Chapter Thirty-Seven

South Korea–Japan Bilateral Investment Treaty

Bilateral Investment treaties (BITs) are comparatively new legal structures. These treaties go back over 50 years, when Germany and Pakistan signed a bilateral investment treaty on November 25, 1959. Tax practitioners have had little opportunity to address the tax issues of these BIT agreements. The Korea–Japan BIT treaty provides an example of the tax issues relevant to the tax practitioner.

BACKGROUND

At the present time, country participants participate in more than 2,500 BITs, involving most countries in the world. Bilateral investment tax treaties are, for the most part, not tax treaties. Nevertheless, some BITs contain significant tax components. One such BIT having tax components is the Korea–Japan BIT. This treaty, perhaps uniquely, contains treaty shopping provisions.

BITS are unique among other treaties. BIT treaties give the investor significant rights vis-à-vis the treaty country, treating the host country and investor almost as equals. The investor achieves these rights through powers that its own country grants to the investor.

A BIT is distinct from an income tax convention. Countries might have income tax conventions, might have BITs, or might have both or none depending on the circumstances. BITs are akin in many respects to treaties of friendship and navigation, which also might exist with the same countries.

U.S. INVOLVEMENT IN BITS

The United States has 40 BITs in force. The United States operates its BITs through the Office of the United States Trade Representative, which is part of the Executive Office of the President. The U.S. BITs are designed to help protect U.S. foreign investment, to help market-oriented policies in partner countries, and to promote U.S. exports.

Many countries undertake BITs with large, well-developed market-driven economies. In contrast to BITs that America’s treaty partners undertake, the United States has developed a BIT structure with smaller countries that only recently sought inbound investment. As a result, the U.S. BIT programs attempt to accomplish these objectives:

• Protect investment abroad, in countries where investor rights are not always protected through existing agreements. Such protections include agreements such as modern treaties of friendship, commerce, and navigation, or free trade agreements.
• Encourage the adoption of market-oriented domestic policies, where these policies treat private investment in an open, transparent, and nondiscriminatory manner.
• Support the development of international standards that are consistent with the protection objective and market-oriented policy objective.

ARBITRATION

BIT treaties typically provide an arbitration provision, enabling the investor and the host country to arbitrate disputed provisions. BIT treaties provide for arbitration under the International Centre for Settlement of Investment Disputes (ICSID) or with United Nations Commission on International Trade Law (UNCITRAL) provisions. The Korean–Japan BIT treaty contains both ICSID and UNCITRAL provisions.

ICSID ARBITRATION

Enterprises facing investment disputes with their host governments could potentially seek to resolve these disputes through the ICSID mechanism or through other dispute mechanisms. BITs might or might not specifically address these tax concerns through the ICSID dispute process.

The ICSID convention is a multilateral investment treaty that was entered into force on October 14, 1966. However, the ICSID mechanism contemplates that the parties would enter bilateral agreements as opposed to multilateral agreements.

At this writing, 155 countries have joined the ICSID Convention, of which 144 countries have ratified, accepted, or approved the ICSID Convention. Canada, Russia, and Thailand are among the countries that have joined the Convention but have not ratified, accepted, or approved it. Bolivia had been an ICSID member but denounced the Convention on May 2, 2007, effective November 3, 2007. Ecuador had been an ICSID member but denounced the convention on July 6, 2009, effective January 7, 2010. Commentators have suggested that Nicaragua and Venezuela will be leaving ICSID as well.

The ICSID Convention is an autonomous entity within the World Bank Group (i.e., the International Bank for Reconstruction and Development). Technically, the ICSID Convention is termed the Convention on the Settlement of Investment Disputes Between States and Nationals of Other States. ICSID operates through an Administrative Council, chaired by the president of the World Bank, and a Secretariat. ICSID provides facilities—legal and physical—for conciliation and arbitration of investment disputes between member countries and investors in these host countries. The Administrative Council consists of one representative of each state that has ratified the ICSID Convention. The Administrative Council meets annually in conjunction with World Bank annual meetings.

During the immediate post–World War II period, the World Bank and its presidency became involved in disputes between governments and private foreign investors. As the BITs proliferated, the World Bank and its presidency sought to institutionalize the burden of becoming involved in these investment disputes. The World Bank finances the cost of the ICSID Secretariat, but the parties to ICSID proceedings fund the cost of these proceedings through a fee system (e.g., $25,000 for an arbitration proceeding).

TREATY SHOPPING WITHIN THE BILATERAL INVESTMENT TREATY CONTEXT

Relatively few BITs include tax-oriented investment provisions. In addition, relatively few BITs having such tax provisions include a treaty shopping limitation. Consider Article 22(2) of the Agreement between the Government of the Republic of Korea and the Government of Japan for the Liberalisation, Promotion and Protection of Investment, signed at Seoul on March 22, 2002, and entered into force on January 1, 2003. The treaty applies a limited treaty shopping provisions, not limited to tax considerations.

Article 22(1) extends the scope of the BIT treaty to local governments within that jurisdiction. Article 22(1) provides, as a general matter, that, each party, in fulfilling the obligations under this agreement, is to take reasonable measures as may be necessary and as may be available to it to ensure the obligations of local governments in its territory.

Article 22(2) itself provides the treaty shopping limitations:

Each Contracting Party to the Agreement between the Government of the Republic of Korea and the Government of Japan for the Liberalisation, Promotion and Protection of Investment reserves the right to deny the benefits of this Agreement to an investor of the other Contracting Party under specified circumstances.

Article 22(2) limits the scope of this treaty shopping to a legal person or any other entity referred to in Article 1(1)(b). Article 1(1)(b) refers to a legal person or to any other entity constituted or organized under the applicable laws and regulations of that contracting state. Such an entity includes an entity, whether for profit or not, and whether private or government owned or controlled. Such an entity includes a company, corporation, trust, partnership, sole proprietorship, joint venture, association, or organization.

The treaty, in two circumstances, would deny to the investor the benefits of the treaty if the investors of any third country own or control that investor of that other contracting party:

Note that Article 22(2) fails to define “own” or “control.” The treaty shopping provision, for example, would preclude alien countries such as North Korea from taking advantage of the South Korea–Japan BIT.

Article 22(2) of the agreement enforces a “most favored nation” clause regarding investment and business activities. Each contracting party in its territory is to accord investors of the contacting party and to their investments treatment no less favorable than the treatment it accords in like circumstances to investors of any third country and to their investments. Article 22(3) provides that the most favored nation provisions of Article 22(2) are not to be construed so as to extend to investors of the other contracting party and their investments any preferential treatment resulting from its membership in a free trade area, a customs union, an agreement for economic integration, or a similar international agreement.

TAX PROVISIONS WITHIN THE KOREA–JAPAN BILATERAL INVESTMENT TREATY

Article 19(1) provides that nothing in the agreement is to apply to taxation matters except as expressly provided in paragraphs 2, 3, and 4 of the article. Paragraphs 2, 3, and 4 enumerate nine articles in the agreement to which the tax matters do apply for purposes of the agreement. Note that these nine articles contain both procedural and substantive provisions.

Article 19(2) provides that Articles 1, 3, 7, 10, 22, and 23 apply to taxation matters:

• Article 1 is a definitional section, addressing the terms:
  1. “Investor”

  2. “Investment”

  3. “UNCITRAL Arbitration Rules”

  4. “ICSID Convention”

  5. “Centre” in reference to ICSID

  6. “Territory” as to contracting party

  7. “Contracting Party”

  Article 19(2), then, appears to limit the scope of the tax provisions to (1) the term “investor” and to (2) the term “investment” as to the substantive subject matter under review, including tax matters. Article 19(2) then applies to paragraphs (3) through (7) as to procedural issues under review, including tax matters.
• Article 3 provides for the procedural issues that impact national treatment. It provides investors of the other contracting party treatment that is “no less favorable” to the treatment the contracting party accords in like circumstances to its own investors, or investors of any third country, as to access to the courts of justice and to administrative tribunals. Article 19(2) extends this Article 3 national treatment provision to tax matters.
• Article 7 provides for transparency as to the publication of the contracting party’s laws, regulations, and judicial decisions of general application as well as international agreements that pertain to or affect investment and business activities. Article 19(2) extends this Article 7 transparency provision to tax matters.
• Article 10 provides for fair and equitable treatment, full and constant protection and security, and limits the potential for expropriation. Article 19(2) extends this Article 10 expropriation provision to tax matters. As international tax practitioners, we take the position that the expropriation would have equal tax impact in situations in which a contracting party undertakes an expropriation of property belonging to the other contracting party.
• Article 22 provides for treaty shopping, not only in the tax context but other nontax situations as well. Article 19(2) explicitly extends this Article 22 treaty shopping provision to tax matters.
• Article 23 provides for the effective date of the Korean–Japan Agreement. Article 19(2) extends this Article 23 effective date provision to tax matters.

Article 19(3) provides that Article 14 and Article 15 apply to disputes under Article 19(2). Article 19(1) makes clear that Article 19(3) applies to tax matters under dispute.

Article 14 addresses disputes between the contracting parties themselves (i.e., situations in which the investor or the investment are not involved). Article 14 provides for the use of an arbitral tribunal to resolve such dispute, providing for application of the UNCITRAL Arbitration Rules unless the contracting parties agree otherwise. Article 19(3) provides that such a dispute includes tax matters as to Articles 1, 3, 7, 10, 20, and 23.

Article 15 addresses disputes between a contracting party and an investor of the other contracting party as to investment disputes. Article 15 provides three methods for resolving investment disputes:

Article 19(3) provides that such a dispute between a contracting party and an investor of the other contracting party as to investment disputes includes tax matters as to Articles 1, 3, 7, 10, 20, and 23.

Article 19(4) provides that Article 20 is to apply to taxation measures as to the matters set out in Article 19(2) (i.e., Articles 1, 3, 7, 10, 20, and 23) concerning the application of a Joint Committee representing Japan and Korea in implementing the agreement.