Tax Carve Outs Under Bilateral Investment Protection Agreements

A review


Before the Second World War, the only protection available to foreign investments was under customary international law. Due to the absence of a framework that offered protection to foreign investments coupled with the lack of an effective dispute resolution mechanism between foreign investors and States, host states resorted to espousal indiscriminately against foreign investment. The League of Nations, established in, strived for functional cooperation between states and codification of international law and the ICC offered a forum to settle disputes by way of arbitration. However, since there were no comprehensive treaties for the protection of investments, after the Second world war, several newly independent states expropriated foreign investments in exercise of their sovereign rights. Naturally, developing countries sought to protect their investments in developing states and developing countries in turn wanted to attract more capital. Thus, Bilateral Investment Protection Agreements (“BIPAs”) were born. A BIPA is an agreement between two countries that seeks to protect and promote the investments made by investors of such countries by imposing conditions on the regulatory behaviour of the host State. The network of BIPAs developed extensively after the OECD provided legal materials and the 1962 Draft convention on Protection of Foreign Assets on which developed countries based their BIPAs.

BIPAs typically contain protections by incorporating clauses on how the foreign investments are to be treated (treatment provision), protection against expropriation of investments (expropriation provision), allowing free transfer of funds (transfers provision) and mechanisms to resolve disputes between the host state and the foreign investor (ISDS mechanism). States also carve out certain matters which endanger the policy priorities of the State from the applicability of BIPAs. Some of these carve-outs or exceptions are the essential security exception, the general public policy exception and tax carveouts. For example, the Israel – Japan BIT (2017) has an essential security exception. Therefore, if any foreign investments are adversely affected by a host state’s measures or actions that it considers necessary for the protection of its essential security interests, the investments will not have some/ all protections guaranteed under the BIPA.

Similarly, if tax measures are carved-out from the applicability of the BIPA, then foreign investments that are adversely affected by such tax measures will not be protected under the BIPA. The right to tax is at the very core of sovereignty and therefore, most states naturally want to carve tax measures from BIPAs. Tax carve-outs were not as widely discussed earlier. However, over time, rise in investor disputes resulting from a state’s measures relating to taxation have put tax carve-outs in the limelight.

Analysis and Findings of the Report

In this report, we discuss:

  1. Meaning and scope of taxation measures
  2. The distinction between tax disputes and tax-related investment disputes 
  3. Different types of tax carve-outs and how they were interpreted by Tribunals
  4. The principle of Kompetenz-Kompetenz
  5. The difference between a Double Taxation Convention (“DTC”) and a BIPA and the areas of overlap between them
  6. India’s Revised Model BIPA of 2015 and Canada’s Revised Model BIPA of 2021 and the tax carve-outs under each
  7. The Indian Perspective on enforcing arbitral awards

We found that:

  1. Most BIPAs do not define a tax measure and therefore, its determination is left to Tribunals. Moreover, while determining what constitutes a tax measure, the question arises as to whether the domestic law of the host state is relevant or international law.
  2. While a tax dispute cannot be brought before an Arbitral Tribunal if the BIPA contains a tax carveout, a tax related investment dispute i.e., a dispute on whether substantive standards of treatment guaranteed under a BIPA were violated due to the exercise of the State’s authority in the field of taxation can be arbitrated.
  3. General Tax carve-outs are not very common. Tribunals have limited the scope of the general tax carve-out if the measure was not a bona fide tax measure.
  4. In case of limited carve-outs, where some protections under a BIPA are not available against a contracting party’s tax measures, other protections are still available. 
  5. The determination of a ‘tax measure’ and the application of a tax carve-out thereof, for the purpose of applicability of a BIPA, is part of a Tribunal’s power to determine its own jurisdiction also known as the principle of Kompetenz-Kompetenz. Several Model BIPAs have restricted this power of the Tribunal by providing that the competent authorities of the contracting states will determine what constitutes a tax measure. Such determination is typically required to be time-bound.
  6. If a company can establish that they are incorporated in a State as per the domestic legislation and can furnish a certificate of incorporation, then the same shall suffice to invoke the provisions of BIPA. The Tribunals also do not interfere with nationality planning engaged by the investors. This approach encourages treaty shopping which is prohibited by Double Tax Conventions which otherwise, supports a Principle Purpose Test.
  7. BIPAs oblige a Host State to ensure free inward and outward movement of funds, most times, without the mention of restrictions that allow a Host State to restrict the transfer in case any tax obligations are not obliged with.
  8. The ICSID Convention is considered more promising from investors’ point of view but poses a risk of uncertainty due to the annulment proceedings. The New York Convention which India is a party to contains a commercial reservation. India’s The Revised Model BIT seems more promising by expressly characterising claims under BIPA as ‘commercial’ for the purpose of enforcement under the NYC.


We recommend that:

  • Following the definition adopted in Encana, tax measures must be defined as a measure that creates a new legal liability on a class of persons to pay money to the State in respect of some defined class of transactions, the money to be used for public purposes.
  • Instead of burdening tribunals with determining the applicable law, specific choice of law rules should be determined and then applied depending on the characterisation of the dispute and the connecting factor which will bring them closer to the choice of law rules. Accordingly, in case a tax measure is defined in India’s future treaties, the applicable law to determine whether a measure of a state is a tax measure may be the law of the host state.
  • The power of the host state to determine what constitutes a “tax measure” even after the commencement of the arbitration proceedings should be done away with.
  • Awards arising out of investment arbitration be included within the ambit of foreign awards under Section 44 of the Arbitration and Conciliation Act, 1996.
  • A Joint Committee consisting of authorities from both the treaty partners, that allows for a unilateral decision by the Host State must determine what constitutes a tax measure under India’s future BIPAs. India’s BIPAs must also prescribe fixed timelines within which the decision must be rendered.
  • The Indian government must include Indian Investors and industry experts in the consultation process when finalising its BIPAs.
  • Instead of excluding taxation measures from the protections guaranteed under BIPAS, India should consider offering protection against taxation as resulting in expropriation in certain cases like in the US model BIT and Canada’s Revised Model BIPA.
  • India must consider the inclusion of Multilateral Investment Courts in its BIPAs while ensuring that all the concerns associated with it are ironed out.
  • States must consider establishing a common platform to discuss BIPA-related matters.
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