• 1 Reference prices are price benchmarks compiled and published for reference purposes by commodity ex (...)

1‘Prescriptive’ valuation methods are simplified and targeted means to counter commodity trade mispricing and reclaim diverted profits. To varying extents, they involve the regulatory use of reference prices1 and fixed margins for tax purposes for the sake of administrative simplicity (Musselli and Bürgi Bonanomi, 2021, 14–17; 2022, 452–54). An instance of this is the requirement to use reference prices when determining the selling price of minerals, or specific limitations on the types of expenses and costs that can be deducted for calculating a mine’s net income (see Section 2 for further details). These methods are known as ‘prescriptive’ because they are based on laws and regulations that set the applicable price ranges, margins, pricing formulas and profit allocation methods (Musselli and Bürgi Bonanomi, 2021, 14). In tax literature, they are often called ‘administrative approaches’ or ‘alternative policy options’ for pricing and tax valuation (Readhead and Viola, 2023).

• 2 The principle states that related parties should transfer goods and services to each other at the p (...)
• 3 Mispricing in trade transactions occurs when goods or services are ‘abnormally priced’ with referen (...)
• 4 Under the ‘arm’s-length principle’, prices between related parties should approximate the prices th (...)

2Prescriptive methods go beyond administrative simplification. They can be characterised as anti-abuse rules primarily driven by tax avoidance concerns (Readhead et al., 2023; Readhead and Viola, 2023; Taquiri, Lassourd and Viola, 2023). For example, the so-called ‘sixth method’ approach (see Section 2) was developed by resource-rich countries in Latin America to address abusive tax avoidance schemes in the commodities sector (Readhead et al., 2023). As discussed in Section 4, the tax avoidance aspect is important since it is the government’s response to avoidance or misconduct that forms the basis of several defences under investment law. If well designed, prescriptive methods reduce opportunities for abusive tax avoidance practices that exploit ambiguities in the interpretation of the ‘arm’s-length’ principle (for a discussion, see Musselli and Bürgi Bonanomi, 2020),2 while providing predictability and certainty for economic actors to plan their transactions (Durst, 2016; Faccio and Picciotto, 2017; Musselli and Bürgi Bonanomi, 2022; Picciotto, 2018; Readhead, 2017; 2018). Prescriptive methods, especially in their most rudimentary forms, offer workable ways for countries with understaffed tax administrations to counter the undervaluation of their commodity exports and the erosion of their tax base.3 Compared with transactional arm’s-length rules,4 they entail less administrative burden or staff requirements and reduce room for administrative discretion and corruption if properly designed and implemented. Compared with technology-driven innovations and transparency frameworks, they require lower capital costs and lower investment in technology.

• 5 For example, ‘sixth method’ approaches may allow for or require comparability adjustments to the qu (...)
• 6 Under such an approach, companies that transact at regulated prices are exempt from tax scrutiny, w (...)

3Certainly, prescriptive methods on their own involve complex design features and trade-offs: if overly rigid and too simplified, they may lead to distortions and economic inefficiencies; if, instead, open to complex adjustments, they offer scope for manipulation and are difficult to administer, frustrating their very rationale (Musselli and Bürgi Bonanomi, 2022; Picciotto, 2018). It is important to stress, in this respect, that many countries still make complex (and necessary) adjustments for quality differences/processing, which significantly complicate simplified methods.5 Yet a number of design features can help mitigate or reconcile such trade-offs, for example when some leeway is allowed for the taxpayer in a ‘safe harbour’ approach (Musselli and Bürgi Bonanomi, 2022, 455–56).6

• 7 Although the Guiding Principles are not an authoritative statement of relevant domestic and interna (...)

5Regulatory chill continues to persist notwithstanding the possible defences that host governments may have against arbitral claims arising from the adoption of predictive methods. Several defences find political support in the 2020 OECD Guiding Principles on Durable Extractive Industry Contracts,7 which, for example, exclude bona fide anti-avoidance measures from fiscal stabilisation provisions (OECD, 2020). From a political and legal point of view, this introduces the notion of revenue certainty for governments—the opposite of tax certainty. Additionally, there is little evidence of investors initiating legal action against prescriptive pricing approaches, and a lack of conclusive case law regarding stabilisation clauses and changes in fiscal and price terms (see Section 4). These factors alone should be sufficient to mitigate regulatory chill.

• 8 While the use of reference prices as such does not represent a departure from the OECD Transfer Pri (...)

10Several countries concerned about systemic trade mispricing legislate the use of reference prices (with or without adjustments) to determine the tax value of commodity sales, particularly in the context of related-party sales. This is the so-called sixth method under transfer pricing law (for an overview of state practice, see CIAT (Inter-American Center of Tax Administrations), n.d.; Grondona, 2018; UN, 2017b, 217–19). Reference prices are price benchmarks compiled and published for reference purposes by commodity exchanges, other recognised market data providers, and government agencies (OECD, 2017 para. 2.18, ‘quoted prices’). Examples include prices discovered on the London Metal Exchange (LME) for base and ferrous metals, and prices listed on the London International Futures and Forwards Exchange (LIFFE) for forward cocoa sales. In the context of transfer pricing laws, the sixth method requires looking at such reference prices when determining the fair market value of commodity sales. The requirement concerns taxpayers, when filing their tax returns, and/or tax administrations, when auditing the taxpayer’s position. The more straightforward the requirement is (use of reference prices without adjustment, or with standardised/minimum adjustments), the more it departs from business practice and transactional ‘arm’s-length’ rules (as codified in the OECD Transfer Pricing Guidelines, OECD, 2017).8

• 9 The so-called law EGalim 1 (Loi n° 2018-938 du 30 oct. 2018, JO 1er nov.) and EGalim 2 (Loi n° 2021 (...)
• 10 Many EU Member States, for example, have implemented national rules on unfair trading practices in (...)

12Finally, other prescriptive approaches do not simply set values for tax assessment purposes, but directly intervene regarding prices and price-related terms in contracts (for an overview, see Musselli and Bürgi Bonanomi, 2022, 453–54). An interesting development in this respect are the EGalim laws in France,9 which require that farmers propose prices on the basis of production costs and that inter-branch organisations develop benchmarks of production costs and market indicators (Delpech, 2021; Ministère de l’agriculture et de la souveraineté alimentaire, n.d.; Vogel and Vogel, 2018). Also of potential relevance are those laws or regulations, whether sector-specific or general, that render certain price-related terms in contracts ineffective.10 Such rules on unfair trading practice do not regulate prices directly, but they may affect the way prices are negotiated and set.

• 11 For example, Article 7 (3) of the United Nations Model Double Taxation Convention between Developed (...)
• 12 On a transactional basis, for example, Brazil’s transfer pricing legislation sets forth fixed profi (...)
• 13 For example, Article 7 (3) of the United Nations Model Double Taxation Convention between Developed (...)
• 14 OECD/G20 Inclusive Framework on Base Erosion and Profit Shifting (BEPS) Action 4 recommends limitin (...)

13While the aforementioned techniques aim to prevent the undervaluation of commodity exports, there are other methods that incorporate prescriptive elements to determine deductible taxpayer costs (Durst, 2016). The main emphasis here is on the input aspect of the commodity trade equation, which includes the cost of services, supplies, and equipment acquired from affiliated entities. Additionally, intra-group funding is also considered (Durst, 2016). As Durst has pointed out, certain prescriptive methods implement ‘bright-line’ limitations on deductible expenses for taxpayers, with the goal of maintaining the taxable base in ‘source countries’ (Durst, 2016, 11–14). In certain situations, such as intra-group transactions, the law may prohibit markups on costs for tax purposes.11 A less severe approach is to establish legally defined profit margins and markups for tax assessment purposes.12 Some schemes and model laws further disallow tax deductions for the use of intangible properties, including technological know-how.13 Going one step further, several countries have implemented bright-line interest limitation rules that restrict the amount of deductible interest to a certain percentage of a company’s earnings.14 Another solution to make up for the decrease in taxable income caused by making too many payments to foreign affiliates is to impose withholding taxes on outbound payments (Meyer-Nandi, 2018). As summarised elsewhere (Musselli and Bürgi Bonanomi, 2021), all such rules set bright-line restrictions designed to preserve the taxable income of subsidiaries within multinational groups.

• 15 The regulatory space a country has to implement prescriptive methods legally can only be assessed i (...)
• 16 See, e.g., Eco Oro Minerals Corp. v Republic of Colombia, ICSID Case No. ARB/16/41, Decision on Jur (...)
• 17 See, e.g., LG&E Energy Corp., LG&E Capital Corp. and LG&E International Inc. v Argentine Republic, (...)

16Depending on jurisdictional requirements and any concrete commitments,15 a state’s regulatory adjustment of the existing tax regime or contractual price terms may trigger claims by foreign investors of ‘unfair treatment’ under applicable investment treaties. The customary minimum standard of ‘fair and equitable treatment’ has been interpreted to include legitimate expectations regarding a predictable business environment.16 The standard may be interpreted to cover legislative changes that might adversely affect the investor’s position.17

• 18 See, e.g., Article 9(2) of the Germany – Ghana BIT (1995) (‘(2) Each Contracting Party shall observ (...)
• 19 Although frequently found in BITs, the effect of umbrella clauses is still being debated. While mos (...)

18A related constraint arises from the ‘repackaging’ of contractual and commercial claims into treaty claims under so-called umbrella clauses in investment agreements. Broadly worded, an umbrella clause provides that each state party to the investment treaty shall observe any other obligation it has assumed regarding the investor or the investment in its territory.18 Such clauses may render the host state internationally liable under the investment treaty for breach of obligations stemming from investment contracts and/or domestic law.19

• 20 See, e.g., Watkins v Spain, ICSID Case No. ARB/15/44, Award (21 January 2020); Oxus Gold v Uzbekist (...)

20This in spite of the fact that relevant case law on the matters raised above—namely, the scope of fair and equitable treatment standards, stabilisation clauses, and the elevation of claims from domestic to international law—is far from conclusive. As regards stabilisation clauses, for example, while in some arbitration awards such clauses are strictly upheld by the adjudicator, other cases recognise specific defences from domestic and international law as applicable in investment and commercial arbitration20 (for a review, see Viñuales, 2020). Some investment cases point to a nuanced scenario whereby fiscal incentives, including stabilisation commitments, ‘may be adjusted within the bounds of reasonableness and proportionality’ (Hailes, 2022, 168). As we will point out in the concluding section of this chapter, legal interpretations of the issue are ‘fluid and contested’, shaped by a ‘social process of interpretation’ in what has been termed ‘the inherent indeterminacy of the law’ (Miola and Picciotto, 2022, 155–56).

• 21 For a more comprehensive review of ‘defence arguments’ under investment law, the reader is referred (...)

21As briefly discussed above, there is lack of conclusive case law on the matter of the legality under international investment law of well-designed prescriptive methods implemented in the public interest despite stabilisation arrangements. However, when it comes to legal reasoning, developing countries that unilaterally adopt bona fide prescriptive measures to address tax abuse would have strong legal defence arguments in favour of such measures. Drawing on Viñuales’s comprehensive analysis of ‘defence arguments’ under investment law (Viñuales, 2020), we introduce three broad sets of ‘defences’ that can be mobilised to justify a shift from transaction-based valuation systems to alternative, prescriptive valuation methods. Arguments in the first of these three sets are based on considerations of wrongdoing by the investor; those in the second are generally available excuses that can be invoked as circumstances precluding wrongfulness; the third set is based on the assessment of overarching public interests. Such defences may arise from international law, domestic law, or both, and intervene at different stages (jurisdiction/admissibility, liability, quantum/compensation) (Viñuales, 2020, 13–18).21

• 22 Since the prohibition of corruption is an important public provision established in the public inte (...)
• 23 Accordingly, the adjudicator concluded that the dispute did not fall within the scope of the treaty (...)

23At one extreme are allegations of corruption surrounding the investment whose protection is sought. Let us consider, for example, the award of a mineral concession whose financial terms result from political capture and interference, conflicts of interest, bribery, etc. In our hypothetical case, the government subsequently modifies or abrogates the concession, or adjusts its price/financial terms by adopting prescriptive valuation methods. The investor claims compensation for the loss of economic benefit. If corruption is proven, a defence would be that the investment is illegal and does not deserve protection since the benefits of an investment treaty are reserved for lawful investments.22 For example, as reviewed by Viñuales (2020), in Metal-Tech v. Uzbekistan the tribunal concluded that it lacked jurisdiction over the treaty claims since the investor had violated Uzbekistan law on corruption in connection with its investment in Uzbekistan and hence the investment was not covered by the applicable treaty. Article 1(1) of the applicable Israel–Uzbekistan BIT (a legality clause) defined investments as only those implemented in compliance with local law.23 The illegality defence can be grounded in the applicable treaty (e.g. a legality clause, as in the above case), or stem from the ‘implicit understanding that illegal investments do not deserve protection’ (Viñuales, 2020, 20). If proven, the illegality of the investment may exclude jurisdiction (the investment treaty does not apply) or make the claim inadmissible.

• 24 The precise standard of proof required by tribunals has seen some variation in case law. For instan (...)

24Practical difficulties may arise in connection with the burden and standard of proof, particularly in a context where company directors and managers remain intentionally unaware of the details (‘wilful blindness’ or ‘conscious avoidance’). Case law has endorsed a high standard of proof,24 suggesting that red flag indicators raising suspicions regarding corrupt activities would, in principle, not be enough (for a more detailed assessment, see Viñuales, 2020, 46–49). This makes the detection and sanctioning of corruption difficult. The problem is compounded when the investment is made through a third party who engages in corruption. In this case the critical factor is the level of institutional control and oversight deployed by the investor in relation to the process. Failure to exercise due diligence, or fraud in the form of ‘wilful blindness’, may still matter when assessing the admissibility of a compensation claim (for a discussion, see Viñuales, 2020, 49–51).

• 25 Lao Holdings N.V. v Lao People’s Democratic Republic, ICSID Case No. ARB(AF)/12/6, Award (6 August (...)

25Let us now move on to consider subsequent financial misconduct by foreign investors, for example when companies engage in abusive transfer practices and other tax avoidance techniques. The question is, if the host state implements prescriptive taxation methods as anti-avoidance measures in response to an investor’s abusive tax avoidance, can the investor use a stabilisation clause to seek compensation? More generally, does an investor who engages in unlawful tax avoidance deserve the protection of the investment treaty? As held by the tribunal in Lao Holdings v. Laos, serious financial misconduct by investors in the host country, in breach of their good faith obligations, is not without treaty consequences: it bears implications in relation to the guarantee of fair and equitable treatment, as well as to investors’ entitlement to compensation.25

• 26 This refers to a situation where an investor, who is not protected by an investment treaty, restruc (...)
• 27 A scenario where companies within the same group routinely bring claims against the same measures u (...)

27The above arguments essentially intervene at the quantum/compensation stage. Beyond compensation, the doctrine of ‘abuse of right’ is a legal concept that can impact liability and the admissibility of a claim. Under case law, the ‘abuse of right’ doctrine has been used to deny protection in situations involving ‘abusive restructuring’26 or ‘multiple suits’27 (Viñuales, 2020, 42–46). Our hypothetical case involves a different set of circumstances. Specifically, it concerns an investor who has engaged in tax abuse and is now seeking compensation due to a tax reform that aims to prevent such abusive practices. The effectiveness of the ‘abuse of right’ defence forwarded by the state would depend on how the adjudicator defines the requirements of this defence in the dispute context, and their more or less restrictive character.

• 28 Drawing on (model) private law, there is ‘hardship’ where ‘the occurrence of events fundamentally a (...)

30Such excuses generally refer to a fundamental change of the circumstances in which an agreement was concluded.28 For example, booming demand and supply scarcity for some critical minerals in the clean energy transition may lead to a fundamental supply/demand imbalance that may require a renegotiation of pending contracts. The objective would be to re-establish the balance of the contract in a changed scenario.

• 29 In some cases, however, unexpected events such as the COVID-19 pandemic can cause a price shock tha (...)

31Yet the availability of this defence depends on various requirements that can be interpreted with varying levels of strictness in the dispute context. To be successful, for example, a plea of ‘hardship’ must meet stringent requirements—drawing from contract law and practice. As codified in model contract law (Article 6.2.2 (b) and (d), the International Institute for the Unification of Private Law (UNIDROIT) Principles), ‘hardship’ may not be invoked if, for example, adverse price developments could reasonably have been taken into account by the disadvantaged party at the time the contract was concluded, or when the risk of the events was assumed by the disadvantaged party. This seems to apply to price fluctuations that are a result of market fundamentals and business cycles, which cannot be considered unforeseeable.29 Eventually, as discussed in the concluding section of this chapter, much depends on the standard of review adopted by the adjudicator when scrutinising the factual and legal aspects of the state’s decision.

• 30 The term ‘police’, in its original English, coming from the Greek politeia, i.e. ‘policy’ or ‘gover (...)

32Finally, a range of defence arguments support the view that a state can permissibly regulate in the public interest without being liable for compensating the investor. This argument is based on legal concepts of ‘police powers’ and ‘international public policy’. The exercise of ‘police powers’ refers to the exercise of governmental functions.30 This notion, grounded in general international law, acknowledges a state’s ‘entitlement, indeed [its] duty to regulate’ (Viñuales, 2020, 66), and posits that ‘the exercise of regulatory powers is permitted unless prohibited’ (Viñuales, 2020, 66). The principle acknowledges that the exercise of police powers may be subject to limitations, including by treaty norms such as investment protection standards. Going one step further, ‘international public policy’ commonly refers to ‘a narrow core of principles of fundamental importance to a wide number of legal orders’ presumed to ‘override any inconsistent instrument, agreement or claim’ (Viñuales, 2020, 35). The notion is generally advocated when tensions arise with higher-ranking values that cannot be superseded transactionally, such as ‘public order’ and ‘human rights’. This brings us to the following section, which explores human rights claims.

• 31 See Sempra v Argentina, ICSID Case No. ARB/02/16, Award (28 September 2007), paras. 331-332; Feldma (...)

36A rigid application of stabilisation clauses implies that states agree to refrain from using their legislative or administrative prerogatives in a manner that adversely affects the investor. Under human rights law, this would directly encroach on the state’s obligation to fulfil human rights and to protect them from deprivation by third parties.31 Regarding contractual and legislative stabilisation clauses in particular, there is an issue of ranking between international law commitments—in the field of human rights––and the contractual/legislative stabilisation mechanism. Importantly, Principle 4 of the Office of the United Nations High Commissioner for Human Rights (OHCHR) 2015 Principles for Responsible Contracts (OHCHR, 2015) focuses on stabilisation clauses: while recognising investors’ need for financial stability, the Principles underscore that stabilisation clauses have the potential to restrict states’ policy space in areas of human rights. The Principles for Responsible Contracts recommend that if stabilisation clauses are included in contracts, they should be ‘carefully drafted so that any protections for investors against future changes in law do not interfere with the state’s bona fide efforts to implement laws, regulations or policies, in a non-discriminatory manner, in order to meet its human rights obligations’ (OHCHR, 2015, 15).

• 32 In the Kokopelli case (Case C 59/11 Association Kokopelli v Graines Baumaux), for example, the Cour (...)

39If permitted under the applicable law, the adjudicator will then resort to techniques of conflict resolution in its efforts to deal with tensions between legal rules and principles in public international law. There are well-established legal techniques (lex specialis, lex posterior, lex superior) capable of resolving normative conflicts or overlaps (International Law Commission, 2006). One relevant technique in our context may be the maxim lex specialis derogat legi generali. It suggests that ‘…whenever two or more norms deal with the same subject manner, priority should be given to the norm that is more specific’ (International Law Commission, 2006,105). The risk is that the adjudicator comes to the conclusion that human rights law does not contain an obligation that is sufficiently unconditional and precise to challenge the validity of detailed investment treaty clauses.32 The lex superior (hierarchy) rule may also play a role. It posits that some rules of international law enjoy a superior position. Article 103 of the United Nations (UN) Charter stipulates that the obligations of UN Member States under the Charter prevail, in the event of a conflict, over their obligations under any other international agreement. The Article has been taken to suggest that the Charter-endorsed promotion and protection of human rights constitutes an international public order to which other treaty regimes must conform. Yet the scope of the supremacy clause of the UN Charter is not settled and its precise meaning and scope of application are contested (Liivoja, 2008).

• 33 A method of review is ‘a technique used by adjudicators (such as proportionality analysis) to deter (...)
• 34 As developed in administrative law in continental Europe, the doctrine of proportionality ‘requires (...)

42This approach also means that adjudicators should find a way to balance both the investor’s (legitimate) expectations and the host state’s right to regulate in the public interest (Gehne and Brillo, 2014; Gjuzi, 2018). The approach has implications for the ‘method’ and ‘standard of review’ employed by the adjudicator.33 In reviewing the prescriptive measure, the adjudicator should strike the right balance between overseeing a state’s compliance with its obligations under the investment treaty and respecting the state’s right to regulate in the public interest (Bürgi Bonanomi, 2015; Henckels, 2015). Some suggest that a ‘proportionality analysis’ approach to review, along with an appropriate level of deference in situations of normative or empirical uncertainty, would help achieve this balance (Henckels, 2015, 193–94). The approach entails a method of review whereby the adjudicator assesses the legitimacy of the objective of the measure, its suitability to achieve its stated objective, its necessity, and possibly the importance of achieving the objective vis-à-vis competing interests, with appropriate deference to the regulating state in situations of normative uncertainty.34 When evaluated under this method and standard of review, prescriptive methods are considered proportional means to achieve desirable outcomes if they are non-discriminatory and rationally connected to their stated goal, more effective than less restrictive methods in reaching their objective, and designed in a balanced manner (based on market data and industry practices) (for more details, see Musselli and Bürgi Bonanomi, 2022).