- OECD Releases Discussion Draft on Treaty Abuse
- April 9, 2014
- Law Firm: Sutherland Asbill Brennan LLP - Washington Office
On March 14, the Organisation for Economic Cooperation and Development (OECD) released a public discussion draft on Action 6 of its Base Erosion and Profit Shifting (BEPS) project, on how to prevent treaty abuse. The discussion draft covers many issues, but five key recommendations stand out. The first four are changes to the OECD Model Tax Convention itself (the “Model Convention”), and the fifth is an addition to the introduction of the Model Convention:
A limitation-on-benefits clause
A general anti-abuse rule
A savings clause
A new title and preamble
A discussion of tax policy considerations in the introduction
Limitation on Benefits Clause
The discussion draft recommends that the Model Convention include a limitation-on-benefits clause (an “LOB clause”), based on the LOB clause used in some U.S. income tax treaties. In the LOB clause, benefits are limited in most cases to a “qualified person” that meets the requirements of the LOB clause. For a company which may otherwise be considered a resident of a treaty country (and thus entitled to the treaty’s benefits), the LOB clause provides benefits only if, among other requirements, the company’s principal class of shares is traded on a “recognized stock exchange,” and either
the country of residence is that same country that the stock exchange is located or
the country of residence is also the company’s “primary place of management and control.”
The primary place of management and control test is a robust version of the one found in some U.S. income tax treaties. The recommended language would allow benefits to residents of a contracting state:
only if executive officers and senior management employees exercise day-to-day responsibility for more of the strategic, financial and operational policy decision making for the company (including its direct and indirect subsidiaries) in that Contracting State than in any other state and the staff of such persons conduct more of the day-to-day activities necessary for preparing and making those decisions in that Contracting State than in any other state.
Companies which are not publicly traded are qualified persons if at least 50 percent of the vote and value of their shares or interests are held by individual residents of the contracting states or companies meeting the qualified person requirements discussed above. If intermediate companies sit between the company seeking treaty benefits and an individual or company that is a qualified person, to meet this requirement, each intermediate company needs to be a resident of the treaty country.
General Anti-Abuse Rule
The discussion draft also recommends the addition of a general anti-abuse rule (“GAAR”), which says that:
a benefit under this Convention shall not be granted in respect of an item of income if it is reasonable to conclude, having regard to all relevant facts and circumstances, that obtaining that benefit was one of the main 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 this Convention.
Additions to the Model Convention commentary would explain that the GAAR applies where an arrangement can only be reasonably explained by a benefit arising under a treaty. Treaty benefits do not need to be the sole purpose or even a primary purpose of a transaction ¿ if treaty benefits are just one of many “main purposes,” the benefits could be lost under the GAAR.
Domestic law changes to prevent treaty abuse
The discussion draft recommends the addition of a “savings clause,” common in U.S. income tax treaties. A savings clause confirms a general principal that a contracting state is not restricted in how it taxes its own residents. Some taxpayers claim that a treaty prevents their own country from taxing them on certain income. The savings clause would prevent taxpayers from making this claim, unless the income at question is specifically excepted from the savings clause.
New Title and Preamble
Currently, the Commentary to the Model Convention includes a sentence that “[i]t is also a purpose of the tax convention to prevent tax avoidance and evasion.” The discussion draft gives this phrase a big promotion, and recommends a title change, to:
Convention between (State A) and (State B) for the elimination of double taxation with respect to taxes on income and on capital and the prevention of tax evasion and avoidance.
In addition to the title change, a new preamble is added also making reference to tax evasion and avoidance, especially through treaty shopping. A new introduction will include similar language, and would state that the treaty should be interpreted “in light of its object and purpose,” which can be derived in part from the title and preamble.
Tax Policy Considerations
Finally, the discussion draft recommends the addition of a new section to the Model Convention introduction, on the tax policy considerations for entering into a tax treaty. Notably, the new language includes tax policy reasons for not entering a treaty with another country, and even to consider terminating an existing treaty. The new language advises a country to consider whether there is an actual risk of double-taxation between itself and a potential treaty partner, or if elements of the potential partner’s tax system create higher risks of non-taxation.