Yenkong has now clarified that his original post was suggesting that a State may raise a defense (rather than a counter-claim) to a claim that it violated an investor’s legitimate expectations, on the grounds that the investor engaged in tax avoidance. I agree wholeheartedly that an investor’s own conduct may be relevant to a determination of whether its legitimate expectations were violated. That is an uncontroversial point. However, to be relevant, the investor’s conduct must relate in some way to the State’s alleged breach such that it contextualizes or justifies the State’s actions. Where the State’s conduct would otherwise violate the applicable legal standard, it may show that its conduct was in fact an appropriate response to some action or omission of the investor. In contrast to such a circumscribed approach, Yenkong’s original post seems to argue that a State may raise a “tit for tat” defense without needing to establish the existence of a causal relationship between the investor’s tax avoidance and the State’s allegedly breaching conduct.
Further, it is still not clear to me how invoking “legitimate expectations” would advance the State’s position in such a scenario or even how that standard would become legally applicable to the investor’s conduct. Yenkong acknowledges that the fair and equitable treatment (FET) obligation on which the legitimate expectations standard is based runs one way, defining the State’s obligations to the investor. That the investor’s actions may be relevant to assessing whether the State violated its FET obligation does not imply a reversal of the direction of the obligation. It is not the objective of investment treaties to govern the investor’s obligations toward the host State. The treaties instead set out substantive obligations of the State and offer investors recourse to arbitration in order to correct a real or perceived power imbalance created by the obsolescing bargain problem and a lack of credibility of domestic courts in handling claims by foreigners. The aim is to permit the host State to make a credible commitment to protect foreign investors. The investor’s obligations toward the State, by contrast, are governed by its contract with the State (where applicable) and the host State’s laws. The State is able to pursue the captive investor for violations through its own domestic administrative, criminal, and civil processes and, where applicable, international arbitration. In short, investment treaties do not seek to protect the State’s legitimate expectations (expressly or implicitly), because there are other legal mechanisms available for that purpose.
As regards balancing the interests of the investor and the development needs of the host State as a method of interpreting the State’s substantive obligations, the treaty would have to provide a textual basis for such an approach. While BIT preambles often refer to economic development, as José Alvarez and Kathryn Khamsi have pointed out (Yearbook on International Investment Law & Policy 2008-2009, at 418-19), reliance on such preambular language to interpret a State’s obligations toward investors takes the language out of context. Economic development is typically identified as a consequence of achieving the treaty’s object and purpose of protecting foreign investment rather than as a freestanding objective. Such general language cannot override a more specific treaty obligation.
Finally, I remain unpersuaded that tax avoidance is at odds per se with the stated objectives of investment treaties or that it is “of course incompatible with the spirit of any FDI as a development tool.” An investment may increase national income, create jobs, raise local wages, lower prices, improve the quality of infrastructure or services, introduce new technical expertise into the domestic economy, and have a number of other positive effects while still minimizing its tax liability in the jurisdiction within the bounds of the law. I have not closely followed the recent efforts of various States to address tax avoidance, but it seems me that States must find ways (and are working to find ways) to improve and rationalize their tax laws to address the problem of inequitable sharing of the tax burden. In the meantime, penalizing investors for lawful and rational behavior would violate the principle of legality and risks drying up the flow of FDI, to the detriment of developing States, by introducing massive legal uncertainty.