Many international businesses that currently obtain benefits, or plan to obtain benefits, under double tax treaties will find that the landscape changes in 2019.
Tax treaty related measures to prevent base erosion and profit shifting will enter into force from 1 July 2018 and will start to have a direct impact as early as 1 January 2019. The changes will be implemented en masse through the OECD’s Multilateral Instrument (MLI).
The change process
The MLI allows countries the flexibility to specify which treaties are covered and how they will meet certain aspects of the minimum standards. They can also opt out of all or part of provisions that extend beyond the minimum standards. This flexibility means that each DTA will be changed in a unique way depending on how the relevant countries adopt the MLI provisions. It is only where both parties agree to amend their treaties for that particular article (i.e. there is a ‘match’) that a treaty article will be amended. 78 jurisdictions have already signed up to the MLI and the OECD has already been notified that over 1,200 existing tax treaties will change.
Limiting treaty benefits
The MLI may limit access to almost all treaty benefits, including those providing for an elimination or reduction of taxation on interest, dividends and capital gains. It may limit access to benefits in two ways:
- Denying treaty benefits where it is ‘reasonable’ to conclude that obtaining a DTA benefit was one of the ‘principal purposes’ of any arrangement or transaction that resulted directly (or indirectly) in that benefit, or
- An objective, but highly mechanical, Simplified Limitation of Benefits (SLOB) provision which, essentially, determines whether ultimate beneficial owners would be entitled to the benefit had the payment been made directly.
In most cases, the principal purpose test will be the prevailing rule, with the SLOB selected by some jurisdictions as an additional test. In practice, this will create considerably uncertainty as to how different tax authorities will interpret the SLOB.
Companies that have, historically, had their tax residence determined by the ‘place of effective management’ tiebreaker treaty provision may now find their residence position more uncertain. The new MLI rule requires that tax residence will instead be determined by mutual agreement between the two countries’ tax authorities. Importantly, it also provides that in the absence of such mutual agreement, no relief or exemption from tax will be granted under the treaty.
There are measures aimed at artificial avoidance of permanent establishment (PE) status, including a new, lower threshold for agents who will create a PE if they habitually play “the principal role” leading to the conclusion of contracts. There are other PE measures regarding the use of “preparatory or auxiliary” exemptions and anti-fragmentation rules, for example the splitting of building contracts.
There are many other measures included in the MLI, including minimum holding periods for treaty benefits on dividends and on capital gains on shares in land-rich companies. Most importantly, there are no grandfathering provisions for existing arrangements. In addition, it should not be assumed that the changes are limited to the most egregious types of aggressive tax planning: many traditional tax structures may be adversely affected.
All businesses should, therefore, be undertaking an initial impact assessment to identify:
- Which treaties they currently/expect to rely on
- Which of these treaties will be changed by the MLI
- Which provisions of the MLI will take effect in relation to those treaties
- How anticipated treaty benefits will change / be removed
- What action should be taken before the changes take effect
For help and advice on how the MLI and wider BEPS changes could affect your group please contact Nick Udal or Katherine Brown.
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