Tax treaties are based on a set of common principles designed to eliminate double taxation that may occur in the case of cross-border trade and investments. The current network of bilateral tax treaties dates back to the 1920s and the first Model Tax Convention developed by the League of Nations. The Organisation for Economic Co-operation and Development (OECD) and the United Nations have subsequently updated model tax conventions based on that work. The contents of those model tax conventions are reflected in thousands of bilateral agreements among jurisdictions.
As was stated in the OECD’s BEPS Action Plan 15 report, globalization has exacerbated the impact of gaps and frictions among different countries’ tax systems. As a result, some features of the current bilateral tax treaty system facilitate base erosion and profit shifting (BEPS) and need to be addressed. Beyond the challenges faced by the current tax treaty system on substance, the sheer number of bilateral treaties makes updating the current tax treaty network highly burdensome. Even where a change to the Model Tax Convention is consensual, it takes a substantial amount of time and resources to introduce it into most bilateral tax treaties. The report also acknowledged that the current network of tax treaties is not well synchronized with the model tax conventions, and issues that arise over time cannot be addressed swiftly. Without a mechanism to swiftly implement them, changes to Models only make the gap between the content of the Models and the content of actual tax treaties wider. Under the OECD/G20 BEPS initiative, governments agreed to explore the feasibility of a multilateral instrument (MLI) that would have the same effects as a simultaneous renegotiation of thousands of bilateral tax treaties. Action 15 of the BEPS Action Plan concluded that an MLI is desirable and feasible, and that negotiations for such an instrument should be convened quickly. This is an innovative approach with no exact precedent in the tax world, but precedents for modifying bilateral treaties with an MLI exist in various other areas of public international law.
On 7 June 2017, 68 jurisdictions signed the Multilateral Convention to Implement Tax Treaty Related Measures to Prevent Base Erosion and Profit Shifting during a signing ceremony hosted by the OECD. At the time of signature, signatories submitted a list of their tax treaties in force that they designate as Covered Tax Agreements (CTAs), i.e., to be amended through the MLI. Together with the list of CTAs, signatories also submitted a preliminary list of their reservations and notifications (MLI positions) in respect of the various provisions of the MLI. The definitive MLI positions for each jurisdiction will be provided upon the deposit of its instrument of ratification, acceptance or approval of the MLI.
The tax treaty related BEPS measures covered by the MLI include: (i) Action 2 on hybrid mismatch arrangements, (ii) Action 6 on treaty abuse, (iii) Action 7 on artificial avoidance of the permanent establishment (PE) status and (iv) Action 14 on dispute resolution. The substance of the tax treaty provisions relating to these actions was agreed under the final BEPS package released in October 2015. The MLI does not modify or add to the substance of these provisions. The MLI is solely focused on how to modify the provisions in bilateral tax treaties in order to align these treaties with the BEPS measures. One of the primary aims of the MLI is to enable all jurisdictions to meet the treaty-related minimum standards that were agreed as part of the final BEPS package. These include the minimum standard for the prevention of treaty abuse under Action 6 and the minimum standard for the improvement of dispute resolution under Action 14. Given, however, that each of those minimum standards can be satisfied in multiple different ways and given the broad range of jurisdictions involved in the negotiations, the MLI was designed to be flexible enough to accommodate the positions of different jurisdictions.
At the time of signature, India submitted a list of 93 tax treaties entered into by India and other jurisdictions that India would like to designate as CTAs, i.e., tax treaties to be amended through the MLI. Together with the list of CTAs, India also submitted MLI positions in respect of the various provisions of the MLI.
India has chosen to apply the Simplified Limitation of Benefits rule, which provides an objective determination to deny treaty benefits, along with the mandatory minimum standard of the Principal Purpose Test to counter treaty shopping in all its tax treaties, including the most recently re-negotiated Mauritius and Singapore tax treaties. This raises a question on the status of the “grandfathering” benefit provided for under the bilateral protocols. It enabled taxpayers resident in the respective countries to avail of source country capital gains tax exemption for investments made up to 1 April 2017.
India has also adopted the minimum standards prescribed under dispute resolution through mutual agreement procedure (MAP) to permit corresponding adjustment arising on account of primary adjustment, to adopt a minimum time limit of three years for providing MAP access and to confer an obligation on competent authorities to suo moto resolve treaty interpretation and double taxation issues. However, consistent with its earlier stance, India has not opted in for mandatory binding arbitration.
On PE-related provisions, India has opted for a wider scope of dependent agency PE to include activities of an agent playing a principal role in concluding contracts even though such contracts are formalized abroad or such activities of an agent who claims to be independent even though he or she is working exclusively or almost exclusively for closely-related enterprises. Furthermore, India has adopted that specific activity exemption from creating a PE is available, subject to the fulfilment of preparatory or auxiliary conditions as well as what is commonly referred to as the “anti-fragmentation” rule.
The expectation that 1,100 tax treaties will be modified as a result of 68 jurisdictions signing the MLI constitutes an unprecedented moment in international taxation. It is also a key milestone in the implementation of the treaty-based BEPS recommendations. That number is also expected to rise during the course of 2017 and beyond. While the definitive MLI positions for each jurisdiction will be provided upon the deposit of its instrument of ratification, acceptance or approval of the MLI, relevant information that enables companies to assess their current position in relation to the BEPS minimum standards now exists and such assessment should be carried out in a thorough but time sensitive manner.
The author is Partner, International Tax Services, EY India