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 EU Anti-Tax Avoidance Package included a Commission recommendation on the implementation of measures against tax treaty abuse. Specifically, this statement was issued to address artificial avoidance of permanent establishment status as stated in BEPS Action 7 Action Plan.
Re: tax treaties of Member States that include a “principal purpose test” (PPT) based general anti-avoidance rule, the following modification is encouraged to be inserted:
“Notwithstanding the other provisions of this Convention, a benefit under this Convention shall not be granted in respect of an item of income or capita l if it is reasonable to conclude, having regard to all relevant facts and circumstances, that obtaining that benefit was one of the principal purposes of any arrangement or transaction that resulted directly or indirectly in that benefit, unless it is established that it reflects a genuine economic activity or that granting that benefit in these circumstances would be in accordance with the object and purpose of the relevant provisions of this Convention.”
This subjective phrase, that applies notwithstanding other provisions of the Convention, has already been used in new treaties and will proliferate as new treaties are drafted by a Member State, not necessarily with another Member State. Thereby, it is important to draft supporting documentation that will provide support for transactions against which it is aimed. This phrase will elicit additional appeals and court cases as to its meaning and / or intent for which non-consistent answers will be provided.
Questions that may be asked re: this statement:
- Who is concluding on the reasonableness? What facts are used for such determination?
- Which facts and circumstances are relevant?
- What are all of the principal purposes of the arrangement or transaction?
- How is a benefit measured, directly or indirectly?
- What is a genuine, vs. non-genuine, economic activity?
- How do you determine if such arrangement is in accordance with the object and purpose of the “relevant provisions” of the Convention?
The phrase is purposefully vague, and thereby subject to inconsistent interpretation.
It is hopeful that tax administrations will use this statement wisely to address egregious transactions rather than ordinary business transactions for which the clear intent was not an evasion of tax. This subjectivity will be important to monitor going forward to further understand subjective enforcement interpretations around the world.
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.
OECD has released guidance on the BEPS Action Plan item 7: Preventing the Artificial Avoidance of PE Status. Comments should be sent by 9 January 2015. A link to the OECD guidance is attached for reference:
- Commissionaire arrangements: 4 alternatives are provided re: PE avoidance
- “Independent agent” activities: the independent agent must not act exclusively for one enterprise
- Options to counter specific activity exemptions are introduced to counter artificial avoidance of PE
- Two options are provided re: splitting up of construction contracts to avoid the 12 month rule, one of which is the Principal Purpose test general anti-abuse rule
- Insurance agent PE proposals are introduced
- Profit attribution concepts to PE are discussed
In summary, additional subjectivity rules are introduced while the current exemption definitions are narrowed. These actions will tend to significantly increase tax appeals and the risk of double taxation.
All MNE’s should review the guidance to understand the trend for future PE guidance, while also identifying current structures that may be affected by the new rules. Notably, countries may unilaterally develop legislation based upon this guidance without waiting for final guidelines to be issued, thereby introducing greater complexity and challenges in the determination of PE.