BEPS Action Plan 6: Preventing the granting of treaty benefits in inappropriate circumstances

SUITS THE C-SUITE By Fidela I. Reyes and Michelle C. Arias

Business World (02/16/2015 – p.S1/5)

(Second of two parts)

In last week’s article, we discussed the first set of recommendations in the Organization for Economic Co-operation and Development’s (OECD) Base Erosion and Profit Shifting (BEPS) Action Plan 6 to address abuses that may arise when entities operating out of different countries misuse tax treaties to obtain tax benefits. This first set of recommendations for the development of treaty provisions and domestic rules to prevent the granting of benefits under inappropriate circumstances revolved around the inclusion of a limitation on benefits (LOB) rule and a principal purpose test in tax treaties and the promotion of domestic anti-abuse rules and judicial doctrines. We now look at the two other recommendations under the BEPS Action Plan 6 — which are clarifying the purpose of tax treaties, and identifying tax policy considerations relevant to signing a tax treaty with another country — as well as the comments submitted by Ernst and Young (EY) to the OECD.

CLARIFYING THE PURPOSE OF TAX TREATIES

To emphasize that tax treaties are developed primarily to eliminate double taxation and prevent tax avoidance and evasion, the Report suggests that the title and preamble of tax treaties expressly state in the treaty itself that the Contracting States intend to eliminate double taxation without creating opportunities for tax evasion and avoidance (including through treaty-shopping arrangements).

IDENTIFYING TAX POLICY CONSIDERATIONS

The Report considers that a clear articulation of tax policy considerations for entering into a tax treaty with another country, before actually entering into the tax treaty, will help countries carefully evaluate and explain their decisions to enter, modify, or terminate a tax treaty with another country, especially with certain low or no-tax jurisdictions.

Some of the tax policy considerations discussed in the Report include the risk of double taxation or double non-taxation, the extent to which the risk of double taxation actually exists, the risk of excessive taxation resulting from high withholding taxes in the Source State, the various features of tax treaties that encourage economic ties between countries (i.e., non-discrimination rules, mutual agreement procedures, and arbitration), and the willingness and ability of treaty partners to effectively implement the tax treaty provision concerning administrative assistance (i.e., exchange of information).

THE REPORT AS A WORK IN PROGRESS

The OECD recognizes that further work is needed with respect to the precise contents of the model treaty provisions, the implementation of the minimum standard for addressing treaty abuse, and the policy considerations relevant to treaty entitlement of Collective Investment Vehicles (CIVs) and non-CIV funds.

To assist the OECD Committee in its follow-up work on Action Plan 6, EY submitted comments on the discussion draft and raised the following points:

· Treaty entitlement of CIVs and non-CIV funds. Future work of the OECD must consider the changes in the industry, motivations to invest in CIVs and non-CIVs (including non-tax motivations), and regulatory restrictions that exist in certain jurisdictions. It is also suggested that the OECD acknowledge and continue to support the recommendations made in the 2010 report entitled “The Granting of Treaty Benefits with Respect to the Income of Collective Investment Vehicles”. EY likewise proposed the setting of a threshold on ownership by equivalent beneficiaries.

· Issues related to the Principal Purpose Test (PPT) rule. The determination of the principal purpose of a transaction is dependent on the intent of the taxpayer which, in practice, would be difficult to evaluate and administer. The OECD could consider eliminating or modifying the PPT rule to make it more practical and reduce uncertainty for treaty qualification purposes. EY also recommended the inclusion of a special procedure for review and mandatory consultation for denial of treaty benefits under the PPT rule, and availability of the mutual agreement procedure and arbitration in Article 25 of the OECD Model Tax Convention.

· Derivative benefits test. The requirement of the derivative benefits test that each owner be an equivalent beneficiary is too restrictive. Instead, EY proposed that focus be made on other anti-treaty abuse rules.

· Publicly-listed entity provision. Given the complexity of obtaining a publicly-listed entity status and the safeguards against treaty shopping, future work on this may consider providing a rule for a publicly-listed entity to claim treaty benefits even if the LOB provisions are satisfied for less than a full taxable year.

· Active trade or business. The OECD may consider adding a safe harbor clause to provide certainty and clarity in measuring the substantiality of an income recipient’s trade or business.

A number of the tax treaty provisions proposed in the Report offer alternatives and some degree of flexibility. As a signatory to several bilateral tax treaties, the Philippine government should take this opportunity to collaborate with businesses and individuals and discuss how the country could protect itself against the adverse effects of treaty abuse, while at the same time take advantage of the world’s growing appetite for foreign trade and investment.

Fidela I. Reyes is a Partner and the International Tax Services Leader and Michelle C. Arias is a Tax Senior Associate, respectively, of SGV & Co.