Tax treaty trouble expected from OECD’s Multilateral Instrument

Action 15 of the OECD’s BEPS Project sets out the development of a Multilateral Instrument to assist countries in swiftly implementing the tax treaty-related BEPS recommendations and reduce the opportunity for tax avoidance by multinationals. These measures intend to tackle hybrid mismatches, tax treaty abuse, the avoidance of permanent establishments, while also improving the tax dispute resolution process. The OECD established the Multilateral Instrument (MLI) to tackle these BEPS issues and the OECD announced that more than 100 countries adopted the MLI in November 2016.

However, tax advisers have expressed concerns that the MLI will lead to a series of challenges for taxpayers when applying tax treaties.

“One of the main challenges of the MLI is tracking the alignment between signatories based on the various options and reservations selected and then trying to determine with respect to each new agreement the effective date of changes,” said Manal Corwin, national leader of international tax at KPMG US in Washington, DC.

Corwin told TP Week that the complexity arises because most provisions of the MLI will apply to an underlying tax treaty only if both jurisdictions choose the same option.  

“Another challenge that may arise is interpreting the effect of the MLI on existing tax treaties,” Corwin added. “Because the MLI does not amend the actual text of the underlying tax treaty, the extent to which the existing treaty provisions are modified or remain in effect may not always be entirely clear.”

Kevin Ashman, a tax partner at Hogan Lovells in London, said the two parties to a particular double tax treaty (DTA) may not make the same decision where the MLI does not make a provision mandatory, which in most cases will mean that the MLI will not have effect.

“The MLI is likely to significantly increase the complexity of interpreting DTAs, as the MLI itself will not directly amend double taxation agreements. Instead, the MLI will need to be applied alongside existing DTAs. This will mean looking at the DTA in question, the MLI, whether the parties to the DTA are signatories to the MLI and whether the MLI has entered into effect, and notifications made under the MLI by each party,” Ashman told TP Week. He added that although consolidated versions of DTAs are possible to show the effects of the MLI, these are not required by the OECD or the MLI.

“We are left with a system that is even more complex than before, adding to the already significant compliance burden that companies are facing,” KPMG said in an alert.

Impact of the MLI on multinationals

Although the MLI should not change the way multinationals assess the BEPS Project’s impact on their businesses, the MLI may impact the DTAs that businesses rely on.

KPMG’s Corwin said that depending on how many countries sign and how many mutual agreements are reached, the MLI could result in changes to over 3,000 treaties.

“As a result, companies will have to determine the extent to which the treaties on which they rely are affected and consider the impact on the access to treaty benefits,” Corwin said.

Multinationals could also face rising costs and having to repeatedly review the implications of the MLI. Ashman said that as the MLI does not directly amend DTAs and there is no obligation for signatories to publish consolidated DTAs, interpreting and applying these is likely to become more complex. “Compliance costs for multinationals that rely upon DTAs are likely to increase,” Ashman said. “This is likely to be exacerbated by the fact that not all countries will sign the MLI, and not all of those that do will sign it at the same time. Rather than a one-off review, multinationals will need to be alert to the MLI entering into force for different signatories at different times.”

Benefits of the MLI

Despite the potential pitfalls, multinationals could also see benefits from the MLI.

Ashman said that the benefits are in the introduction of mandatory binding arbitration, a dispute resolution mechanism designed to give a binding result where two countries disagree on the interpretation of a DTA. “This is separate to the bulk of the MLI changes, and signatories are not obliged to adopt it. However, where signatories do adopt mandatory binding arbitration and it can be enforced by multinationals seeking to rely upon a DTA, multinationals will be provided with a more powerful route than the often slow and unproductive mutual agreement procedure in the context of international tax disputes,” Ashman said.

However, multinationals do have some time to prepare. To date, countries have only concluded the negotiations on the provisions of the MLI. The agreement will be opened for signature from December 31 2017, and will enter into force when five of the signatory countries have ratified, accepted or approved it. In terms of specific tax treaties, it will enter into effect after all parties to that treaty have ratified the MLI and a certain period has passed to ensure clarity. The signing ceremony of the MLI will be held in June 2017 in Paris.

Members of the MLI Ad hoc group and adopters of the MLI