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.
After a long waiting period, with many discussions as to its predicted content, the OECD’s Multilateral Convention pursuant to BEPS Action 15 is ready for prime time. Links to EY’s Global Tax Alert, and OECD’s Explanatory Statement and Multilateral Convention are provided for reference.
The Multilateral Convention is very flexible as to what a country wants, or does not want, within its treaty related provisions to signify its alliance with BEPS Actions.
EY’s Global Tax Alert states: “The tax treaty related BEPS measures covered by the multilateral instrument include (elements of): (i) Action 2 on hybrid mismatch arrangements, (ii) Action 6 on treaty abuse, (iii) Action 7 on the artificial avoidance of the PE status; and (iv) Action 14 on dispute resolution. The substance of the tax treaty provisions relating to these actions was agreed under the final BEPS package released in October 2015. The multilateral instrument does not modify or add to the substance of these provisions. The instrument is solely focused on how to modify the provisions in bilateral or regional tax treaties in order to align these treaties with the BEPS measures.”
Due to the flexibility of the new Convention, this unilateral based process poses many questions as to the consistency of intent for the related BEPS Actions around the world. It is certain that, in the short term, there will be considerable complexity and varying interpretations of what the Convention means. Accordingly, the Explanatory Statement and Multilateral Convention are to be reviewed carefully to understand short and long-term trends in this new era of international tax.
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.
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.
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.
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.