Redefining the boundaries of International Taxation

In what may be regarded as the single-most collaborated cross-border tax reform, the final reports relating to the OECD project on base erosion and profit shifting (BEPS) were released by the OECD on 5 October 2015. The reports include recommendations, which potentially cause a tectonic shift in international laws and treaties.

Armed with the directive to put an end to double non-taxation, the OECD, vide its BEPS reports seeks to propose measures to restore taxation to several instances, which would otherwise go untaxed. To address a key task, the OECD, vide its report on BEPS Action Plan 6: Prevent Treaty Abuse has come up with its recommendations to address treaty abuse.

The final report notes that countries have committed to a “minimum standard” to provide a minimum level of protection against treaty shopping. Under the minimum standard, countries are likely to implement: (i) the combined approach of a principal purpose test (PPT) rule and limitation of benefit (LOB) rule; or, (ii) a PPT rule alone; or, (iii) an LOB rule, supplemented by specific rules targeting conduit financing arrangements. In cases where a county decides to use a combination of the PPT and LOB rules, the final report includes a variation on the LOB rules referred to as the “simplified version”.

The LOB rules (heavily borrowed from the LOB rule from the US Model Treaty) are objective self-applied tests, introduced to address “Treaty Shopping” concerns. The LOB Rules restrict the access to treaty benefits only to certain defined tax residents. The LOB rule and Commentary related thereto are marked as draft and subject to change pending finalization, in the first half of 2016, of the proposed revisions to the LOB rule in the US Model Treaty.

The PPT rules are subjective anti-abuse rules, according to which a treaty benefit cannot be availed, if one of the principal purposes of that transaction or arrangement is to obtain treaty benefits. This is similar to the “main purpose” test found in UK treaties. The report provides for the recommendation that PPT Rules be applied by tax authorities only after approvals from a senior officer within the tax administration, akin to the Indian prescription for the application of the proposed GAAR.

The Report also provides for (i) revisions to the title and preamble of the OECD Model Tax Convention so that it is clear that the intention is to eliminate double taxation without creating opportunities for non-taxation, and (ii) identification of tax policy considerations relevant for the decision to enter into a tax treaty with another country, which will also be relevant in determining whether to modify (or ultimately terminate) a treaty, if there has been a change in circumstances.

With the BEPS reports now open for respective Government’s consideration, the focus on BEPS moves to a more localized one, focusing on the needs of the country and the approach that may be adopted among the many recommendations. Various countries have taken their first steps toward preventing the abuse of treaty provisions. Unilateral actions such as: i) application of domestic GAAR provisions (e.g., India, Italy, Spain, Finland & Norway), ii) Specific treaty overriding anti shopping rules (e.g., France, Germany and Canada) and iii) strict interpretation of “beneficial ownership” criteria (e.g., China and Korea), have been undertaken. Bilateral action, such as treaty renegotiations are also underway, e.g., India-Mauritius Tax treaty renegotiations.

Most view the reports as an opportunity for Governments to be able to garner their share of taxes, i.e., widening the tax base by eliminating treaty benefits in inappropriate circumstances. However, what it also provides for the Governments’ is an opportunity to set them apart by offering more clarity and certainty on interpretation and action arising from the BEPS reports. A specific cause for concern is the fear of treaty uncertainty and litigation, raised by the more subjective test, i.e., the PPT rule.

As the Government of India gears up for specific legislative response from the BEPS recommendations, there are some basic tenets that should not be lost sight of. The first being the fact that any such response should promote certainty and clarity. India can ill afford to go wrong here, since it is still venturing out of the “woods” of controversy and tax uncertainty. Secondly, as a developing nation, India has to balance the need for tax revenues and tax competiveness by attracting investments.

On the tax administration front, the Government needs to ensure that the new paradigm of global information exchange and transparency is met with adequate infrastructure, training and comfort around confidentiality of sensitive information.


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