(Pascal Saint-Amans Head of the OECD Centre for Tax Policy and Administration)
If you are an International Business and Financial Services Centre whose competitive advantage lies in a network of tax treaties; or you are about to develop an tax treaty network; or you are a developing country (as defined by the OECD Global Forum on Transparency and the Exchange of Tax Information) particularly from the African Continent; the following recommendations related to Action 6 of the OECD BEPS (Base Erosion and Profits Shifting) are of central importance to you.
According to the Report:
“Action 6 of the OECD/G20 Base Erosion and Profit Shifting (BEPS) Project identifies treaty abuse, and in particular treaty shopping, as one of the most important sources of BEPS concerns. Taxpayers engaged in treaty shopping and other treaty abuse strategies undermine tax sovereignty by claiming treaty benefits in situations where these benefits were not intended to be granted, thereby depriving countries of tax revenues. Countries have therefore agreed to include anti-abuse provisions in their tax treaties, including a minimum standard to counter treaty shopping. They also agree that some flexibility in the implementation of the minimum standard is required as these provisions need to be adapted to each country’s specificities and to the circumstances of the negotiation of bilateral conventions.”
Here are the three recommendations which will materially impact the conduct of International Tax Diplomacy:
- EFORMULATION 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.
- PREVENTING GRANTS 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.
These developments represent the most substantial revision of bilateral tax agreements designed to not only provide certainty for those involved in the free movement of goods, services, capital and people; but also how countries so align their domestic tax affairs to attract and retain investment.