporate Structure, and Previous Relocations ..................................... 7

         C. Starr's Move to Switzerland .......................................................................................... 9

         D. Starr's Request for Treaty Benefits Under Article 22(6) .............................................. 12

         E. Administrative and Procedural History ....................................................................... 14

         II. Legal Standards ............................................................................................................... 16

         III. Analysis ............................................................................................................................ 17

         A. The Proper Legal Standard for Awarding Treaty Benefits Under Article 22(6) ............ 18

         1. Starr's Third-Country-Resident Argument ............................................................. 18

         2. Starr Misunderstands the Technical Explanation's Conception of “Residency” ..... 20

         3. If It Were Valid, Starr's Third-Country Rule Would Be a Mechanical Test; It Is Not ........................................................................................................ 23

         4. Starr's Test Clashes With the Nature of Article 22's Discretionary Provision and Its Overriding Purpose .................................................................. 25

         5. Starr's Test Would Result In a Cramped Conception of Treaty Shopping ............... 27

         B. The Competent Authority's Application of the Article 22(6) Standard ........................ 30

         1. Whether Certain, Purportedly Key Evidence Required a Contrary Result .............. 31

         2. Whether the Competent Authority's Analysis Rested on Irrelevant or Incorrect Determinations ...................................................................................... 33

         IV. Conclusion ........................................................................................................................ 37

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

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

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

         I. Background

         A. Statutory Background

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

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

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

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

         The drafters also recognized, however, that certain entities with legitimate reasons for residing in a treaty nation might nevertheless fail Article 22's rigid mechanical tests. See Technical Explanation 60 (“[T]hese mechanical tests cannot account for every case in which the taxpayer was not treaty shopping.”). Accordingly, in paragraph 6 of the Article, the treaty leaves open the possibility for discretionary relief:

A person that is not entitled to the benefits of this Convention pursuant to the provisions of the preceding paragraphs may, nevertheless, be granted the benefits of the Convention if the competent authority of the State in which the income arises so determines after consultation with the competent authority of the other Contracting State.

Treaty art. 22(6). The Technical Explanation indicates that “[w]hile an analysis under paragraph 6 may well differ from that under one of the other tests of Article 22, its objective is the same: to identify investors whose residence in the other State can be explained by factors other than a purpose to derive treaty benefits.” Technical Explanation 60. The Technical Explanation elaborates that

[t]he competent authority of a State will base a determination under [the discretionary provision] on whether the establishment, acquisition, or maintenance of the person seeking benefits under the Convention, or the conduct of such person's operations, has or had as one of its principal purposes the obtaining of benefits under the Convention. Thus, persons that establish operations in one of the States with a principal purpose of obtaining the benefits of the Convention ordinarily will not be granted relief under paragraph 6.

         Technical Explanation 72.

         This Court previously concluded that the above guidance from the Technical Explanation-at times referred to as the “principal purpose” test-provided the appropriate standard for evaluating whether someone is entitled to relief under Article 22(6), both for the IRS in the first instance and on judicial review. See Starr Int'l Co., Inc. v. United States (“Starr I”), 139 F.Supp.3d 214, 229 (D.D.C. 2015).

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

         Starr International was founded in 1943 by Cornelius Vander Starr. A.R. 44. Initially incorporated in the Republic of Panama, the company aimed at developing a worldwide network of insurance agencies that generated international business for U.S.-based insurance companies. A.R. 45. By 1970, Starr was headquartered in Bermuda, and had come to operate over 100 offices in 40 countries. Id. That same year, Starr entered into a transformative agreement with American International Reinsurance Company, Inc. (“AIRCO”), another insurance company founded by Vander Starr. In essence, Starr swapped its insurance businesses for stock in AIRCO. A.R. 45-46. At the same time, Starr reorganized. In a stated effort to keep the gains from the 1970 stock acquisition “within [Starr] for future investment and use and ultimate disposition to charity, ” Starr's voting shareholders created a new class of non-voting common stock, with full residual rights to Starr's assets (now mostly AIRCO stock), and issued it to a charitable trust, whose ultimate beneficiary was a New York foundation. A.R. 47. Other 1970 amendments placed restrictions on the voting shareholders' use of the so-called “Restricted Surplus”-essentially, the economic gain that resulted from Starr's acquisition of AIRCO stock. See A.R. 46-48. In 1978, when AIRCO merged with AIG, the AIRCO stock became AIG stock, and Starr became AIG's largest shareholder. A.R. 48.

         As the Government points out, Starr itself concedes, and a Southern District of New York court has discussed at length, see Starr Int'l Co. v. Am. Int'l Grp., Inc., 648 F.Supp.2d 546 (S.D.N.Y. 2009), the factors motivating the vesting of the corporation's economic value in a charitable trust were not wholly charitable in nature (to say the least). Beyond seeking “to build value for eventual long range use and distribution to the common stock owners for charitable purposes, ” id. at 558, Starr's charity ownership structure was also designed to prevent the hostile takeover of AIG, id. at 555, and to fund compensation grants to AIG executives, id. at 571. See also A.R. 148-49 (“[T]he [Charitable] Trust was set up as [a] long-term arrangement with multiple goals ..... [A]mong the goals of the arrangement were the intentions to protect AIG from unwarranted hostile bids for change in control and to permit [Starr], as AIG's largest shareholder, to make incentive compensation grants . . . to AIG employees.”). Motivations aside, Starr maintained this capital structure-voting shares with virtually no economic value, sitting atop valuable non-voting shares owned by a charitable trust-through the time period relevant here. As of 2007, Starr had 10, 000 shares of non-voting common stock owned by Starr AG, the latest incarnation of Starr's charitable trust; 120 shares of voting stock owned by ten U.S. and two foreign individuals, largely current or former AIG executives; and 199 shares of “first preferred stock, ” owned by two U.S. individuals. A.R. 48-49.

         Again, Starr was based in Bermuda at the time of its 1970 reorganization. It remained there until 2004, when it moved to Ireland. As with the motives underlying the corporation's capital structure, its reasons for this move are a matter of some dispute. In a July 2009 meeting with U.S. Competent Authority[2] officials, Starr-through counsel-represented that Bermuda was simply “too small of a place for a $20 billion charity, ” and that “Bermuda has political problems as well as a lack of skilled workers and professionals.” A.R. 173. However, as the Government notes, there is abundant evidence that the move from Bermuda to Ireland was tax-motivated. In a 2005 New York Times article, lodged in the administrative record, a Starr voting shareholder and former AIG vice chairman explained that “Ireland taxes stock dividends at ¶ 5 percent to 10 percent rate, compared with 30 percent in Bermuda, and that prompted the move to Dublin.” A.R. 298. The Government also points to evidence brought out in the litigation between Starr and AIG, including a 2004 memo from Starr's then-president Michael Murphy, recommending that Starr move to Ireland for tax reasons, and a payment schedule for Starr's AIG dividends, showing that those payments surged in 2003. Def.'s Reply Supp. Cross-Mot. Summ. J. (“Def.'s Reply”) 19. (The payments increased by $16 million from the year before; previous annual increases had ranged from $1 million to $7 million. Id.)

         C. Starr's Move to Switzerland

         In 2005, roughly a year after Starr relocated to Ireland, the company began planning for yet another move. The ostensible reason for this move-as Starr represented in a pre-filing presentation to the Competent Authority on December 6, 2007, and again in its December 21, 2007 request for treaty benefits-was that Irish law was not amenable to its charitable objectives. See A.R. 23-42, 49. In particular, Starr indicated that Irish law prohibited it from making donations to charities that were not approved as exempt charities by the Irish Revenue Commissioners. A.R. 49. This, combined with Starr's “related commitments to the Irish authorities, ” purportedly placed “severe practical limitations on the amounts that could be distributed to donees outside of Ireland.” A.R. 50. Starr also said it wanted to amend the trust deed so that the trustee-and not Starr itself-would have the power to direct the Trust's investments and distributions, but the deed “could not effectively be amended under Irish law.” Id.

         In a separate presentation and submission to the Competent Authority roughly eighteen months later, however, Starr offered an additional (and wholly distinct) reason for its desire to leave Ireland. The company explained that “beginning in September 2005, [Starr had become] the target of a number of fiercely contested lawsuits with AIG” regarding the proper ownership of Starr's “most significant asset, ” its AIG shares. A.R. 141-42; see also A.R. 152, 167 (July 23, 2009 presentation to the Competent Authority, explaining that “litigation risk was in fact an immediate and pressing reason for [Starr's] move to Switzerland”).[3] Starr was worried that those assets were not sufficiently insulated from litigation in Ireland, and so it began looking for a “jurisdiction [that] would provide the most safety in light of the assault being mounted by AIG.” ...


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