The OECD recently published its peer review report on treaty shopping re: prevention of treaty abuse under the inclusive framework on BEPS Action 6. A link to the document is included for reference.
Article 6 targeted treaty abuse; Action 15 introduced the multilateral instrument (MLI) to implement BEPS actions. The MLI is the mechanism whereby countries are implementing the treaty-shopping minimum standard.
The first Peer Review shows the effectiveness of implementing the minimum standard for treaty abuse. The intent of Action 6 is to stop treaty shopping in its entirety.
The treaty shopping minimum standard requires countries to include two components in their tax agreements; an express statement on non-taxation and one of three ways to address treaty-shopping. The provisions require bilateral agreement. The 2017 OECD Model Tax Convention includes the following express statement: “Intending to conclude a Convention for the elimination of double taxation with respect to taxes on income and on capital without creating opportunities for non-taxation or reduced taxation through tax evasion or avoidance…”
The three methods of addressing treaty shopping include;
Principal Purpose Test (PPT) alone, or
PPT with a simplified or detailed version of the Limitation on Benefits (LOB) rule, or
Detailed LOB rule with a mechanism to deal with conduit arrangements.
As the MLI’s are agreed, it is important to understand the three methods above, and the express statement which includes reference to the elimination of double taxation, a concept which is sometimes ignored in the pursuit of perceived treaty / tax abuse.
Exempt permanent establishment (PE) rule that will also apply to US branches
Denial of treaty benefits re: articles 11 (Interest), 12 (Royalties), and 21 (Other income) for recipients in a “special tax regime.” There are several exceptions applicable to the general rule.
Disallowance of treaty benefits for payments of dividends, interest, royalties and other income for 10 years after a company expatriates.
Changes to Limitation on Benefits (LOB) article: (i) New derivative benefits test which is inclusive of a base erosion test, (ii) a base erosion test to the subsidiary of a public company requirement, (iii) changes to base erosion requirements in the public company test, ownership base erosion test and derivative benefits test, and (iv) a change to the discretionary grant of relief clause inclusive of a principal purpose test.
Partial termination provisions for subsequent law changes exempting, or reducing the tax rate to less than 15% for dividends, interest, royalties and other income.
These significant changes represent acknowledgment of the OECD BEPS impact and its impact on the world’s tax treaties that will directly impact the taxation of a multinational company’s global structure. Accordingly, these changes are required reading for international tax practitioners, as the rest of the world will be following along in measuring its respective treaties and new protocols. BEPS Action 6, Preventing treaty abuse, recognized the US Model Treaty’s LOB article, with an additional inclusion for a derivative benefits test. The US proposal has now addressed that intent.
PwC has published a very informative article addressing the impact of EU case law, exemplified by cases from the Court of Justice of the European Union, on the OECD BEPS international tax proposals. There may be additional uncertainty by EU Member States after the OECD BEPS measures are announced due to the “fundamental freedoms” in the Treaty on the Functioning of the European Union (CJEU), State Aid principles and the EU direct tax initiatives, including the Parent-Subsidiary Directive. The link to the article is included for reference:
The article provides excellent references to current EU Law concepts, including the basic premise that domestic legislation must be compliant with EU law. Additionally, the OECD proposals for hybrid mismatch transactions, tax treaty abuse and harmful tax practices are discussed against the backdrop of EU legislation.
The article concludes with the takeaway: “The implementation of OECD BEPS proposals within the EU/EEA Member States will only be possible to the extent that those proposals are also compliant with EU Law. So far, however, little attention seems to have been paid to potential EU Law issues in the OECD’s draft discussion papers, so that EU/EEA Member States might actually risk breaching EU Law. As a result, companies doing business in the EU/EEA will be faced with legal uncertainty about the lawfulness of implemented OECD BEPS proposals in domestic law or tax treaties.”
As an additional observation, there is a likelihood that the domestic legislation enacting OECD BEPS proposals will not be consistent for each Member State, thereby the legal uncertainty should be reviewed for each Member State as domestic legislation and OECD proposals are implemented.