OECD Work On Restricting The Abuse Of Double Taxation Treaties
24 June 2015
Posted by: Author: BDO LLP
Author: BDO LLP
In September 2014, the OECD released proposed changes to its model tax convention to prevent abuse of treaties based on the convention. A further discussion draft was issued in November 2014 setting out work carried out on the proposed limitation of benefits rule and issues related to the treaty entitlements of collective investment vehicles (CIV) and non-CIV funds.
The proposals are intended to provide a variety of mechanisms that territories are free to use in agreeing treaties with other countries. Not all the suggested provisions need to be included but implementation of at least a minimum level of protection is recommended.
The OECD makes a distinction between arrangements designed to circumvent limitations provided by a double tax treaty and those where a person seeks to circumvent domestic tax laws to obtain tax treaty benefits. It focusses on combatting the former and recognises that work on the later types of arrangement is in progress through the other BEP actions (eg Action 2: hybrid mismatch arrangements).
Measures intended to prevent abuse of treaty provisions include:
a) A clear statement in the title and preamble of treaties that they are not intended to allow for non-taxation or reduced taxation through avoidance or evasion arrangements
b) A specific anti-abuse rule known as the 'limitation on benefits (LOB) rule', based closely on the rule included in treaties concluded by the USA and a few other countries
c) A more general anti-abuse rule based on the principal purposes of transactions or arrangements (the so-called principal purposes test or PPT).
As a minimum, countries should agree to include a) and at least one of b) or c) above in their treaties supplemented by a mechanism to deal with conduit financing arrangements not already dealt with in the tax treaties. This might take the form of a restricted PPT rule applicable to such arrangements or domestic anti-abuse rules/judicial doctrines that would achieve a similar result.
The LOB rule
The overriding position under the LOB rule is that a resident of a contracting state shall be entitled to all of the relevant benefits under the treaty only if it constitutes a 'qualified person'. Other persons may also benefit from specific benefits provided the associated income is derived in connection with the active conduct of a trade or business in the person's state of residence. Further provisions allow for certain entities owned by residents of other states to obtain treaty benefits that those residents would have obtained had they invested directly (thereby allowing for some form of treaty benefits to accrue to certain genuine conduit arrangements not set up for the purpose of gaining a tax advantage). In addition, the competent authorities of contracting states may grant treaty benefits on a discretionary basis where the LOB rule would otherwise deny them.
The test ensures that benefits will not be granted under the treaty if it is reasonable to conclude that obtaining the benefit was one of the principal purposes of the arrangement or transaction, unless granting the benefit is in accordance with the object and purpose of the relevant treaty provision.
Dealing with other treaty limitations
The report also contains targeted rules which could be used to combat the following types of arrangements:
- Certain dividend transfer transactions
- Transactions designed to circumvent rules which allow for the source taxation of shares or companies that derive their value primarily from immoveable property
- Dual resident companies
- Arrangements designed to take advantage of provisions which exempt the profits of permanent establishments set up by residents in third party states.
Tax policy considerations on adoption or termination of treaties
Finally, the report sets out policy considerations that territories should bear in mind when deciding whether or not to enter into treaties with certain low or no-tax jurisdictions and whether to modify or terminate an existing treaty as a result, for example, of changes in the domestic law of the treaty partner.
This article first appeared on mondaq.com.