Action 6 Prevention of tax treaty abuse

Over the last decades, bilateral tax agreements, concluded by nearly every jurisdiction in the world, have served to prevent harmful double taxation and remove obstacles to cross-border trade in goods and services, and movements of capital, technology and persons. This extensive network of tax agreements has, however, also given rise to treaty abuse and so-called “treaty-shopping” arrangements.

Treaty shopping typically involves the attempt by a person to indirectly access the benefits of a tax agreement between two jurisdictions without being a resident of one of those jurisdictions. There are a wide number of arrangements through which a person who is not a resident of a jurisdiction that is a party to a tax agreement may attempt to obtain benefits that a tax agreement grants to a resident of that jurisdiction.

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 jurisdictions of tax revenues.

Treaty abuse is one of the most important sources of BEPS concerns. It is undesirable for several reasons, including:

• Treaty benefits negotiated between the parties to an agreement are economically extended to residents of a third jurisdiction in a way the parties did not intend. The principle of reciprocity is therefore breached and the balance of concessions that the parties make is altered;
• Income may escape taxation altogether or be subject to inadequate taxation in a way the parties did not intend; and
• The jurisdiction of residence of the ultimate income beneficiary has less incentive to enter into a tax agreement with the jurisdiction of source, because residents of the jurisdiction of residence can indirectly receive treaty benefits from the jurisdiction of source without the need for the jurisdiction of residence to provide reciprocal benefits.

As part of the BEPS package, the Action 6 Report sets out one of the four BEPS minimum standards, which is that members of the BEPS Inclusive Framework commit to include in their tax treaties provisions dealing with treaty shopping to ensure a minimum level of protection against treaty abuse. They also agreed that some flexibility in the implementation of the minimum standard is required as these provisions need to be adapted to each jurisdiction’s specificities and to the circumstances of the negotiation of tax agreements.

The minimum standard on treaty shopping requires jurisdictions to include two components in their tax agreements: an express statement on non-taxation (generally in the preamble) and one of three methods of addressing treaty shopping.

To foster the implementation of the minimum standard and other BEPS treaty-related measures in the global treaty network, a Multilateral Instrument (the MLI) that can modify existing bilateral tax agreements was concluded.

The implementation of the Action 6 minimum standard is subject to a peer review process. The first peer review on the implementation of the Action 6 minimum standard was carried out in 2018. The peer review for 2019 is currently ongoing.

The first peer review on the implementation of the Action 6 minimum standard reveals that a large majority of Inclusive Framework members have begun to translate their commitment on treaty shopping into actions and are now in the process of modifying their treaty network. In total, on 30 June 2018, 82 jurisdictions had some treaties that were already compliant with the minimum standard or that were going to shortly comply.

The first peer review shows the efficiency of the Multilateral Instrument (MLI) in implementing the minimum standard and the other treaty-related BEPS measures. It is by far the preferred tool of Inclusive Framework members for implementing the minimum standard. The majority of the jurisdictions that have signed the MLI have listed almost all their treaties under the MLI.

As of 1 January 2019, the provisions of the MLI started to take effect with respect to some treaties. For the treaties for which the MLI is effective, tax administration can now use effective treaty provisions to put an end to treaty-shopping.  

THE EXPRESS STATEMENT

As set out in paragraphs 22 and 23 of the Final Report on Action 6, jurisdictions have agreed to include in their tax agreements an express statement that their common intention is to eliminate double taxation without creating opportunities for non-taxation or reduced taxation through tax evasion or avoidance, including through treaty-shopping arrangements. The following preamble now appears in the 2017 OECD Model Tax Convention:

Intending to conclude a Convention for the elimination of double taxation with respect to taxes on income and on capital 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 Convention for the indirect benefit of residents of third States)

THREE METHODS OF ADDRESSING TREATY SHOPPING

Jurisdictions have also committed to implement that “common intention” through the inclusion of treaty provisions in one of the following three forms:

1. a principal purpose test (PPT) equivalent to paragraph 9 of Article 29 of the 2017 OECD Model Tax Convention together with either a simplified or a detailed version of the limitation on benefits (LOB) rule that appears in paragraphs 1 to 7 of the 2017 OECD Model; or
2. the PPT alone; or
3. a detailed version of the LOB rule together with a mechanism (such as a treaty rule that might take the form of a PPT rule restricted to conduit arrangements, or domestic anti-abuse rules or judicial doctrines that would achieve a similar result) that would deal with conduit arrangements not already dealt with in tax treaties.

Concerns about treaty shopping are not new. In 1977, the concept of “beneficial owner” was introduced into the dividends, interest, and royalties articles of the OECD Model Tax Convention to clarify the meaning of the words “paid to”, and deal with simple treaty-shopping situations where income is paid to an intermediary resident of a treaty country who is not treated as the owner of that income for tax purposes (such as an agent or nominee).

In 1977, the Commentary on Article 1 of the OECD Model was also updated to include a section on the improper use of tax agreements. In 1986, the Committee on Fiscal Affairs (CFA) published two reports: Double Taxation and the Use of Base Companies and Double Taxation and the Use of Conduit Companies. In 2002, the Committee published the report, Restricting the Entitlement to Treaty Benefits. The Commentary on Article 1 was expanded on several occasions, notably in 2003, with the inclusion of sample provisions that countries could use to counter treaty shopping.

A review of jurisdiction practices shows that they have tried to address treaty shopping in the past and have used different approaches to do so. Some have relied on specific anti-abuse rules based on the legal nature, ownership, and general activities of residents of a jurisdiction party to a tax agreement. Others have favoured a general anti-abuse rule based on the purpose of transactions or arrangements.