Base Erosion and Profit Shifting: Update on Action 6 on Treaty Benefits
In our previous post published on 6 December 2016 we described the OECD’s BEPS Project in the context of the publishing of the draft Multilateral Convention to Implement Tax Treaty Related Measures to Prevent Base Erosion and Profit Shifting (the “Convention”).
One area that the OECD has itself acknowledged requires further consideration is in relation to BEPS Action 6, the final report on which was published in October 2015, which seeks to prevent access to treaty benefits in inappropriate circumstances (“treaty shopping”).
The final report on Action 6 included various proposals designed to prevent treaty shopping, including the proposed introduction into double tax treaties of:
a limitation on benefits (LOB) rule that limits the availability of treaty benefits to entities that meet certain conditions
a general anti-abuse rule which looks at the principal purpose of the transactions or arrangements in question (the principal purpose test, or PPT),
with the OECD recommending that as a minimum standard either (i) a PPT, or (ii) a PPT with either a “simplified” or “detailed” LOB provision should be adopted.
The European Commission has expressed a general preference for the PPT rather than the LOB provisions. HMRC have indicated that the UK will not adopt the LOB.
The application of Action 6 has been of particular concern to many types of widely-held investor funds, either whose investors or whose investment subsidiaries rely on double tax treaties in order to receive dividend and interest income free of, or at a reduced rate of, withholding.
Where a participating jurisdiction adopts the LOB, treaty relief will, in broad terms, be denied unless an entity can show that its ultimate beneficial owners are themselves entitled to equivalent treaty relief. Demonstrating this is likely to prove to be a difficult or impossible task for many funds with a large number of investors.
Although Action 6 provided for an LOB safe-harbour for any fund which is a “collective investment vehicle”, funds that are likely though to fall outside this definition (so-called “non-CIV funds”) include many private equity funds, REITs, securitisation companies and pension funds.
The paper concludes that few non-CIV funds should fail to qualify for treaty benefits under the simplified LOB rule included in the Convention – this view likely being based on the Convention’s simplified LOB provision not including the CIV / non-CIV distinction – but advises that governments may in any event wish to develop a comprehensive mutual agreement that extends to non-CIV funds to ease practical compliance and administrative issues. As noted above however, not all jurisdictions will adopt the simplified LOB test in the Convention (including the UK).
The potential difficulties for non-CIV funds seemingly remain though in respect of the detailed LOB, which it appears adopting jurisdictions will have to implement on a case-by-case bilateral basis rather than under the Convention, although how many jurisdictions adopt the detailed LOB remains to be seen
Under the PPT, if one of the principal purposes of transactions or arrangements is to obtain treaty benefits, treaty benefits would be denied unless it were established that granting these benefits would be in accordance with the object and purpose of the provisions of the treaty.
The self-evident subjectivity of the PPT has generated significant uncertainty in relation to non-CIV funds but also cross-border matters generally, the concern being that tax authorities may, if they are so minded, be able to use that subjectivity to unilaterally deny treaty benefits.
The OECD’s January 2017 discussion paper sets out three draft examples to be included in OECD guidance, with a view to providing some clarity as regards the parameters of the PPT in relation to non-CIVs. The draft examples relate to the application of the PPT to:
A regional investment platform.
A securitisation company.
An immoveable property non-CIV fund.
It remains to be seen what, if any, comfort the inclusion of these examples will provide non-CIV fund managers, investors and other stakeholders. The examples seek to provide reassurance by stating that the relevant parties merely considering applicable tax treaty benefits would not be sufficient to trigger the PPT, and that the wider context must be considered. However, the examples have relatively simple facts and accordingly are unlikely to be instructive in more common commercial circumstances.
The discussion paper itself notes that many example scenarios provided by commentators were not included on the basis of being too controversial – however it seems that examples focusing on more marginal cases with more complicated facts may be exactly what is required to clarify some of the prevailing uncertainty as regards how a “principal purpose” is to be properly distinguished from more general tax considerations.
Comments on the examples are requested by the OECD by 3 February 2017.