IC Power Asia Development Ltd. v. The Republic of Guatemala, PCA Case No. 2019-43
The tribunal in IC Power Asia Development Ltd. v. The Republic of Guatemala dismissed the claimant’s claims in their entirety, holding that neither Guatemala’s initiation of criminal proceedings against the company nor the associated conduct of its courts or tax authority amounted to arbitrary treatment or a subversion of legitimate expectations or due process. As the unsuccessful party, the claimant was ordered to pay two thirds of the respondent’s legal and arbitration fees.
Background of tax dispute
In 2011, Actis LLP, a U.K.-based investment fund, acquired DEOCSA and DEORSA (distributors), Guatemalan electricity distribution companies operating over 70,000 km of distribution lines. The acquisition was somewhat complicated, taking the form of a reverse triangular merger. As part of that transaction, the distributors merged with Guatemalan subsidiaries of two companies Actis had incorporated in the Netherlands. The distributors’ prior owner (Fenosa) was paid a premium, funded by bank loans for which the distributors were ultimately liable.
In 2012, the distributors filed their 2011 financial statements with the Guatemalan Superintendence of Tax Administration (SAT). They claimed two tax deductions related to the reverse triangular merger: one for the amortization of goodwill and one for the interest payments on their new bank loans. Before the end of the year, the SAT had begun an audit of the distributors’ statements, later extended to the 2012 financial statements, on which the same deductions were claimed. The SAT’s auditing teams issued two reports in late 2013 and early 2014, in which they concluded that these tax deductions were inadmissible. A criminal proceeding, however, was found unwarranted at the time by the Department of Legal Affairs.
Over the course of 2014 and 2015, the distributors objected, ultimately unsuccessfully, to the audit reports. However, in a separate procedure in 2015, they submitted requests to the Consulting Department of the SAT for “binding tax opinions” on the methods used to calculate their deductions and on the appropriateness of the deductions themselves. Per Guatemala’s Tax Code, such opinions are not disputable, and bind the tax administration on the particular question at issue. The binding tax opinions stated that the accounting practices used by the distributors to calculate their deductions were technically correct and the deductions appropriate, so long as they were properly supported and documented. Shortly thereafter, in accordance with the opinions, the distributors submitted rectification payments to the SAT related to their tax declaration for the years 2011–2013.
Later in 2015, the claimant in this case, IC Power, a private company incorporated in Israel, learned that Actis was looking to sell the distributors. Its team, in conducting due diligence and valuation studies, came upon the binding tax opinions. Ultimately, the team reported to the company that the opinions left no doubt as to the resolution of the tax issues. It also informed IC Power that Actis had confirmed that the previous tax payments had been rectified, but that Actis had not presented verifying documents. IC Power acquired the distributors in 2016.
Beginning of criminal proceedings
After the release of the Panama Papers and a wave of corruption scandals in Guatemala, including some implicating tax officials, a new SAT head took office. He quickly began a large number of investigations into files that had been resolved to the detriment of the SAT. This included the audit of the distributors. In July 2016, the SAT filed a criminal complaint for tax fraud for the distributors’ 2011 and 2012 tax deductions.
Shortly after the initiation of the case, the criminal court held an ex parte hearing with SAT representatives and ordered the precautionary seizure of the distributors’ bank accounts for the full amount alleged to be owed to the tax authority for 2011–2012. The SAT also began a second audit, for the tax years 2014 and 2015. Out of concern that a second criminal case would be brought, and more assets seized, which would leave the companies inoperable, the distributors paid the SAT USD 75 million for the alleged tax deficiencies for 2011–2015. These payments included a note asserting that the payments were made under protest, and that they were not an admission of liability.
The precautionary seizure was lifted, and the distributors requested that the SAT provide them with a new calculation of their tax bill, with charges for interest and penalties decreased to reflect the payments made. A new calculation was indeed made, but the distributors worried that it did not properly consider those payments. Indeed, the SAT pursued the perceived missing interest and penalties payments and requested that the court place the distributors in receivership. Again, the distributors paid under protest.
Eventually, as court proceedings progressed, the SAT issued reports admitting that the rectification payments had not been considered when the interest and penalties were charged. Soon thereafter the criminal court ordered compensation. The SAT has refused on multiple occasions, insisting that the distributors request the money through the proper administrative procedure.
The criminal procedure remained in the investigative phase, with no formal indictment issued, until the time the arbitral claim was brought, 4 years after the case began. Meanwhile, in 2017, IC Power sold the distributors to I Squared Capital, an American private equity firm, but retained, by contract, the exclusive right to pursue a treaty claim regarding the SAT dispute.
In 2018, IC Power filed notice of arbitration, seeking USD 113,130,000 for breach of the Israel–Guatemala BIT. It complained of a breach of Article 2’s protections of FET and against impairment by unreasonable measures, as well as umbrella clauses imported into the treaty via Article 3’s MFN protection.
Jurisdictional arguments dismissed
Guatemala argued that IC Power could not bring a claim for several reasons. It argued that because, at the time of the complaint, IC Power had no assets protected by treaty in the country, the arbitral tribunal lacked jurisdiction. IC Power argued that its contractual retention of the right to bring a claim was itself an investment. The tribunal found otherwise, holding that IC Power’s claim did not involve an asset located in Guatemala, and that an investor who has sold their assets in a country is unable to bring a claim, barring special circumstances. It further found, however, that the contractual retention of the right to bring a claim comprised just that sort of qualifying special circumstance, so long as the retention was absolute and so long as the holder of the right was at one point in possession of a qualifying investment.
Guatemala also argued that IC Power was asking the tribunal to act as a domestic or appellate court on matters of Guatemalan law since the claims were really domestic in nature. The company disputed this on the grounds, first, that there had been a violation of the treaty, and second, that there had not even been an indictment, let alone a ruling, and so the tribunal could not be acting as an appellate body. The tribunal found that there was a dispute regarding application of the treaty, and that it was unnecessary to ignore that aspect of the dispute simply because it also had domestic aspects.
The tribunal also rejected five other jurisdictional objections, leaving some for the merits stage of the proceedings.
Guatemala’s treatment of IC Power did not breach FET
The tribunal first addressed IC Power’s claims regarding Article 2 on FET, particularly concerning the SAT’s disregard of the binding tax opinions and the initiation and carrying out of criminal proceedings, including the ex parte hearings and the seizure of assets. It complained that this behaviour was arbitrary, a breach of legitimate expectations, and a denial of due process and procedural fairness.
The tribunal broke these claims down into three parts. IC Power argued that, in beginning criminal proceedings and submitting seizure applications, the SAT flouted its own tax opinions, which it was bound to respect. This was done without exhausting the administrative proceedings required by Guatemalan law. Furthermore, it alleged that the criminal court breached FET when it granted the seizure application. In response, Guatemala contended that the binding tax opinions were issued based on an incomplete set of facts provided by the distributors, and were conditioned on the relevant expenses being properly documented and actually generating taxable income, which was not the case. It also argued that the tax opinions were binding only on the SAT and did not preclude the initiation of criminal actions. It maintained, further, that the SAT had no obligation to exhaust administrative procedures, and, indeed, was obliged to suspend such proceedings to file a complaint when indications of tax fraud were verified. Finally, it submitted that precautionary seizures are not unusual in Guatemala, and that in ordering one, the court complied with Guatemalan law.
The tribunal agreed with Guatemala in determining that, by law, binding tax opinions do not preclude the SAT from filing a criminal complaint upon a finding of indications of crime. Quite the opposite: it is required to do so, without any accompanying requirement that it exhaust administrative proceedings. As such, IC Power had no legitimate expectations that Guatemala subverted. The tribunal also agreed that the opinions were only valid insofar as the representations made to the SAT were complete and accurate and that the SAT was not responsible for validating them. Finally, due process was not undermined because the criminal court’s order to seize assets followed legal procedure and because there was no evidence that the court had acted in tandem with the SAT to coerce payments. The tribunal also noted that, since criminal proceedings were ongoing, and due to the high deference owed to national courts, it was very reluctant to interfere without a showing of egregious conduct. In sum, it found no breach of FET.
Guatemala did not impair IC Power’s investments by unreasonable measures
The tribunal found that IC Power’s Article 2 complaint that Guatemala impaired its investment by unreasonable measures was based on the same facts as its complaint about FET. Since IC Power failed to argue that the same facts could constitute impairment of an investment without reaching the level of arbitrariness, the claim was dismissed for the same reasons.
Binding tax opinions were not specific commitments and so did not breach umbrella clauses
IC Power argued that Guatemala breached umbrella clauses from other investment treaties imported into the Israel–Guatemala BIT by way of its Article 3 MFN provision. Treaties with Belgium-Luxembourg Economic Union (BLEU), Argentina, and South Korea include provisions protecting commitments made to individual investors as if they were included in the treaty itself. IC Power characterized the binding tax opinions as commitments that Guatemala entered into and subsequently abandoned. Guatemala, for its part, argued that the MFN clause would only apply to the exercise of the rights and duties actually secured in the treaty with Israel, and that IC Power was attempting to create new protections not originally provided for. Guatemala also maintained that the binding tax opinions were not specific commitments anyway.
Because the binding tax opinions did not preclude the SAT initiating criminal proceedings, the tribunal agreed with Guatemala that they did not constitute a commitment to the investor. It refrained from deciding the question of whether Article 3 allowed for the importation of umbrella clauses in other treaties or whether IC Power could rely on them.
Decision and costs
The tribunal rejected all of Guatemala’s jurisdictional objectives as well as all of IC Power’s substantive claims.
The tribunal ordered IC Power to pay two thirds of Guatemala’s arbitration and legal fees. In arriving at this decision, the tribunal noted that the unsuccessful party is generally responsible for all costs, but since Guatemala raised six unsuccessful jurisdictional issues that IC Power had to litigate, it would bear one third of its costs.
Notes: The tribunal was composed of Professor Albert Jan van den Berg (president, Dutch national), Professor Guido S. Tawil (claimant’s nominee, Argentine national), and Professor Raúl Emilio Vinuesa (respondent’s nominee, Spanish/Argentine national). The award is available at https://jusmundi.com/en/document/decision/en-ic-power-asia-development-israel-v-republic-of-guatemala-friday-15th-november-2019.
Dave Duckett is a student at the University of Michigan’s Law School and its School for Environment and Sustainability, and an extern with IISD’s Investment for Sustainable Development Program.