Application of Article 7 in the MLI to Covered Tax Agreements with respect to the Prevention of Treaty Abuse

 

The Action Plan on Base Erosion and Profit Shifting ("BEPS Action Plan") identified 15 actions to address BEPS in a comprehensive manner. In October 2015, the G20 Finance Ministers endorsed the BEPS Package, which includes the report on Action 6: Preventing the Granting of Treaty Benefits in Inappropriate Circumstances ("the Report on Action 6" or "the Report", OECD (2015)). The minimum standard on treaty-shopping included in the Report on Action 6 is one of the four BEPS minimum standards. 

 

Article 6 of the MLI, titled "Purpose of a Covered Tax Agreement", replicates the preamble language of the Model Tax Convention. Article 7 of the MLI, titled "Prevention of Treaty Abuse", also replicates Article 29 of the Model Tax Convention. Both Article 6 and Article 7, taken together, fall under the scope of one of the minimum standards as documented in the Action 6 Final Report entitled "Preventing the Granting of Tax Benefits in Inappropriate Circumstance". The parties to the MLI must adopt all the minimum standards to the CTAs including Article 6 and Article 7, and the implementation of the minimum standards is subject to a monitoring mechanism of peer reviews, as provided under the Inclusive Framework on BEPS.  

 

Overview of the MLI Structure

 

Articles 3 to 17 under Part II to V of the provisions of the Multilateral Convention to Implement Tax Related Measures to Prevent Base Erosion and Profit Shifting (the MLI), signed by over 70 countries or jurisdictions on 7 June 2017, are substantive provisions addressing the BEPS issues. The substantive provisions have the following common structure: (i) operative clauses, (ii) compatibility clauses, (iii) reservation clauses and (iv) notification clauses.

 

The operative clauses replicate the contexts in the 2017 version Model Tax Convention that has incorporated the counter-BEPS measures. The operative clauses do not directly modify the Covered Tax Agreements (the CTAs). Instead, by the operation of the compatibility clauses, a contracting jurisdiction adapts the provision in operative clause to the CTAs, subject to any reservations entered by that contracting jurisdiction. The modified provisions shall become in force after the OECD Depositary has received the deposit of notification by the MLI parties.

 

Opt-in Provisions in the MLI

 

There are three classes of options in the MLI: opt-out provisions (reservations), opt-in provisions and alternative provisions. Article 7 contains 3 opt-in provisions and 4 reservations, and it could best be used as an example to shed light on the underlying legal principles of the MLI. This paper examines i) the design of the options with respect to Article 7, and ii) how contracting jurisdictions apply the opt-in provisions in Article 7 (titled "Prevention of Treaty Abuse") to the CTAs, subjec to the reservations made under different circumstances.

 

Opt-in provisions supplement the application of a primary operative clause. [1] One example is Article 7(4) ("Prevention of Treaty Abuse"). Article 7(3) provides that a Party that has not made the reservation for Article 7(1), - that is, the party has not opted out of the principal purpose test (PPT) - may choose to apply paragraph 4 to supplement its application of paragraph 1 to its CTAs. A party to the MLI should adopt the PPT in article 7(1) alone if it does not opt-in for article 7(4). If a party opts in for article 7(4), Article 7(1), as modified by article 7(4), shall apply in circumstances that a person that has failed the PPT would still be granted the tax benefits on a specific item of income or capital. Article 7(1) and Article 7(4) provide, as below:

 

1. Notwithstanding any provisions of a Covered Tax Agreement, a benefit under the Covered Tax Agreement shall not be granted in respect of an item of income or capital if it is reasonable to conclude, having regard to all relevant facts and circumstances, that obtaining that benefit was one of the principal purposes of any arrangement or transaction that resulted directly or indirectly in that benefit, unless it is established that granting that benefit in these circumstances would be in accordance with the object and purpose of the relevant provisions of the Covered Tax Agreement.

 

4. Where a benefit under a Covered Tax Agreement is denied to a person under provisions of the Covered Tax Agreement (as it may be modified by this Convention) that deny all or part of the benefits that would otherwise be provided under the Covered Tax Agreement where the principal purpose or one of the principal purposes of any arrangement or transaction, or of any person concerned with an arrangement or transaction, was to obtain those benefits, the competent authority of the Contracting Jurisdiction that would otherwise have granted this benefit shall nevertheless treat that person as being entitled to this benefit, or to different benefits with respect to a specific item of income or capital, if such competent authority, upon request from that person and after consideration of the relevant facts and circumstances, determines that such benefits would have been granted to that person in the absence of the transaction or arrangement provided that the competent authority of the contracting jurisdiction to which a request has been made by a resident of the other contracting jurisdiction shall consult with the competent authority of that other contracting jurisdiction before rejecting the request.

 

Granting of Discretionary Benefit 

 

Article 7(4) provides that, where a person has been denied the tax benefit on grounds that one of the principal purpose of any arrangement or transaction was to obtain tax benefits, the competent authority, upon request from that person and after considering the relevant facts, could make a determination whether the taxpayer could have been granted the tax benefits in the absence of the transaction or arrangement resulting in the denial of benefits.

 

Both paragraph 4 of Article 7 (prevention of treaty abuse) and paragraph 1 of Article 16 (mutual agreement procedure) contain the provision providing a remedy that the taxpayer can request the competent authorities of the contracting jurisdiction of which he is a resident, to reconsider his case after the tax benefits have been denied. However, the provisions in articles 7(4) and 16(1) are different in the following areas:

 

  • if the contracting jurisdiction chooses not to adopt Article 7(4), the taxpayer cannot proceed to make such a request. In contrast, the taxpayer access to MAP under Article 16(1) is not optional and is guaranteed by the MLI article that the contracting jurisdictions must comply with;
  • Article 16(1) is a discretionary benefit conditioned upon an agreement reached between the competent authorities of two contracting jurisdictions while Article 7(4) is a discretionary benefit conditioned upon the unilateral action of one single compentent authority;
  • the taxpayer can only present his case to the tax authority of the contracting jurisdiction of which he is a resident under Article 7(4) while the taxpayer may present his case to the tax authorities of either contracting jurisdiction under Article 16(1), unless one of the contracting jurisdictions chooses the alternative rule that does not allow the taxpayer to do so;
  • Article 16(1) provides that the taxpayer must present his case within a period of not exceeding three years. Article 7(4) does not provide such a time period. Instead, it is determined by the domestic rules of the contracting jurisdiction;

 

The second and third examples of opt-in provisions are Article 7(6) and Article 7(7). Where a contracting jurisdiction chooses to adopt the simplified limitation of benefits provision in addition to the PPT article, it may opt-in for articles 7(6) or 7(7), whose texts are given below:

 

“6. A Party may also choose to apply the provisions contained in paragraphs 8 through 13 (hereinafter referred to as the "Simplified Limitation on Benefits Provision") to its Covered Tax Agreements by making the notification described in subparagraph c) of paragraph 17 (Article 7(17)(c)). The Simplified Limitation on Benefits Provision shall apply with respect to a Covered Tax Agreement only where all Contracting Jurisdictions have chosen to apply it.” [Emphasis added.]

 

“7. In cases where some but not all of the Contracting Jurisdictions to a Covered Tax Agreement choose to apply the Simplified Limitation on Benefits Provision pursuant to paragraph 6, then, notwithstanding the provisions of that paragraph, the Simplified Limitation on Benefits Provision shall apply with respect to the granting of benefits under the Covered Tax Agreement:

 

a) by all Contracting Jurisdictions, if all of the Contracting Jurisdictions that do not choose pursuant to paragraph 6 to apply the Simplified Limitation on Benefits Provision agree to such application by choosing to apply this subparagraph and notifying the Depositary accordingly; or

b) only by the Contracting Jurisdictions that choose to apply the Simplified Limitation on Benefits Provision, if all of the Contracting Jurisdictions that do not choose pursuant to paragraph 6 to apply the Simplified Limitation on Benefits Provision agree to such application by choosing to apply this subparagraph and notifying the Depositary accordingly.” [Emphasis added.]

 

Asymmetry resulting from the choice of simplified limitation of benefit provision

 

As paragraphs 88 and 89 of the Explanatory Statement to the MLI explain, the Action 6 Report includes three alternative rules to address situations of treaty abuse. The first of these alternatives is a general anti-abuse rule based on the principal purpose of transactions or arrangements. In addition to this principal purpose test (PPT), the Action 6 Report provides two versions (a simplified and detailed version) of a specific anti-abuse rule, the limitation on benefits (LOB) provision, which limits the availability of treaty benefits to persons that meet one or more categorized tests listed in paragraphs 9 to 13 of Aritcle 7. The Action 6 Report states that countries, at a minimum, should implement:

  • a PPT only;
  • a PPT and either a simplified or detailed limitation of benefit (LOB) provision (the PPT-SLOB or PPT-DSLOB, (denoted as"PPT-plus")); or
  • a detailed LOB provision, supplemented by a mechanism either that would deal with conduit arrangements not already dealt with in tax treaties or a PPT (the DLOB-conduit-structure or DLOB-and-PPT (denoted as "DLOB-plus")).

 

The Explanatory Statement further provides that, as the default option, the PPT in Article 7(1) is the only approach that can satisfy the minimum standard on its own. [2] Parties are then permitted pursuant to Article 7(6) to supplement the PPT by choosing to apply a simplified LOB provision (SLOB). The MLI does not provide the detailed LOB, but the contracting jurisdictions that adopt the detailed LOB should endeavor to reach a mutually satisfactory solution that meets the minimum standard.

 

It is noted that some of the contracting jurisdictions may not adopt the SLOB because choosing the PPT alone is sufficient to meet the minimum standard. The asymmetry in choice of options, if Article 7(6) is opted in for, will be at odds with the principle of reciprocity and thus result in the entire Article 7 not being applied to the CTAs for those contracting jurisdictions. Article 7(7) provides an option to address the asymmetry if all of the PPT-only and the DLOB-plus parties agree that either i) all parties adopt the SLOB when granting the tax benefit under the CTA, pursuant to Article 7(7)(a), or ii) only the PPT-plus parties adopt the SLOB when granting the tax benefit, pursuant to Article 7(7)(b). In the absence of any agreement reached pursuant to Article 7(7)(a) or 7(7)(b), a PPT-plus parties (the party who chooses to adopt the SLOB) can opt out of the entire Article 7. In that case, the parties shall endeavor to reach a mutually satisfactory solution which meets the minimum standard as mentioned above, pursuant to Article 7(16).

 

Notifications

 

Notifications are required if a contracting jurisdiction makes a reservation for an article, or a provision of an article, of the MLI not to apply to the relevant provision of the CTA, or that the CTA already has a provision that addresses the same issue as the provision of the MLI. That is, the existing provision is a provision compatible to the corresponding MLI provision.

 

 Notifications are also required to give legal effect to the opt-in provision that a contracting jurisdiction has chosen. Table A below shows the notifications, as denoted by the letter "Y", given in respect of Article 7 under Article 7(17) by some selected contracting jurisdictions as required under Article 29 – Notifications, as of 9 April 2019, using information from the MLI database's matrix of options and reservations, which is provided by the contracting jurisdictions to the OECD Depositary.

 

Table A: Notification given for opt-in provisions under Article 7(17)(b),(c), and (d)

 

 

(i)

(ii)

(iii)

Jurisdictions

Status

Opt-in for article 7(4) to supplement the application of the PPT under article 7(1).

Opt-in for the S-LOB under Article 7(6) in addition to the PPT.

A party that adopts the PPT, agrees to adopt S-LOB symmetrically under Article 7(7)(a) or asymmetrically under 7(7)(b).

Notifications

 

pursuant to article 7(17)(b)

pursuant to article 7(17)(c)

pursuant to article 7(17)(d)

Greece

P

 

 

Y

Hong Kong, China

P

 

 

 

India

P

 

Y

 

Ireland

 

Y

 

 

Japan

 

 

 

 

Mauritius

P

Y

 

 

New Zealand

 

Y

 

 

Norway

P

 

 

Y

Russia

P

 

Y

 

Singapore

 

Y

 

 

Slovak Republic

 

 

Y

 

United Kingdom

 

Y

 

 

 

P = provisional list pending deposit of Instrument of Ratification; S-LOB = simplified limitation of benefit

 

The parties that do not choose to adopt the SLOB under Article 7(6) may agree that the SLOB shall apply when granting the benefits under the CTA by choosing to opt-in for the provisions either under Article 7(7)(a) or (b). The asymmetry of choices will be dealt with later in this article. 

 

Note that if Article 7(4) is chosen, it will modify Article 7(1). Article 7(17)(b) of the MLI provides that each Party that chooses to apply paragraph 4, which modifies paragraph 1, shall notify the Depositary of its choice. Paragraph 4 shall apply to a Covered Tax Agreement only where all Contracting Jurisdictions have made such a notification. [emphasis added.] If notification is not given by all the parties, the choice shall not apply with respect to the CTAs. Articles 7(17)(c) and (d) also impose such a condition that provides that only where all contracting jurisdictions have given notifications, the provision of the MLI shall apply to the CTAs. The term "all contracting jurisdictions" covers both parties of a bilateral tax treaty and multiple parties of a multilateral tax treaty respectively.

 

An example of a multilateral tax treaty is the Convention between the Nordic Countries for the Avoidance of Double Taxation with respect to Taxes on Income and Capital (23 Sept 1996), as concluded by six signatory states: Denmark, the Faroe Islands, Finland, Iceland, Norway, and Sweden. Iceland and Norway, which are two of the contracting jurisdictions listed in Table A, have made a matched notification, but the opt-in provision under Article 7(4) shall not apply as it does not satisfy the approval requirement of "all contracting jurisdictions" in Article 7(17)(b) with respect to the Nordic Multilateral Double Taxation Convention. 

 

Table B - Notification Matrox for some of the parties choosing paragraph 4 in Table A

 

 

India

Mauritius

New Zealand

Singapore

United Kingdom

India

P

X

 

 

 

 

Mauritius

P

 

X

Y

Y

Y

New Zealand

 

 

Y

X

Y

Y

Singapore

 

 

Y

Y

X

Y

United Kingdom

 

 

Y

Y

Y

X

 

It is observed that except for India, 4 other contracting parties have chosen to opt-in for Article 7(4). Therefore, Article 7(4) shall apply to the New Zealand-Singapore CTA, the New Zealand-UK CTA, and the Singapore-UK CTA because each of the bilateral (or paired) CTAs contains a matched notification with respect to the application of Article 7(4).  With regard to the CTAs concluded by Mauritius provisionally, they have no legal force until after Mauritius has doposited the Instrument of Ratification to the OECD Depositary, pursuant to Article 34(2).

 

 

Reservations under Article 7(15)(a), 15(b), and 15(c)

 

For copyright reasons, please contact the author at alfred@china-tax.net for a copy on the application of Article 7 to the CTAs, subject to the modification by the reservation clauses.

 

[1] One more example is Article 6(3) that supplements the purpose and object of Article 6(1).

[2] Article 23 –Types of Arbitration Process also provides for the "final offer" approach as the default option, as compared to the independent opinion approach. See paragraph 241, Explanatory Statement to the MLI.