Tax Carve-Out under the ECT for Purposes of Jurisdictional Competence - ARIA - Vol. 35, No. 4

This article explores the tax carve-out provision within the Energy Charter Treaty (ECT) at Article 21 and its implications for the jurisdiction of tribunals constituted pursuant to the Treaty. Taxation is inherent to investment. Unsurprisingly, there has been a notable increase in tax-related disputes under International Investment Agreements (IIAs), many of which under the ECT. This trend underscores the need to distinguish between tax disputes and tax-related investment disputes, with the latter falling under the purview of Investor-State Dispute Settlement (ISDS) mechanisms. To address this, many states have introduced “tax carve-out” clauses in IIAs that are similar to Article 21 of the ECT, seeking to exclude tax matters from ISDS jurisdiction.

By examining legal precedents, state practices, and recent developments, this article aims to provide insights into the nuanced interplay between tax and investment law within the context of the ECT. It seeks to enhance a deeper understanding of the jurisdictional challenges faced in international investment arbitration arising from taxation. The article argues that a case-by-case interpretation of Article 21 is the best option to maintain a balance between investor rights and state prerogatives.

I. INTRODUCTION

Until recently, the tax and investment domains were regulated by different regimes and authorities. However, this is changing, and the two areas are progressively overlapping. Indeed, since 2000, the issue of fiscal measures under international investment law has become increasingly topical. This is evidenced by empirical data: out of the 1,190 Investor-State Dispute Settlement (ISDS) cases based on International Investment Agreements (IIAs), over 165 involved taxation-related issues. Most cases revolve around the imposition of capital gains taxes, tax investigations and large tax assessments, regulatory changes to feed-in tariffs for renewable energy production and value-added tax refund disputes.

At first glance, it would seem unfounded for investment tribunals to deal with tax issues. However, upon closer inspection, investment treaties offer to foreign investors greater protection than tax treaties, both in terms of substantive protections and availability of procedural remedies. In addition, governments are increasingly resorting to fiscal leverage to attract foreign investments. Nevertheless, this strategy has turned out to be a double-edged sword for states because it exposes them to potential ISDS claims arising from the change or withdrawal of those fiscal incentives.

It is important to note that not every tax dispute can be submitted to ISDS. A clear distinction ought to be drawn between tax disputes and tax-related investment disputes. Tax disputes concern whether and how a particular transaction should be taxed under the municipal law of a state (or several states if the transaction is international). In contrast, tax-related investment disputes concern allegations of a breach of an investment treaty arising from specific sovereign actions taken by a state in the field of taxation. Only a tax-related investment dispute that challenges the legitimacy of the tax measure itself can be submitted to ISDS.

In response to this phenomenon, states began to include so-called “tax carve-out” clauses, without, however, defining terms such as “taxation measures.” This has resulted in arbitral tribunals being tasked with interpreting whether tax carve-outs are applicable in each case. Tribunals can adopt different interpretations of the same or very similar wording of tax carve-outs, which either affects the possibility of bringing tax-related claims or reduces the effectiveness of tax carve-outs. One may wonder whether the introduction of carve-out provisions and the renegotiation of treaties represents the most efficient way to harmonize tax and investment regimes and whether carve-outs are an effective tool for safeguarding regulatory space.

The Energy Charter Treaty (ECT) is by far the most popular among this type of IIAs, with 68 tax-related cases. The ECT’s popularity in investment litigation is also attributable to the fact that the tax-carve-out provision, because of its ambiguous wording, leaves room for debate as to the exact definition of tax measures for the purposes of determining the jurisdictional scope.

Furthermore, the increase in significance of fiscal measures in investment arbitration is easily explained because of its combination with the key-sector addressed by the ECT, namely energy. Energy is currently at the forefront of national financial and environmental policies, with numerous emergency measures having been implemented to counteract volatile energy prices, particularly in light of the Russia-Ukraine conflict. It is noteworthy that the European Union (EU) has put forward new taxes and measures against energy producers who have not hesitated to pursue their claims through arbitration. Furthermore, the turmoil behind new environmental regulations and the renewable energy sector should not be underestimated. More recently, tax policies, particularly those related to the ECT, are not solely aimed at tax collection. Instead, they serve as a crucial tool for directing investments, particularly in light of the ongoing ecological transition.

In light of these considerations, the aim of this article is to analyze the definition of tax measures under the carve-out in Article 21 of the ECT and related case law in order to ensure the protection of investors on the one hand and to prevent the abuse of investment treaties as a basis for tax-related claims against states on the other. The article argues that the adoption of a flexible interpretation of Article 21 of the ECT is the most effective approach to achieve a balanced protection of the divergent interests of investors and states. The analysis herein also helps elucidate the increase in tax related ISDS cases, which in turn provides context to the legitimacy crisis currently facing this investment system.