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.
The European Commission has aimed its sights upon the Limitation on Benefits (LOB) provision between Netherlands and Japan. Netherlands has been asked to change this treaty provision on the grounds that it is incompatible with EU law.
As the LOB provision is widely used in the US treaty network, as well as many other countries, the impact of this recent development may expand exponentially with global ramifications. Accordingly, this pursuit should be closely followed.
The IRS issued Rev. Proc. 2015-40 recently, and this EY summary provides details re: the Limitation on Benefits (LOB) provisions for granting competent authority assistance.
The new rules highlight rules focusing on recent proposals for the US Model Tax Convention as well as the intent of BEPS re: “special regimes.”
These changes are critical to resolving issues, and the impact of double taxation, accompanying an increasing trend in foreign tax adjustments. This new procedure will become more visible as more countries implement BEPS guidelines via unilateral legislation and adoption of the OECD multilateral instrument.
OECD’s latest draft on Action 6 of the BEPS Action Plan (Prevent Treaty Abuse) addresses previous questions raised and comments received, in addition to some new proposals. Part I of the draft presents the alternative “Simplified” Limitation on Benefits (LOB) Rule, while Part II outlines the previous 20 questions for follow-up work, including changes to domestic law made after the conclusion of a treaty.
Succinct comments are to be submitted by 17 June 2015. A link to the draft is provided:
The discussion draft is very comprehensive and principle based, including additional examples from its previous draft.
However, it is worth noting that the OECD would not require an approval process for application of the subjective principal purposes test (PPT) (i.e. the state may “wish” to apply such process) and that the PPT would be included in the arbitration mechanism of paragraph 5 of Article 25, although this issue should also be discussed as part of the work on Action 14 (Make dispute resolution mechanisms more effective). This latter point would seem to be area for additional confirmation in providing comments to avoid double taxation on issues that are inherently subjective.
The draft will provide important precedent in obtaining treaty relief in a post-BEPS era, thus the proposals should be reviewed in detail, with consideration to provide succinct comments.
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.
Tax Executives Institute, Inc. (TEI) has issued follow-up comments in response to the OECD public discussion draft on 21 November 2014, in addition to its prior comments on 8 April 2014 on the first discussion draft. The latest comments are referenced herein:
The Principal Purpose test remains highly subjective and susceptible to unpredictable interpretations, therefore TEI opposes including this test in the OECD model treaty.
Jurisdictions should adopt an administrative appeal process if the Principal Purpose test is asserted.
A treaty incorporating a Limitation on Benefits provision (LOB provision) and a Principal Purpose test may deny benefits if the LOB test is satisfied and the benefit is denied under the Principal Purpose test. The LOB provision should be the primary (objective) tool rather than one part of a two-part treaty abuse test.
The Principal Purpose test may result in benefits not recorded on audited financial statements due to its uncertainty.
Transition relief and prospective arrangements should be included in the final guidelines.
TEI’s comments should be reviewed to understand the myriad issues proposed to combat treaty abuse. Additional uncertainty, accompanied by appeals of such assessments, will be the likely result of the proposal as currently drafted.
The OECD has published a public discussion draft on its BEPS Action Item 6: Preventing Treaty Abuse. Comments by interested parties are due by 9 January 2015. A link to the draft is attached for reference:
Some key points:
Comments are invited on the Limitation of Benefits (LOB) clause re: interaction with Competent Authority (CA) relief
Alternative LOB provision for EU countries?
“Active business” test of the LOB: clarification/application
Process for approval to apply the “Principal Purpose” test for disallowing treaty benefits
Interaction of domestic and treaty anti-abuse rules
This Action item is very comprehensive and will also serve as a blueprint for some countries designing unilateral legislation. Accordingly, the LOB and Principal Purpose tests, among other complex provisions in the draft, should be reviewed to convey its terms succinctly and simply to others not well versed in the technical intricacies to promote further understanding and practical application.
The OECD invites public comments with respect to Action 6 (Prevent Treaty Abuse) of the BEPS Action Plan.
A summary of the OECD press release, the OECD proposal and Best Practice comments are included herein for reference:
The Action Plan identifies treaty abuse, and in particular treaty shopping, as one of the most important sources of BEPS concerns. Action 6 (Prevent Treaty Abuse) reads as follows:
Prevent treaty abuse
Develop model treaty provisions and recommendations regarding the design of domestic rules to prevent the granting of treaty benefits in inappropriate circumstances. Work will also be done to clarify that tax treaties are not intended to be used to generate double non-taxation and to identify the tax policy considerations that, in general, countries should consider before deciding to enter into a tax treaty with another country. The work will be co-ordinated with the work on hybrids.
The Action Plan also provided that “[t]he OECD’s work on the different items of the Action Plan will continue to include a transparent and inclusive consultation process” and that all stakeholders such as business (in particular BIAC), non-governmental organisations, think tanks, and academia would be consulted.
As part of that consultation process, interested parties are invited to send comments on this discussion draft, which includes the preliminary results of the work carried out in the three different areas identified in Action 6:
A. Develop model treaty provisions and recommendations regarding the design of domestic rules to prevent the granting of treaty benefits in inappropriate circumstances.
B. Clarify that tax treaties are not intended to be used to generate double non-taxation.
C. Identify the tax policy considerations that, in general, countries should consider before deciding to enter into a tax treaty with another country.
These comments should be sent on 9 April 2014 at the latest (no extension will be granted). The comments received by that date will be examined by the Focus Group at a meeting that will be held on the following week.
Persons and organisations who intend to send comments on this discussion draft are invited to indicate as soon as possible, and by 3 April at the latest, whether they wish to speak in support of their comments at a public consultation meeting on Action 6 (Prevent Treaty Abuse), which is scheduled to be held in Paris at the OECD Conference Centre on 14-15 April 2014. Persons selected as speakers will be informed by email by 4 April at the latest.
This meeting will also be broadcast live on the internet and can be accessed on line. No advance registration is required for this internet access.
General observations of proposal:
The OECD proposal provides a three-pronged approach:
Treaty statement re: anti-avoidance rule and treaty shopping opportunities
Specific anti-abuse rule based on Limitation of Benefit (LOB) provisions
General anti-abuse rule
Other OECD recommendations include comments re: Permanent Establishment (PE), tax policy, and broad General Anti-Avoidance Rule (GAAR) interpretation (including allowance of domestic GAAR provisions notwithstanding the relevant double tax treaty). The GAAR proposal provides that obtaining a treaty benefit was one of the main purposes of any arrangement or transaction that resulted directly or indirectly in that benefit. Note this GAAR proposal supplements the LOB provisions.
Proposals are also introduced to address tax avoidance risks via changes to domestic laws. Such risks include thin capitalization, dual residence, arbitrage transactions (including timing differences), and transfer mispricing. Intentions of the UN Model Convention are also introduced for analogous interpretation.
The proposal notes that treaties should not prevent application of domestic law provisions that would prevent transactions re: CFC rules and thin capitalization.
Finally, the OECD proposal indicates that the treaty should clearly state that prevention of tax evasion and tax avoidance is a purpose of the tax treaties.
The proposal, in alignment with the overall OECD BEPS proposals, is targeted at avoidance of double non-taxation, without a balanced commentary and measures addressing the risk of double taxation. Additionally, the terms “tax evasion” and “tax avoidance” are used in tandem within the proposal, although such terms are literally construed as having significantly two separate meanings and relative intent. Finally, the allowance of domestic GAAR provisions in addition to, or in lieu of, treaty provisions and EU Parent-Subsidiary guidelines will promote additional uncertainty re: subjective interpretations of broad proposals that will ultimately lead to increased tax disputes, double taxation and the loss of multilateral symmetry.
This proposal has tremendous significance in the transfer pricing arena that must be seriously considered and reviewed in its entirety, including the possibility for early comment to ensure OECD consideration.
The Tax Executives Institute (TEI) has submitted comments in response to Canada’s treaty shopping proposals. TEI’s comments are referenced herein:
Canada proposes that if all of the following circumstances exist, it would be justified in denying treaty benefits due to the lack of economic substance, and a bona fide purpose, and the ultimate beneficiaries are third-country residents not entitled to direct benefits from the treaty. Such circumstances include all of the following:
A tax treaty resident uses the tax treaty to obtain a reduction of Canadian tax otherwise payable on Canadian source income,
The intermediary entity is owned or controlled mainly by residents of another country which are not entitled to at least the same treaty benefits,
The intermediary entity pays no or low taxes in its country on the item of income earned in Canada, and
The intermediary entity does not carry on real and substantial business activities, other than managing investment income) in its country.
TEI also provides general comments stating the following concepts:
Treaty Limitation on Benefit (LOB) Provisions should be the favored approach rather than domestic legislation
Unilateral Approach should be eschewed in favor of a multilateral approach
Evidence of the scope and degree of treaty abuse in Canada is inconclusive
TEI’s comments also addressed the specific questions raised in the consultation paper of 14 August, 2013:
Advantages and disadvantages of a domestic law approach, a treaty based approach, or a combination of both
Merits of OECD approaches to treaty shopping, and other possible approaches re: treaty shopping
Preference for a general, versus a specific and objective approach; achieving balance between effectiveness, certainty, simplicity, and administration
Views on a domestic law general purpose test and its effectiveness in preventing treaty shopping and achieving taxpayer certainty
Details for preference of a specific approach
Comments addressing applicability of a domestic anti-treaty shopping rule in addition to a comprehensive anti-treaty shopping rule
TEI’s comments are well written, posing arguments for all multinationals to consider for Canada, and in the broader context of domestic general anti-avoidance rules (GAAR), vs. treaty based benefits, and the impetus behind countries to adopt unilateral domestic rules prior to dates in the OECD BEPS Action Plan for issues that should be internationally consistent. For reference, prior posts have addressed GAAR provisions advocated by several countries that can be accessed for future insight.