Organization for Economic Cooperation and Development (OECD) Issues Final Report on Base Erosion and Profit Shifting (BEPS) Action Plan 6, Inappropriate Use of Tax Treaties
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The Organization for Economic Cooperation and Development (OECD), a non-governmental forum established to promote economic growth, has developed a 15-point action plan to shape “fair, effective and efficient tax systems.” The OECD’s project regarding Base Erosion and Profit Shifting (BEPS) has addressed issues arising from tax planning strategies that exploit gaps or mismatches in member countries’ tax rules.
On October 5, 2015, the OECD released its final reports for the BEPS Action Plan. This Alert discusses “BEPS Action 6: Prevent Treaty Abuse,” which addresses the inappropriate use of tax treaty benefits.
Background and Details
In an effort to address BEPS issues in a coordinated and comprehensive manner, the G20 finance ministers called on the OECD to develop an action plan to equip countries with instruments that will better align tax with economic activity. One of the most important BEPS concerns, treaty abuse and treaty shopping, is addressed by Action 6 of the BEPS Action Plan.
In discussing treaty shopping, the OECD October 2015 Report (“Report”) observes that multinational companies have engaged in treaty shopping and other treaty abuse strategies in order to undermine tax sovereignty by claiming treaty benefits in situations where such benefits were not intended, thereby depriving countries of tax revenues. The Report does note that contracting States have agreed to include some form of anti-abuse provisions in their tax treaties, including minimum standards to counter potential treaty shopping. The Report does, however, recognize that some degree of flexibility is needed in the implementation of such minimum standards, as these provisions need to take into account each country’s specific laws and to the unique circumstances involved in the negotiation of bilateral conventions.
The Report makes the following recommendations to address treaty shopping:
- Providing clear statements in tax treaties that the State(s) intended to avoid creating opportunities for non-taxation or reduced taxation through tax evasion or avoidance, including through treaty shopping arrangements.
- Including in the OECD Model Tax Convention a specific anti-abuse rule, i.e., a limitation-of-benefits (“LOB”) rule that limits the ability to claim treaty benefits to entities that meet certain conditions.These conditions, which are based on the legal nature, ownership structure, and general activities of the entity, seek to ensure that there is a sufficient link between the entity and its State of residence.Such LOB provisions are currently found in treaties concluded by a few countries (such as the United States) and have proved effective in preventing many treaty shopping strategies.
- Adding to the OECD Model Tax Convention a more general anti-abuse rule in order to address other forms of treaty abuse, including treaty shopping that would not be covered by the more specific rule above.Such a general anti-abuse rule would be based on the principal purpose of transactions or arrangements (the “principal purpose test” or “PPT” rule).Under such a rule, if one of the principal purposes of transactions or arrangements is to obtain treaty benefits, such benefits would be denied, unless it is established that granting these benefits would be in accordance with the object and purpose of the provisions of the treaty.
The Report does recognize that both the LOB and PPT rules have strengths and weaknesses and may not be appropriate for – or in accordance with – the treaty policy of all countries. Moreover, the domestic law of some countries may include provisions that would make it unnecessary to combine the two rules in order to prevent treaty shopping.
Further, the Report provides that, given the risk to revenues posed by treaty shopping, countries have committed to ensuring a minimum level of protection against treaty shopping (the “minimum standard”). That commitment will require countries to include in their tax treaties an express statement of intent that the treaty at issue is intended to eliminate double taxation – without creating opportunities for non-taxation or reduced taxation through tax evasion or avoidance, including treaty shopping arrangements. The Report states that countries will implement this minimum standard by including in their treaties either: (1) the combined approach of a LOB and PPT rule, (2) the PPT rule alone, or (3) the LOB rule supplemented by a mechanism that would deal specifically with conduit financing arrangements not already dealt with in tax treaties.
The Report also contains additional rules to be included in tax treaties so to address other forms of treaty abuse. These targeted rules cover (1) certain dividend transfer transactions that are intended to artificially lower withholding taxes payable on dividends, (2) transactions that circumvent the application of the treaty rule that allows source taxation of shares of companies that derive their value primarily from immovable property, (3) situations where an entity is resident of two Contracting States, and (4) situations where the State of residence exempts the income of permanent establishments situated in third States and where shares, debt-claims, rights, or property are transferred to permanent establishments set up in countries that do not tax such income or offer preferential treatment to that income.
In addition, the Report recognizes the need for domestic anti-abuse rules and addresses certain issues relating to the interaction of domestic anti-abuse rules with treaties.
The final version of the Report supersedes the interim version release in September 2014 and contains a number of changes to those rules proposed in the earlier version. The Report recognizes that additional work will be needed in order to fully consider treaty proposals recently released by the United States concerning the LOB rule and other provisions included in the report. The Report further notes that, because the United States does not anticipate finalizing its new model tax treaty until end of 2015, the relevant provisions included in the Report will need further study after release of the new U.S. model tax treaty. The Report is, therefore, expected to be finalized in early 2016. An examination of the issues related to the treaty entitlement of certain types of investment funds will also continue after in late 2015 with a similar deadline.
Multinational companies often rely on tax treaties to reduce their global tax burden. Given the approach in Action Plan 6, these companies must carefully evaluate their current legal and tax structures and the ability to claim treaty benefits with respect to countries that adopt these recommendations.
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