1. and other BEPS related issues
Travelling Lectureship Programme
Comprehensive Seminar on the Implementation of the Multilateral Convention (MLI)
and other BEPS related issues
Belgrade, Serbia
June
Philip Baker
© IFA 2017

2. Agenda ● Background to the Multilateral Instrument (MLI)
● General structure and mechanics of the MLI
● Serbia’s position on the MLI
● Background to BEPS Action 6 (tax treaty abuse)
● Articles 6 and 7 of the MLI
● Serbia’s position on Arts 6 and 7
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3. Background to the Multilateral Instrument
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4. BEPS Project – Overview
● initiated by the OECD in 2013 to address concern that international tax rules and administrative measures had not kept pace with changing business practices and increased economic integration, creating opportunities for international tax avoidance and evasion leading to the erosion of domestic tax bases and risks to tax revenues, fiscal sovereignty and tax fairness
● 15 specific actions listed in 2013 Action Plan
● final reports released in 2015
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5. BEPS Action Points 1. address tax challenges of the digital economy
2. neutralize the effects of hybrid mismatch arrangements
3. strengthen controlled foreign corporation rules
4. limit base erosion through the deduction of interest and other financial payments
5. counter harmful tax practices more effectively
6. prevent treaty abuse
7. prevent the artificial avoidance of permanent establishment status
8-10. ensure that transfer pricing outcomes reflect value creation
11. establish methodologies to monitor BEPS and responses
12. require taxpayers to disclose aggressive tax planning
13. improve transfer pricing documentation
14. make dispute resolution mechanisms more effective
15. develop a multilateral instrument
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6. BEPS and the Multilateral Instrument (MLI)
● four BEPS actions propose changes to tax treaties:
- hybrid mismatches (Action 2)
- treaty abuse (Action 6)
- artificial avoidance of PE status (Action 7)
- improvements to dispute resolution (Action 14)
● with over 3,000 bilateral tax treaties, the MLI constitutes a vehicle for the quick implementation of treaty-related BEPS measures
● the MLI generally implements the final BEPS recommendations with limited modification
● arbitration provision in Part VI of the MLI developed as part
of the MLI negotiation
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7. General Structure and Mechanics of the Multilateral Instrument
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8. General overview of parts and provisions
● scope and interpretation of terms (Part I, Articles 1-2)
● hybrid mismatches (Part II, Articles 3-5)
● treaty abuse (Part III, Articles 6-11)
● avoidance of PE status (Part IV, Articles 12-15)
● improving dispute resolution (Part V, Articles 16-17)
● arbitration (Part VI, Articles 18-26)
● final provisions (Part VII, Articles 27-29)
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9. Relationship to Tax Treaties
● MLI does not amend tax treaties but modifies “Covered Tax Agreements” selected by Contracting Jurisdictions (allowing flexibility in the treaties to which the MLI applies)
● to allow the MLI to interact with a large number of different treaties, provisions of CTAs that are to be modified by the MLI are not listed, but are described by their characteristics, and Parties are required to notify the Depositary of these provisions in their CTAs
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10. Reservations
● Parties may opt out of provisions of the MLI (or part of a provision in some cases) through specific provisions that allow for reservations
● otherwise, reservations are not generally permitted
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11. Options and Minimum Standards
● some provisions allow Parties to choose to apply one or none of two or more options [e.g., Articles 5 and 13]
● where a Party chooses to apply a particular option, it is required to notify the Depository of its choice and the provisions of any of its CTAs that are to be modified by the option
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12. Notifications ● three kinds of notifications:
1. treaties and accompanying instruments that the Contracting Jurisdiction wishes to be covered by MLI (CTAs)
2. provisions of a Contracting Jurisdiction’s CTAs that are to be modified by specific provisions of the MLI
3. choice of options (where available) and provisions of any of its CTAs that are to be modified by specific options
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13. Signature, Ratification, and Entry into Force
● open for signature as of 16 December 2016 with signing ceremony in Paris on 7 June
● subject to ratification, acceptance or approval according to domestic procedures of signatories
● entry into force on the first day of the month after three months from the date when five instruments of ratification, acceptance or approval have been deposited with the Depositary
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14. Serbia’s Position on the MLI
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15. Covered Tax Agreements
● 64 CTAs (including some not yet in force)
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16. Hybrid mismatches (Part II, Articles 3-5)
● Art 3 (Transparent Entities) – doesn’t apply
● Art 4 (Dual Resident Entities) – adopts competent authority approach for all 64 CTAs (if other party agrees)
● Art 5 (Methods for Elimination of Double Taxation) – doesn’t apply
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17. Treaty Abuse (Part III, Articles 6-11)
● Art 6 and 7 – see below
● Art 8 (Dividend Transfer Transactions) – adopts for some CTAs (if other party agrees)
● Art 9 (Capital Gains from Immoveable Property) – adopts Art 9(4) for some CTAs (if other party agrees)
● Art 10 (Anti-abuse Rule for PEs) – doesn’t apply
● Art 11 (“Savings Clause”) – doesn’t apply
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18. Avoidance of PE Status (Part IV, Articles 12-15)
● Art 12 (Commissionnaire Arrangements) – adopts new wording for all 64 CTAs (if other party agrees)
● Art 13 (Specific Activity Exemptions) – adopts Option A (all preparatory or auxiliary) for all 64 CTAs (if other party agrees)
● Art 14 (Splitting of Contracts) – does not apply to exploration and exploitation in Norway
● Art 15 (Definitions)
© IFA 2017

19. Improving Dispute Resolution (Part V, Articles 16-17)
● Art 16 (Mutual Agreement Procedure) – Various CTAs notified under this Article
● Art 17 (Corresponding Adjustments) – Most CTAs already contain this provision
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20. Arbitration (Part VI, Articles 18-26)
● Part VI – No choice to apply this Part
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21. Background to BEPS Action 6
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22. Treaty Shopping and the Abuse of Tax Treaties
● treaty shopping defined as “a premeditated effort to take advantage of the national tax treaty network, and careful selection of the most favorable treaty for a specific purpose” (David Rosenbloom)
● BEPS action plan identifies treaty abuse, and particularly treaty shopping as one of the most important BEPS concerns
● two key OECD concerns:
1. allowing persons who are not directly entitled to treaty benefits to obtain these benefits indirectly through treaty shopping would “frustrate the bilateral and reciprocal nature of tax treaties”
2. the benefits that are indirectly obtained might not be appropriate given the nature of the tax system of the state of the person not directly entitled to treaty benefits, resulting in reduced taxation or non-taxation
© IFA 2017

23. Pre-BEPS Reponses to Treaty Shopping
● domestic anti-avoidance rules and doctrines
● treaty-based responses
1. beneficial ownership
2. inherent anti-abuse principle
3. principal purpose tests
4. limitation of benefit (LOB) provisions
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24. Domestic Anti-Avoidance Doctrines and Rules
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25. Relationship to Tax Treaties
● although it can be argued that domestic anti-avoidance rules and doctrines (like substance over form) contradict tax treaty obligations, it is also arguable that they are consistent with treaty obligations to the extent that they determine the domestic characterization of arrangements and transactions that result in tax liability, which are modified by tax treaties
● 2003 OECD Commentary concludes that domestic anti-avoidance rules are “part of the basic domestic rules set by domestic tax laws for determining which facts give rise to a tax liability” [para of the Commentary on Article 1]
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26. Beneficial Ownership
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27. General Overview of the Notion of Beneficial Owner
OECD roots of the beneficial ownership
Included in the 1977 OECD Model Convention in the “passive income” articles dealing with dividends, interest and royalties to counter “treaty shopping”: Example
Art. 10(2) (Dividends): “…dividends paid by a company which is a resident of a Contracting State may also be taxed in that State according to the laws of that State, but if the beneficial owner of the dividends is a resident of the other Contracting State, the tax so charged shall not exceed: (…)”
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28. General Overview of the Notion of Beneficial Owner
1977 OECD Model Commentary (par. 12 – Art. 10 – and par. 8 – Art. 11)
OECD 1977 Commentary: “…the limitation of tax in the State of source is not available when an intermediary, such as an agent or nominee, is interposed between the beneficiary and the payer, unless the beneficial owner is a resident of the other Contracting State”
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29. General Overview of the Notion of Beneficial Owner
2003 changes to the OECD Model Commentary (par. 12 and 12.1 – Art. 10; par. 8 and 8.1 – Art. 11)
“(…). The term “beneficial owner” is not used in a narrow technical sense, rather, it should be understood in its context and in light of the object and purposes of the Convention, including avoiding double taxation and the prevention of fiscal evasion and avoidance”
“(…) It would be equally inconsistent with the object and purpose of the Convention for the State of source to grant relief or exemption where a resident of a Contracting State, otherwise than through an agency or nominee relationship, simply acts as a conduit for another person who in fact receives the benefit of the income concerned. For these reasons, the report from the Committee on Fiscal Affairs entitled “Double Taxation Conventions and the Use of Conduit Companies” concludes that a conduit company cannot normally be regarded as the beneficial owner if, though the formal owner, it has, as a practical matter, very narrow powers which render it, in relation to the income concerned, a mere fiduciary or administrator acting on account of the interested parties”
© IFA 2017

30. General Overview of the Notion of Beneficial Owner
2006 U.K. landmark Case Indofood
The U.K. Court of Appeals denied beneficial ownership status to a company that acted as a conduit in a back-to-back arrangement to raise capital in the international markets
© IFA 2017

31. General Overview of the Notion of Beneficial Owner
2014 revision of the Commentary (new par and 12.4 – Art. 10; new par. 9.1 and 10.2 – Art. 11)
“Since the term “beneficial owner” was added to address potential difficulties arising from the use of the words “paid to…a resident” in paragraph 1, it was intended to be interpreted in this context and not to refer to any technical meaning that it could have had under the domestic law of a specific country (in fact, when it was added to the paragraph, the term did not have a precise meaning in the law of many countries). (…)”
© IFA 2017

32. General Overview of the Notion of Beneficial Owner
“In these various examples (agent, nominee, conduit company acting as a fiduciary or administrator), the direct recipient of the dividend is not the “beneficial owner” because that recipient’s right to use and enjoy the dividend is constrained by a contractual or legal obligation to pass on the payment received to another person. Such an obligation will normally derive from relevant legal documents but may also be found to exist on the basis of facts and circumstances showing that, in substance, the recipient clearly does not have the right to use and enjoy the dividend unconstrained by a contractual or legal obligation to pass on the payment received to another person. This type of obligation would not include contractual or legal obligations that are not dependent on the receipt of the payment by the direct recipient such as an obligation that is not dependent on the receipt of the payment and which the direct recipient has as a debtor or as a party to financial transactions, or typical distribution obligations of pension schemes and of collective investment vehicles entitled to treaty benefits under the principles of paragraphs 6.8 to 6.34 of the Commentary on Article 1. (…)”
© IFA 2017

33. General Overview of the Notion of Beneficial Owner
Scenario A
SCo pays a dividend to its shareholder RCo, which in turn uses the proceeds from the dividend distribution to service interest payments under a loan with a bank in country T
RCo
SCo
Dividends
T Bank
Obligation unrelated to receipt of payment  Beneficial owner
Interest on loan
Scenario B
SCo pays an interest to a bank in State R, which is bound under a back-to-back collateralized guarantee to upstream that interest to an investor in country T
Guarantee with cash collateral
Loan
Obligation related to receipt of payment  NO beneficial owner
R Bank
SCo
T Inv.
Proceeds on guarantee
Interest on loan
© IFA 2017

34. Tax Court No. 2012 TCC 57 of February 24, 2012
Canadian Velcro Case
Tax Court No TCC 57 of February 24, 2012
Facts
VCI paid royalties to VHBV and applied 10% withholding tax according to the Canada-NL DTT
VHBI was required to pay an amount equal to 90% of the royalties received from VCI to VIBV
Court decision
VHBV is the beneficial owner of the royalties
Royalty payments from VCI were mixed and intermingled with VHBV’s other funds and used for a variety of purposes at VHBV’s sole discretion
Notwithstanding VHBV’s obligation to pay the equivalent of the 90% of the royalties received to VIBV, there was no automated flow of earmarked cash because of VHBV’s discretion to use other sources of cash
In line with the other Canadian precedent Prévost Car
VHBV
(NL)
VIBV
(NL Antilles)
VCI
(Canada)
License agreement
Royalties
10% WHT
90% of royalties paid by VCI
© IFA 2017

35. Federal Tribunal No. 2C 364/2012 of May 5, 2015
Swiss Swap Case
Federal Tribunal No. 2C 364/2012 of May 5, 2015
Facts
A Danish bank entered into total return swaps on Swiss shares and hedged its position by buying the underlying shares
Danish Bank sought refund of the Swiss dividend withholding tax
Court decision
Beneficial ownership requirement implicitly applies to all DTCs even in the absence of express reference
Despite the existence of any legal or contractual obligation, factual interdependence upheld. Structure equated to a direct conduit or stepping stone
According to the Federal Tribunal, beneficial ownership may be denied even where only a portion of the treaty income is transferred to non-residents
DK Bank
Foreign Investor
Increased value + Div.
Decreased value + Int.
Swiss Co
Purchase of shares
35% WHT
Increased value + Div.
© IFA 2017

36. Inherent Anti-Abuse Principle
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37. Origins
● argument based on pacta sunt servanda principle in Articles 26 and 31(1) of the Vienna Convention which require treaties to be performed and interpreted in good faith:
● counter-argument that treaties bind only Contracting States, not taxpayers who are third parties
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38. OECD Commentary
● OECD Commentary amended in 1977 to add that tax treaties “should not ... help tax avoidance or evasion”
● 2003 OECD Commentary also concludes that “a proper construction of tax conventions allows them to disregard abusive transactions,” and that “the benefits of a double tax convention should not be available where a main purpose for entering into certain transactions or arrangements was to secure a more favourable tax position and obtaining that more favourable treatment in these circumstances would be contrary
to the object and purpose of the relevant provisions.” [para. 9 of the Commentary on Article 1]
© IFA 2017

39. A Holdings ApS v. Federal Tax Administration
Facts
CHCo paid dividends to Danish holding company, DKCo
DKCo was wholly-owned by GuernseyCo
GuernseyCo was wholly-owned by BermudaCo
Court decision
Lower court found that the Danish entity was the beneficial owner of the income but denied treaty benefits on the basis of the general reservation of abuse
Federal Tribunal did not address beneficial ownership and denied treaty benefits exclusively on the basis of the inherent Anti-Abuse principle
Federal Tribunal however controversially equated the inherent Anti-Abuse principle to the so-called look-through provision which States may choose to incorporate into their DTCs (see OECD Commentary para. 13 ad Art. 1)
According to Swiss scholars, correct approach would have been to refer instead to the guiding principle (see OECD Commentary para. 9.5 ad Art. 1)
Offshore Co
X. Holding ApS
January 1999
Danemark
Switzerland
H. AG
December 1999
Dividend
© IFA 2017

40. Principal Purpose Tests
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41. Origins
● provisions introduced in UK treaties in the late 1960s denying treaty benefits for interest and royalties where the debt claim or right in respect of which interest or royalties are paid was created or assigned “mainly for the purpose of taking advantage” of the relevant treaty article and “not for bona fide commercial purposes”
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42. Application
● although these treaty provisions do not appear to have been subject to judicial interpretation, guidance may be derived from cases addressing domestic anti-avoidance rules – e.g., Groupe Honco Inc. v. Canada, 2012 TCC 305. aff’d 2013 FCA 128; and AH Field (Holdings) Ltd. v. Revenue and Customs, [2012] TC 01800
● these cases suggest that the purpose of a transaction is “a question of fact” to be determined with “due regard for all of the circumstances” including “objective manifestations of purpose” and taking into account “the inherent likelihood or probability of an event occurring” [Groupe Honco]
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43. Application
● they also suggest that a tax advantage may be “one of the main purposes” of a transaction where a transaction has “some business purpose” but is “so influenced by [its] tax effect” that is it “reasonable to assume that the tax effect must have been one of the main purposes” – for example if the transaction as structured would not have been undertaken but for the tax effect [AH Field (Holding) Ltd.]
© IFA 2017

44. Limitation of Benefit Provisions
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45. History and General Structure
● first included in 1989 U.S.-Germany Tax Treaty
● subsequently included in U.S Model Treaty and all U.S. tax treaties, as well as a few other treaties (e.g., 2011 Japan-Netherlands Treaty and 2015 Germany-Japan Treaty)
● provisions generally limit all or most treaty benefits to persons or items of income that satisfy additional objective requirements beyond the basic treaty requirement of residence
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46. The Minimum Standard on BEPS Action 6 and the Multilateral Instrument
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47. Minimum Standard on BEPS Action 6
FIRST REQUIREMENT: statement in treaties that the common intention of the parties is to eliminate double taxation without creating opportunities for non-taxation or reduced taxation through tax evasion or avoidance (including through treaty shopping arrangements)
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48. Minimum Standard on BEPS Action 6
SECOND REQUIREMENT: implementation through one of three options;
(a) a ”combined approach” with (i) a specific anti-abuse rule based on the limitation of benefits (LOB) provisions concluded by the U.S. and a few other countries, and (ii) a more general anti-abuse rule denying the benefit of a tax treaty where one of the principal purposes of arrangements or transactions is to secure the benefit and obtaining the benefit in these circumstances would be contrary to the object and purpose of the relevant provisions of the treaty (General PPT);
(b) a General PPT alone; or
(c) a LOB and a mechanism to deal with conduit arrangements not already dealt with.
© IFA 2017

49. Article 6 of the Multilateral Instrument addresses the First Requirement of the Minimum Standard on BEPS Action 6
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50. Article 7 of the Multilateral Instrument addresses the Second Requirement of the Minimum Standard on BEPS Action 6
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51. Article 6 – Substantive Provisions
● paragraph 1 modifies the preambles of CTAs to include the following text:
“Intending to eliminate double taxation with respect to the taxes covered in this agreement without creating opportunities for non-taxation or reduced taxation through tax evasion or avoidance (including through treaty shopping arrangements aimed at obtaining reliefs provided in this agreement for the indirect benefit of residents of third jurisdictions),”
© IFA 2017

52. Article 6 – Substantive Provisions
● paragraph 3 gives Parties the option to also include the following text in CTAs that do not contain corresponding language:
“Desiring to further develop their economic relationship and to enhance their cooperation in tax matters,”
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53. ● according to para. 73 of the Final Report on BEPS Action 6:
Article 6 – Comments
● although described as a “clarification” these changes are clearly intended to affect the interpretation and application of tax treaties and are presumably intended to support the PPT in Article 7
● according to para. 73 of the Final Report on BEPS Action 6:
The clear statement of the intention of the signatories to a tax treaty that appears in the … preamble will be relevant to the interpretation and application of the provisions of that treaty.
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54. Article 7 – Substantive Provisions
● paragraph 1 (the General PPT) denies a benefit in respect of an item of income or capital under a CTA if it is reasonable to conclude that obtaining the benefit was one of the principal purposes of any transaction or arrangement that resulted directly or indirectly in the benefit, unless it is established that granting the benefit in these circumstances would be in accordance with the object and purpose of the relevant provisions of the CTA
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55. Article 7 – Substantive Provisions
● paragraph 4 is an optional provision allowing a Competent Authority that does not opt out of the General PPT to grant treaty benefits to a person if, upon request from that person and after consideration of the all the relevant facts and circumstances, the competent authority determines that the treaty benefit would have been granted to the person in the absence of the transaction or arrangement
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56. Article 7 – Substantive Provisions
● paragraphs 8 to 13 set out a ”Simplified Limitation of Benefits” provision (Simplified LOB), that limits treaty benefits to qualified persons, items of income that satisfy an active business test or a derivative benefits test, and persons or items of income subject to discretionary relief
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57. Article 7 – Reservations
● paragraph 15(a) allows Parties to reserve the right not to apply the General PPT to a CTA on the basis that it intends to satisfy the minimum standard by adopting: (1) a detailed LOB, and (2) a General PPT or rules to address conduit financing arrangements; in this case, the Contracting Jurisdictions “shall endeavour to reach a mutually satisfactory solution which meets the minimum standard”
● paragraph 15(b) allows Parties to reserve the right for the General PPT and the discretionary relief rule in paragraph 4 not to apply to CTAs that already contain a General PPT
● paragraph 15(c) allows Parties to reserve the right for the Simplified LOB provision not to apply to CTAs that already contain LOBs that that limit benefits only to residents that meet one or more categorical tests
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58. The General PPT
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59. Elements of the General PPT
● effect of the General PPT is to deny “a benefit under the Covered Tax Agreement” that would otherwise be granted in respect of an item of income or capital
● the provision denies the benefit where the following three criteria are satisfied:
(1) the benefit would otherwise result “directly or indirectly” from “any arrangement or transaction” [the result criterion];
(2) “it is reasonable to conclude, having regard to all relevant facts and circumstances” that obtaining the benefit was “one of the principal purposes” of the arrangement or transaction [the principal purpose criterion];
(3) it is not established that granting the benefit in these circumstances
Is in accordance with the object and purpose of the relevant provisions
of the CTA [the object and purpose criterion]
© IFA 2017

60. General PPT – Final Comments
● provision amounts to a GAAR for tax treaties, providing the same advantages and disadvantages as a statutory GAAR
● advantage: discourages tax motivated transactions that are contrary to the object and purpose of the treaty without creating a roadmap for avoidance, which can be the case with specific anti-avoidance rules
● disadvantage: uncertainty regarding potential application, particularly regarding the object and purpose criterion
● criticized by some on the grounds that the principal purpose and object and purpose criteria favour the tax authority, and also suggested that the test may not survive constitutional challenges based on the legality principle that rules must be clear and their application predictable and not subject to administrative and judicial discretion (similar challenges often aimed at domestic GAARs, without much success)
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61. The Simplified LOB
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62. Simplified LOB – Overview
● adopts the general structure of the more detailed LOB provisions in U.S. treaties, denying most benefits otherwise provided to residents of a Contracting State under a CTA except for: (1) qualified persons, (2) items of income that qualify for limited benefits under an active business criterion, (3) items of income that qualify for limited benefits under an equivalent benefits criterion, and (4) residents or items of income subject to discretionary relief by the competent authority of the source State
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63. Serbia’s Position on Articles 6 and 7
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64. Article 6 ● Applies Article 6(1) to all 64 CTAs:
“Intending to eliminate double taxation with respect to the taxes covered in this agreement without creating opportunities for non-taxation or reduced taxation through tax evasion or avoidance (including through treaty shopping arrangements aimed at obtaining reliefs provided in this agreement for the indirect benefit of residents of third jurisdictions),”
● Adopts Article 6(3) – “Desiring to further develop their economic relationship and to enhance their co-operation in tax matters.”
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65. ● Adopts the PPT as the default provision
Article 7
● Adopts the PPT as the default provision
● Does not adopt Article 7(4) (competent authority override)
● Notifies existing provisions in DTCs with Indonesia, Kazakhstan, Korea, Norway and (in principle) Palestine
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66. Concluding Comments
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67. and other BEPS related issues
Travelling Lectureship Programme
Comprehensive Seminar on the Implementation of the Multilateral Convention (MLI)
and other BEPS related issues
Belgrade, Serbia
June
Philip Baker
© IFA 2017