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 (02/09/2015 – p.S1/5)

(First of two parts)

The Organization for Economic Co-operation and Development’s (OECD) Action Plan 6 on the Base Erosion and Profit Shifting (BEPS) initiative recognizes that countries need to incorporate sufficient safeguards in their tax treaties and domestic rules to protect against practices that take advantage of the differences in national tax systems and the weaknesses in the application of tax treaties.

The OECD’s Report presents three recommendations to address treaty abuse: (1) developing treaty provisions and domestic rules to prevent the granting of treaty benefits under inappropriate circumstances, (2) clarifying the purpose of tax treaties, and (3) identifying tax policy considerations relevant to signing a tax treaty with another country. In this article, we will discuss the first recommendation; the two others will be featured in next week’s column.


The Report considers two situations of treaty abuse or inappropriate circumstances, i.e.: (1) cases where a person tries to circumvent limitations provided by the treaty itself, and (2) cases where a person tries to abuse domestic tax law provisions using treaty benefits.

The Report describes the strategies applied in these cases and recommends a combination of specific anti-abuse rules, general anti-abuse rules, and other anti-abuse provisions for certain situations, such as for dual-resident entities and for low-taxed permanent establishments (PEs) in a third state. The OECD’s proposed treaty provisions focus on the limitation on benefits (LOB) rule and the principal purpose test (PPT) rule, which we discuss below.


LOB provisions are drafted specifically to avoid treaty shopping, whereby a resident of a third country (not otherwise entitled to a treaty benefit), puts up a shell company in a Contracting State to indirectly reduce or eliminate tax on its income from another Contracting State. A shell company has no legitimate business purpose beyond minimizing tax exposure.

LOB provisions typically contain tests to help determine an entity’s qualification for treaty benefits, based on its legal nature or attributes, ownership, and general activities. Proposed LOB provisions include a “derivative benefits” test that allows certain entities owned by residents of a Contracting State to obtain treaty benefits comparable to those which they would have obtained had they had invested directly in the Contracting State. The Report also proposes a method for discretionary relief by which the competent authority of a Contracting State may grant treaty benefits to an entity that would otherwise be disqualified by the LOB provisions.

With respect to collective investment vehicles (CIVs), the Report notes that countries should consider whether the tax treatment of CIVs in their jurisdiction gives rise to treaty shopping concerns, and whether CIVs should be eligible for treaty benefits in their own right or only to the extent that they are owned by qualified treaty residents. The Report provides a test that countries could use to address the availability of treaty benefits to CIVs and other funds. (Depending on domestic rules, CIVs could include investment vehicles, pension schemes, contractual funds, investment companies with variable capital, limited partnerships for collective capital investment schemes, or similar investment vehicles.)


The PPT rule incorporates the principle that a treaty benefit should not be available if, based on all facts and circumstances, it is reasonable to conclude that one of the principal purposes of the transaction or arrangement is to secure a benefit under the tax treaty and that obtaining the treaty benefit is contrary to the object and purpose of the relevant provisions of the tax treaty.

It seeks to deny treaty benefit to treaty avoidance arrangements that would not be caught under the LOB rule, such as conduit arrangements. In conduit arrangements, a resident of a third country that would otherwise qualify for treaty benefits is used as an intermediary by persons who are not entitled to these benefits.


Tax avoidance strategies — including thin capitalization, dual residence, and transfer mispricing — use treaty provisions to circumvent or avoid the application of domestic tax laws. In these cases, anti-abuse rules in treaty provisions are insufficient and domestic anti-abuse rules and judicial doctrines or principles of interpretation may also be used.

However, the application of domestic anti-abuse rules and judicial doctrines could raise possible conflicts with treaty provisions. Under the international law principle of pacta sunt servanda, if a provision of a domestic law conflicts with a treaty provision, the treaty provision should prevail. The Report provides guidance on how to avoid these possible conflicts and states that each case must be analyzed based on its own circumstances.

In next week’s column, we will discuss the two other of recommendations in Action Plan 6 to prevent the granting of treaty benefits in inappropriate circumstances, namely: clarifying the purpose of tax treaties, and identifying tax policy considerations relevant to signing a tax treaty with another country.

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.