On June 7, 2017, 68 jurisdictions signed the Multilateral Convention to Implement Tax Treaty Related Measures to Prevent Base Erosion and Profit Shifting (the MLI) at the Organisation for Economic Co-operation and Development (OECD) in Paris. The United States, Saudi Arabia, and Brazil are the only G-20 countries not to sign. The signing ceremony marks a milestone in the OECD’s continued effort against Base Erosion and Profit Shifting (BEPS) after several years of effort to produce the MLI. The MLI implements tax treaty related measures to prevent treaty abuse, improve dispute resolution, prevent avoidance of permanent establishment status and address other hybrid mismatch arrangements. The MLI is not a standalone treaty, but rather modifies existing bilateral tax treaties. Over 1,100 tax treaties are expected to be modified by the MLI.
Tax Treaty Changes
The MLI requires jurisdictions to abide by basic standards developed by the BEPS project.
- Treaty Abuse and Shopping
The Principal Purposes Test is a new anti-abuse rule based on the principal purposes of transactions or arrangements and seeks to modify arrangements put in place with the principal purpose of obtaining the benefits of a tax treaty. Under this test, if one of the principal purposes of a transaction or arrangement is to obtain treaty benefits (e.g., a lower withholding tax in the case of treaty shopping), these benefits would be denied unless it is established that granting the benefits is in accordance with the purpose of the provisions in the treaty. This approach is similar to domestic anti-abuse and anti-avoidance rules.
- Dispute Resolution
The MLI introduces a binding arbitration mechanism to resolve disputes in cases in which a taxpayer disputes a tax treaty application. The current arbitration process, called the mutual agreement procedure (MAP), only requires parties to use their best efforts to resolve disputes, leading to lengthy unresolved issues. The MLI binding arbitration process seeks to correct this weakness and provide an expedited process before an independent and impartial decision maker.
- Permanent Establishment
The MLI changes the permanent establishment definition and addresses techniques used to inappropriately avoid the existence of a permanent establishment, including through the replacement of distributors with commissionaire arrangements and the use of employees who are labeled as “independent agents.” The changes also address specific activity exceptions in the OECD Model Tax Convention by restricting the types of activities an employee can do without creating a permanent establishment.
- Hybrid Mismatches
The MLI addresses the issue of hybrid mismatches in situations where jurisdictions have different treatments as to the transparency of entities for tax purposes. The MLI also modifies the rules regarding treaty residency of an entity that is a resident of more than one jurisdiction. Finally, the MLI provides several options for the elimination of double tax on items such as dividends.
Scope and Timing
The MLI modifies tax treaties that are “Covered Tax Agreements,” which are agreements for the avoidance of double taxation between signatory parties that those parties have indicated that they wish to modify. The MLI modifications are expected to become effective in 2018.
Signatories are also given flexibility to reserve or opt-out completely from provisions. Due to many signatories reserving on provisions, the final effect of the MLI will not be known until jurisdictions ratify the MLI in their domestic processes.