The Multilateral Convention to implement BEPS Tax Treaty Measures

The Organization for Economic Cooperation and Development (OECD) has announced that over 100 jurisdictions have concluded negotiations on a Multilateral Convention that is intended to enable implementation of the tax treaty related aspects of the OECD’s Base Erosion and Profit Shifting (BEPS) project. The intention is to allow governments to bring their treaties into line with these aspects of the BEPS project via the Convention, rather than renegotiating large numbers of bilateral treaties.

Whilst the Multilateral Convention is undoubtedly a major step forward in ensuring consistency of implementation of the treaty related BEPS actions, in truth a great deal of work still lies ahead for participating jurisdictions. The Convention requires jurisdictions to notify each of their treaties that are to be covered by the Convention and set out in some detail how each such bilateral treaty is to be amended by the Convention. Indeed, in some case, it may still be necessary or desirable for parties to a bilateral treaty to agree the way in which the Convention will modify that treaty.

Background

The OECD’s BEPS Action Plan consisted of 15 separate action points designed to address concerns surrounding tax planning strategies that exploit gaps and mismatches in tax rules to artificially shift profits to low locations where there is little or no economic activity. The reports covered a wide range of issues, including the taxation of the digital economy, transfer pricing rules, Controlled foreign corporation (CFC) rules, base erosion via interest deduction and country by country reporting. In particular, a number of aspects of the Action Plan concerned issues which are typically dealt with, in part, by bilateral double tax treaties. These included use of the use of hybrid instruments and entities in cross border tax planning, double tax treaty abuse and double non-taxation and the definition of a permanent establishment rules as well as dispute resolution mechanisms. Final reports were published by the OECD in October 2015.

Action 15 of the BEPS project specifically dealt with the need for a multilateral instrument to enable countries to modify their bilateral tax treaties to implement BEPS related treaty measures. The report recognised that the changes to the OECD model tax convention would need to be implemented into all the bilateral tax treaties based on the model convention. This would be extremely time consuming in the absence of a multilateral instrument and would limit the effectiveness of BEPS project. Accordingly, following the delivery of the final reports, the OECD continued to work on the development of a multilateral instrument pursuant to Action 15 led by an ad hoc group chaired Mike Williams of HM Treasury. The result is the Multilateral Convention which was published, together with an explanatory statement, on 24 November 2016.

Scope of the Convention

The Multilateral Convention is divided into several discrete sections. The main sections cover:

• hybrid mismatch arrangements
• treaty abuse
• avoidance of PE status, and
• improving dispute resolution.

In addition, the Convention contains a number of administrative provisions concerning entry into force, amendments etc. However, it is important to note that, whilst the Convention sets out provisions which change the interpretation of affected treaties, it is up to each jurisdiction to inform the OECD which particular treaties are to be covered by the Convention (a Covered Tax Agreement) and it is only where both jurisdictions party to the treaty give notice that the bilateral treaty will be affected.

In addition, many of the provisions of the Convention provide options or allow a jurisdiction to reserve the right not to apply particular parts of the Convention on a treaty by treaty basis. As such, the individual signatory jurisdictions still have a great deal of work to do in analysing their existing treaty network and determining (perhaps through negotiation) which treaties are to be covered and which particular aspects of the Convention are to apply to each such treaty, on an individual treaty basis.

Hybrid mismatches

The Convention contains provisions dealing with transparent entities (updating the text of treaties to deal with income received through a transparent entity) and dual resident entities (providing a consistent approach to treaty tie-break clauses). In addition, this section includes optional measures for dealing with problems that arise from the use of the exemption method in treaties in relation to items of income that are not taxed in the source state. In this case, the Convention recognises that jurisdictions to the same treaty may even choose different options, resulting in asymmetric provisions.

Treaty abuse

This section contains a number of provisions including the minimum standard statements required under the BEPS final reports that treaties are to eliminate double taxation without creating opportunities for non-taxation or tax avoidance, including through treaty shopping.

Article seven contain the general anti-avoidance principal purpose test provision (PPT) and the simplified version of a limitation on benefits (LOB) clause for jurisdictions to adopt. The Report on Action six requires as a minimum standard that jurisdictions should adopt (i) a PPT or (ii) a PPT together with a limited LOB or (iii) a detailed LOB supplemented by a mechanism to deal with conduit arrangements. Article seven only deals with the first two provisions, concluding that a detailed LOB clause would need to be negotiated on a bilateral basis.

This Part also includes provisions dealing with minimum holding periods for exempting outgoing dividends, arrangements relating to entities deriving their value from immovable property and application of treaty provisions to PEs situated in third countries.

PE status

Part IV of the Convention deals with issues around PE status. In particular, Article 12 contains provisions intended to deal with commissionaire and similar arrangements, though these are optional. In particular, pursuant to this provision where a person acts exclusively or almost exclusively on behalf of one or more enterprises to which it is closely related, that person shall not be considered to be an independent agent with respect to any such enterprise.

Article 13 contains provisions to ensure that the specific activity exceptions to PE status only apply where they are of a preparatory or auxiliary character or alternatively (where jurisdictions continue to view such activities being intrinsically preparatory or auxiliary) redrafted language for those exclusions.

This Part also contains provisions dealing with splitting of contracts (fragmentation) in relation to construction projects.

Dispute resolution

The final substantive part of the Convention includes a number of provisions to introduce minimum standards for dispute resolution in relation to treaty disputes. They include mutual agreement procedures, provisions dealing with corresponding adjustments and mandatory binding arbitration.

Options and reservations

A number of the BEPS provisions are subject to agreed minimum standards, such as the provisions dealing with countering treaty abuse. Where that is the case, opting out of that provision is only possible in limited circumstances, such as where a treaty already meets that minimum standard. Where a minimum standard can be satisfied in multiple alternative ways, the Convention does not give preference to a particular way of meeting the minimum standard. In cases where jurisdictions adopt a different approach to meeting a minimum standard that requires the inclusion of a specific type of treaty provision, those jurisdictions must endeavour to reach a mutually satisfactory solution consistent with the minimum standard.

Where a provision does not reflect a minimum standard, a jurisdiction is generally given the flexibility to opt out of that provision entirely (or, in some cases, out of part of that provision). This is accomplished through the mechanism of reservations, which are specifically defined for each substantive Article of the Convention. Where a jurisdiction uses a reservation to opt out of a provision of the Convention, that provision will not apply as between that jurisdiction and all other parties to the Convention. However, the Convention also recognises that, whilst a jurisdiction may wish to apply a particular provision of the Convention to its treaty network, it may have policy reasons for preserving the application of specific types of existing provisions. To accommodate this, in a number of cases the Convention permits a jurisdiction to reserve the right to opt out of applying a provision to a subset of Tax Agreements in order to preserve existing provisions.

To ensure clarity and transparency about the application of the Convention, where a provision supersedes or modifies specific types of existing provisions of a Covered Tax Agreement, jurisdictions are generally required to make a notification specifying which Covered Tax Agreements contain provisions of that type. If there is in fact a relevant existing provision which has not been notified, the provision of the Convention will generally prevail over that existing provision, superseding it to the extent that it is incompatible with the relevant provision of the Convention.

Implementation

The OECD will be the depositary of the Convention and will support governments in the process of its signature, ratification and implementation. The Convention is open for signature from 31 December 2016, but a first high level signing ceremony will take place in the week beginning 05 June 2017, with the expected participation of a significant group of countries during the annual OECD Ministerial Council meeting. The Convention will generally take effect in relation to a bilateral treaty for tax periods beginning six months after it has been ratified by the relevant jurisdictions or, in the case of withholding taxes, the following calendar year.