Double Tax Treaties in a BEPS World: A Discussion

Double Tax Treaties in a BEPS World: A Discussion

The OECD’s Base Erosion and Profit Shifting (BEPS) proposal has introduced multiple changes that will impact the application of double tax treaties (DTTs) across the globe. The Multilateral Instrument (MLI), for one, was designed to make it easier for jurisdictions to re-negotiate and amend DTTs so that they meet the minimum standards imposed by the BEPS project.
 
One of the panels at our inaugural international tax conference back in November 2018 tackled this issue, and here’s what was discussed.
 
A special thank you to our panelists:
And this panel’s moderator, Dr. Tatiana Falcão, Policy Leaders Fellow, School of Transnational Governance, European University Institute, Italy.

Do you foresee any challenges for the implementation of the MLI for jurisdictions across the globe?

Dr. Venetia Argyropoulou: “The MLI is spectacular. It is a historic opportunity in the sense that it has managed to align tax policies in a very large scale. But as expected, one can see that there are many challenges in relation to its implementation. It is important to note that the MLI does not operate as an amended protocol to a DTT but coexists with DTTs and supplements them.”
 
“In this sense, one of the most important challenges is understanding the exact wording of the amended DTT following the MLI implementation. You can appreciate the difficulties in understanding the modified tax provision, especially if the DTT is not OECD-based or wasn’t negotiated in one of the official languages of the MLI, which is French or English. In this case, we’ll have significant issues in recognizing the text of the modified DTT itself, and this problem is enhanced by the fact that the MLI does not provide for a procedure for a modification text of the amended DTT. Therefore, this will create significant legal uncertainties.”
 
“Another challenge that I see in relation to the implementation of the MLI is the interpretation of the treaty provisions themselves. So if we’ve managed to identify how the treaty provisions are amended by the MLI, then interpreting the provisions themselves will be a challenge.”
 
“Last but not least, the commentaries of the OECD, although they are of great help, nonetheless their role is ambiguous. It will be very interesting to see how national judges will interpret the MLI when they are faced to interpret national tax law and the DTTs as they are amended by the MLI. This will pose significant challenges to them and it will be reason for academic analysis for many more years.”
 
Dr. Tatiana Falcao: “There are some countries that are already issuing versions of their treaties corresponding to their obligations in the MLI. So what they are doing are unofficial versions of the bilateral treaty but incorporating what they agreed through the MLI into the provisions of a bilateral tax treaty. So that would make it easier for practitioners to interpret the bilateral tax treaty, although that reinterpreted version is not legally binding on any of the parties.”
 
Emmeline Bocherel: “We have to face probably with illusion. There are so many countries that have already ratified it and there are so many optional issues available to countries. You should have to be sure that the different countries will agree to implement these MLI options. You can say, “Yeah, we’ve agreed with MLI,” but we could also decide to not really implement it in the DTT issues.”
 
George Savvides: “About the official languages, there is also the issue of whether amending a DTT that was negotiated between two states through the MLI would be unconstitutional in some countries, because there might be a contrast with their constitution to amend their treaty in that way. That would be a challenge as well.”

How easy is it to interpret the principal purpose test (PPT) to avoid treaty abuse?

Dr. Venetia Argyropoulou: “There are two elements that must be met in order for the principal purpose test to be applied: the objective test and the subjective test. Under the subjective test, the tax authorities need to reasonably conclude that the principle purpose of the transaction was to obtain a tax benefit, while under the objective test, the taxpayer needs to establish that granting the tax benefit is in line with the relevant provisions of the DTT.”
 
“First of all, one can easily see that the burden of proof between the tax authorities and taxpayers is greatly uneven. On the one hand, the tax authorities need to ‘reasonably conclude,’ while the taxpayers need to ‘establish.’ The PPT has been criticized for rewarding too much discretion to the tax authorities, and I think we will see some abusive practices from tax authorities around the world.”
 
“How do we interpret the subjective and objective element? In order to interpret the subjective element, the tax authorities must make an objective analysis of all circumstances surrounding the relevant transaction. This raises the question: what happens if based on this analysis it comes upon that there are several principal purposes that triggered this transaction, some of which are tax-related and some of which that are not?”
 
“On the objective element, the question arises: What do we mean by the scope and purpose of the DTT? What does the taxpayer need to prove? For this reason again, it has been argued that there is a restrictive approach and a wide approach. The restrictive approach can be easily met as in most cases the taxpayers will conform with the relevant provisions of the DTT, so this leads to the best approach to be followed, which is a more broad approach, in the sense that we need to take into account the preamble of the DTT, the relevant provisions of the DTT, the commentaries of the OECD, so the taxpayer has a very difficult job in evaluating all these elements into the specific transactions, understanding what the purpose and object of these elements are and implementing it in specific cases. This would be a very difficult position for the taxpayer to be in.”

Would you agree with the statement that mandatory binding arbitration has lost its pull following the BEPS project?

George Savvides: “To the extent that there is no mandatory arbitration clause in the MLI, then, yes, this statement is right, because there is no certainty that a dispute will be resolved. The options then for a taxpayer in case of a dispute if there is no mandatory arbitration are very limited to some extent. For example, EU countries have access to this new Dispute Resolution Directive where the arbitration is mandatory and not only arbitration but also other forms of alternative dispute resolution such as mediation or conciliation. And also the taxpayer through this directive can even have the court option in case the authorities are not willing to examine a claim or implement a decision. So it really depends on the country as well.”
 
Dr. Tatiana Falcao: “There is an approximation between the UN and the OECD in that sense. As you know, the UN has always had an alternative provision—Article 25 of the UN Model has alternative A, which is only a mutual agreement provision without an arbitration option, and alternative B, which is the mutual agreement provision with the arbitration option.”
 
“The OECD obviously always was of the opinion that arbitration should be mandatory, so it only has an Article 25 with an arbitration option. So it’s mandatory under the OECD model provided certain criteria are fulfilled within the OECD model. But with the expansion of the participation of the policy making process within the OECD, the OECD has found itself in a very interesting situation. In order to pass the MLI, it had to comply with the will and interests of developing countries because all of a sudden they became involved in the whole policy making process through the BEPS implementation framework. And that’s where option Chapter 6 comes in the MLI and now, if you were to reconcile the OECD model with the MLI, you would see actually an opening up of the OECD model towards a little bit of a more democratic approach in the sense that you can opt to be within the parameters of Chapter 6 or you can opt to be out.”

Are you favorable to the creation to a digital permanent establishment (PE) type of approach?

Dr. Venetia Argyropoulou: “India has already taken the step of introducing a digital PE before the OECD plan of action. The issues that were raised there was that it didn’t take into account the effect it would have on start-ups, how the nexus would be established, etc. There were many comments about how India has introduced this digital PE. But from my experience as an in-house tax advisor, where my company deals in the digital market, following this development in India, we’ve decided to step down from doing business in India. The cost for us turned out to be greater than the benefit, and this perhaps will have an effect on enterprises worldwide.”

Has the United States in its 2017 tax reform unilaterally taken steps to enact its own BEPS and to what extent do these steps violate existing tax treaties?

John Richardson: “The United States has absolutely gone the opposite way. What they’ve done with the 2017 tax reform is absolutely astounding. After years of having their CFC regime, which really made US tax lawyers the Grand Masters of eroding the tax base around the world, they made the claim that they were going move to a territorial system to get out of this. But, what’s interesting, and this is why I think they have enacted their own internal BEPS, what you have are two very specific provisions.”
 
“Prior to US tax reform, profits earned by the CFC of US multinationals were of course not subject to taxation, there was a long-term deferral on that. Now with these CFCs, there’s this GILTI provision, which essentially means that any profits in excess of 10% return on depreciable assets have to be included as current income in the parent company at the time it is earned. Not only does this address the problem of eroding the tax base, what I think is very worrying is that this is nothing less than a preemptive tax strike on other countries.”
 
“The second thing they’ve done, which is very worrisome, is this B provision, which essentially means that if a US parent company sells or transfers property to a subsidiary where there’s a 25% or more ownership and claims a deduction for that, then the amount of the deduction actually has to be clawed back into the income of the company, meaning that there’s a minimum of 10% tax on that. What essentially they’ve done instead of cooperating with other countries, they’ve just created a system where US companies cannot escape immediate taxation except under very specified circumstances. When the US says it’s moved to a system of territorial taxation, what they really mean is that they have in fact dramatically increased the territory over which they’re exercising current taxation."
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