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

By Michelle C. Arias

Action Plan 6 of the Organisation for Economic Co-operation and Development (OECD) Base Erosion and Profit Shifting (BEPS) final reports identifies treaty abuse, particularly treaty shopping, as one of the most significant causes of BEPS. It recognizes that existing domestic and international tax rules, including double taxation treaties, should be modified to include sufficient safeguards against practices that take advantage of the differences in domestic tax systems of countries and the gaps in the implementation of tax treaties. Countries have therefore agreed to include anti-abuse provisions in their tax treaties, including a minimum standard to counter treaty shopping.

Released in 2014, the Action Plan 6 Deliverable (2014 Deliverable) proposed changes in the OECD Model Tax Convention provisions and its commentary, and identified areas where follow-up work would be necessary. Subsequently, the Final Report issued on 5 October 2015 supersedes the 2014 Deliverable. It contained the changes presented in the interim version as well as the conclusions reached by the Working Party on the matters for follow-up. The Final Report also indicates that further work will be required under Action Plan 6, particularly on the limitation-on-benefit (LOB) rule and the treaty entitlement of non-Collective Investment Vehicles (non-CIVs) and pension funds.

The Final Report presents three recommendations to address treaty abuse: (1) development of treaty provisions and domestic rules to prevent granting of treaty benefits under inappropriate circumstances; (2) clarification that tax treaties are not intended to be used to generate double non-taxation; and (3) identification of tax policy considerations prior to signing a tax treaty with another country.

Treaty provisions and domestic rules to prevent granting of treaty benefits under inappropriate circumstances

Countries have committed to ensure a minimum level of protection against treaty shopping (the “minimum standard”).

In order to deal with tax avoidance strategies, the Final Report recommends the inclusion of anti-abuse provisions in tax treaties and in domestic tax laws. New treaty anti-abuse provisions include the adoption of a specific anti-abuse rule in the OECD Model Tax Convention, such as the LOB rule that limits the availability of treaty benefits to entities that meet certain conditions. Where the LOB rule cannot apply, a more general anti-abuse rule based on the principal purposes of transactions or arrangements (the principal purposes test or PPT rule) will be included.

The Final Report acknowledges that the anti-abuse rules need to be adapted to the specificities of each country and to the circumstances surrounding the negotiation of tax treaties. Thus, alternatives and a certain degree of flexibility in the implementation of the minimum standard are offered through: 1) the combined approach of an LOB and PPT rule; 2) the PPT rule alone; or 3) the LOB rule supplemented by a mechanism that would deal with conduit financing arrangements not already dealt with in tax treaties.

Anti-abuse rules targeted to address specific forms of treaty abuse are also recommended, particularly for: (1) dividend transfer transactions; (2) capital gains from alienation of shares of companies that derive their value primarily from immovable property; (3) dual-resident entities; and (4) low-taxed permanent establishments in third states.

In cases where tax avoidance strategies seek to circumvent provisions of domestic tax laws which could not be sufficiently addressed by treaty anti-abuse rules, the Final Report recommends that domestic anti-abuse rules should be included. Changes to the OECD Model Tax Convention aimed at ensuring that treaties do not inadvertently prevent the application of such domestic anti-abuse rules are likewise proposed.

Reformulation of the title and preamble of tax treaties

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

Policy considerations before entering into a tax treaty

The Final Report describes the tax and non-tax policy considerations that should help countries explain their decisions not to enter into tax treaties with low or no-tax jurisdictions. These policy considerations will also be relevant for countries that need to consider whether they should modify (or ultimately, terminate) an existing treaty where a change of circumstances raises BEPS concerns.

Two proposals that would specifically address some concerns with the domestic law of a potential treaty partner are included in the Final Report. The first proposal would be to define the term “special tax regime” and to add new provisions that would deny treaty benefits to interest, royalties and other income beneficially owned by residents benefiting from a special tax regime in their country of residence. The second proposal provides a new general treaty provision that would “turn off” the treaty provisions on dividends, interest, royalties and other income if certain changes to a country’s domestic law are made in the future. The Final Report notes that these proposals will be further considered once the United States finalizes the work on the US Model Treaty.

Further work to be done

Further work will be required with respect to the LOB rule and other provisions similar to those proposed in the new US Model Income Tax Convention. The proposed revisions to the US Model Income Tax Convention intended to combat treaty abuse and deny treaty benefits in certain situations, include the incorporation of a “derivative benefits” rule to qualify taxpayers for treaty benefits based on a broader concept of ownership that includes certain third-country ownership. Other proposed changes include (i) introduction of provisions that deny treaty benefits to certain income under a “special tax regime;” (ii) treaty rules imposing full withholding taxes on key payments by “expatriated entities;” (iii) an article providing for a right to partial treaty termination in the event of “subsequent changes” in a treaty partner’s domestic law; and (iv) tightening the “triangular provision” that would deny treaty benefits on certain income attributable to “exempt permanent establishments.”

An examination of the issues related to the treaty entitlement of certain types of investment funds, such as non-CIVs and pension funds, will also continue. The various anti-abuse rules included in the Final Report and their commentary will need to be completed in the first part of 2016 in order to be relevant to the negotiation of the multilateral instrument that will implement the results of the work on treaty issues. It is expected that the multilateral instrument will be open for signature by 31 December 2016.

As further work carries on, companies should continue to stay abreast of the latest developments on Action Plan 6 in the countries where they operate or invest, evaluate how any proposed changes may impact them, and consider participating in the process to provide stakeholder input.

Michelle C. Arias is a Tax Associate Director of SGV & Co.

This article is for general information only and is not a substitute for professional advice where the facts and circumstances warrant. The views and opinion expressed above are those of the author and do not necessarily represent the views of SGV & Co.