BEPS – Preventing treaty abuse: A practical perspective
Keith Brockman, global tax director at Mars and author of the International Tax Best Practices blog, analyses BEPS Action 6 on preventing treaty abuse, calling for more balance in seeking to avoid double taxation and double non-taxation, and more guidance on the interplay between domestic law and treaty interaction.
Interplay of domestic law and treaty application: Taxpayers are at a crossroads and there is no clear indication over right of way
Two objectives of the OECD report are to circumvent: (i) treaty limitations; and (ii) provisions of domestic law using treaty benefits. This article explores some practical considerations that form pillars of fairness, simplicity and transparency, while balancing deliverables addressing double taxation and double non-taxation.
LoB and competent authority
The limitation-on-benefits (LoB) discretionary relief rule has been the focus of numerous comments, primarily focused on increasing the effectiveness for competent authority (CA). Based on the widely accepted premise that the CA process is not timely, routinely inefficient and difficult to implement (especially by smaller and developing countries), numerous comments were submitted to suggest changes thereto. Additionally, the topic of dispute resolutions is receiving separate attention in the OECD Action Plan.
One practical consideration may be to change the discretionary rule to eliminate the use of CA and prescribe a substitute to achieve the primary objectives previously set forth. The use of the CA discretionary rule in existing treaties of major countries should not be a reason for its inclusion without additional consideration.
As a substitute LoB relief measure, a tax return disclosure (check-the-box) process could be implemented indicating that the taxpayer used discretionary relief to achieve treaty benefits, possibly quantifying the benefit for relevant risk review. As a result, tax authorities are advised that the discretionary rule was used, while the burden of proof remains with the taxpayer that can be subsequently reviewed or questioned by the relevant tax administration. This suggestion would allow time for the CA process to become more efficient and effective, while avoiding the timing and implementation interplay to provide integrated 2015 OECD BEPS guidelines.
However effected, transparent relief measures are necessary to achieve simplicity and efficiency in determining treaty benefits by the taxpayer and tax administration.
Principal purpose test
Notwithstanding the subjective wording and interpretations that would be elicited from the application of this rule, the clear intent is to apply this rule viewed through a broad lens. Therefore, the same transaction will receive different treatment depending on the respective jurisdiction's subjective and unilateral interpretation of "reasonableness" and the receipt of a tax benefit, directly or indirectly. Additionally, it is impossible to measure, or predict, the analyses undertaken (if any) to determine the "object and purpose of the relevant provisions of this Convention".
Efforts to build strong pillars of fairness, simplicity and transparency should lead to the provision of practical, effective and objective measures for implementation. For example, this provision was drafted to encompass broader arrangements than the LoB rule. An objective TAAR provision could be proposed to satisfy this aim. The transparency pillar for the principle purpose test (PPT) should be constructed using tools contemporaneously shared by the taxpayer and tax administrations, also producing simplicity leading to worldwide adoption sooner rather than later.
Mitigating double taxation should also be a primary objective for tax administrations, and not just for the taxpayer. The comments received include recommendations for a preliminary review panel pre-assessment, as well as arbitration procedures. Mandatory arbitration should be an express requirement for adoption of this proposal, although current efforts to oppose such measures are winning this battle, further promoting lengthy appeals and incidents of double taxation. The concepts of sovereignty and loss of control are factors that are trumping the objective to mitigate double taxation.
An unwillingness to cede national sovereignty has proved the major stumbling block for many multilateral reform attempts of recent years, and the failure to get proposals such as the European common consolidated corporate tax base (CCCTB) off the ground is testament to this. Despite the political momentum behind the BEPS project suggesting that sovereignty issues should be less of a hurdle for the OECD, they are still proving problematic, as is clear from the stakeholder feedback received to date.
Domestic law and treaty interaction
The specific anti-avoidance rule (SAAR), targeted anti-avoidance rule (TAAR) and general anti-avoidance rule (GAAR) are being used to implement collaborative anti-abuse mechanisms in respective jurisdictions. The EU also issued recent GAAR guidelines in its EU Parent-Subsidiary Directive, presumably with similar principles forthcoming in other Directives.
Accompanying the subjective nature and inherently different interpretations arising from such rules is the very complex interplay of domestic law and treaty application. Therefore, lines of interpretation to apply the rules and determine the relevant source of law are coming together at a crossroads with the driver not sure who has the right of way, and accidents will happen due to this misunderstanding.
Specific, objective guidelines are necessary in the treaties to ensure clear alignment and expectations for the application of these rules. Additionally, it would be beneficial to define vague terminologies, while avoiding the subjective phrase of 'tax avoidance' that has become inextricably communicated as accompanying 'tax evasion,' which are distinctly different concepts to apply legally and practically.
Objectives to target (double) non-taxation and avoid double taxation
These dual objectives receive separate, and unequal, treatment in the report and proposed language for the Model Tax Convention and accompanying Commentary.
The pillars of fairness and transparency would be achieved by using these phrases in equality. This balanced wording would emphasise the dual objectives for which these measures are intended to achieve. One objective should not be viewed unilaterally and aggressively without proper consideration of its counterpart. Additionally, it would lead to international tax practices that are more widely accepted, implemented and executed by all interested parties.
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