19/03/2014 – Public comments are invited on two discussion drafts on Action Item 2 of the BEPS Action Plan.

In July 2013, the OECD published its Action Plan on Base Erosion and Profit Shifting. The Action Plan identifies 15 actions to address BEPS in a comprehensive manner and sets deadlines to implement these actions.

Action 2 of the BEPS Action Plan calls for the development of model treaty provisions and recommendations for the design of domestic rules to neutralise the effect of hybrid mismatch arrangements:

ACTION 2

Neutralise the effects of hybrid mismatch arrangements

Develop model treaty provisions and recommendations regarding the design of domestic rules to neutralise the effect (e.g. double non-taxation, double deduction, long-term deferral) of hybrid instruments and entities. This may include: (i) changes to the OECD Model Tax Convention to ensure that hybrid instruments and entities (as well as dual resident entities) are not used to obtain the benefits of treaties unduly; (ii) domestic law provisions that prevent exemption or non-recognition for payments that are deductible by the payor; (iii) domestic law provisions that deny a deduction for a payment that is not includible in income by the recipient (and is not subject to taxation under controlled foreign company (CFC) or similar rules); (iv) domestic law provisions that deny a deduction for a payment that is also deductible in another jurisdiction; and (v) where necessary, guidance on co-ordination or tie-breaker rules if more than one country seeks to apply such rules to a transaction or structure. Special attention should be given to the interaction between possible changes to domestic law and the provisions of the OECD Model Tax Convention. This work will be co-ordinated with the work on interest expense deduction limitations, the work on CFC rules, and the work on treaty shopping.

The Action Plan calls for this work to be concluded by September 2014. In connection with this work the Committee on Fiscal Affairs (CFA) has now released two consultation documents on Action Item 2 as a single proposal for public consultation.

The first discussion draft (Neutralise the effects of Hybrid Mismatch Arrangements – Recommendations for Domestic Laws) sets out recommendations for domestic rules to neutralise the effect of hybrid mismatch arrangements and the second discussion draft (Neutralise the effects of Hybrid Mismatch Arrangements – Treaty Aspects of the Work on Action 2 of the BEPS Action Plan) discusses the impact of the OECD Model Convention on those rules and sets out recommendations for further changes to the Convention to clarify the treatment of hybrid entities. The recommendations set out in these discussion drafts do not represent the consensus views of the CFA or its subsidiary bodies but rather are intended to provide stakeholders with substantive proposals for analysis and comment.

Comments on these documents should be submitted electronically (in word format) before 5.00 pm on 2 May 2014 (no extension will be granted).  It is the policy of the OECD to publish all responses (including the names of responders) on the OECD website.

Observations:

The Vienna Convention on the Laws of Treaties has been attached as a timely reference to the role of treaties and the interplay of domestic law and treaty provisions.  It is worthy to readdress these historic provisions as contrasted to the OECD’s BEPS proposals, especially with respect to domestic law override provisions of tax treaties.

The subject of General Anti-Avoidance Rules (GAAR) are also of paramount significance, due to the layers of anti-avoidance and anti-abuse rules proposed from a domestic law and / or a tax treaty perspective.  The GAAR provisions are in addition to specific anti-avoidance rules (SAAR) and targeted anti-avoidance rules (TAAR) rules that are already effected into local legislation.  The OECD documents prescribe primary and linking mechanisms between domestic GAAR and Treaty GAAR provisions to ensure consistency and uniformity.  However, such rules should consider the additional uncertainty that the “automatic” rules may generate.

The interplay, and priority, of domestic law and treaty provisions are converging quickly.  As a result, there will be additional controversies as to whether a taxpayer can utilize a treaty to avoid double taxation, and the different interpretations that tax authorities may have interpreting the complex rules.

The OECD proposals are significant in international tax policy and the application of tax treaties vs. domestic law, thereby all interested parties should submit thoughtful and practical comments to the OECD within the prescribed timeline for comment.