Base Erosion and Profit Shifting: while fundamental treaty reform may take time, it’s likely to be preceded by more immediate change

By Mike Cooper

As part of its ongoing Base Erosion and Profit Shifting (BEPS) project, the OECD has published a draft paper detailing proposed changes to its model tax treaty. It’s aimed at restricting the ability to benefit from a treaty in “inappropriate circumstances”. 

The paper’s two principal proposals involve the adoption of a particularly restrictive version of the US-style “Limitation of Benefits” test, along with a purpose-based general anti-abuse clause. But what is appropriate for a huge economy such as the US where most enterprises are majority domestically owned may not be appropriate for other territories whose investor base is more widely spread.

The goal of the OECD’s model treaty is to facilitate free trade between nations.  The OECD’s recent proposals have gone further than many had anticipated and, in focusing so intently on eliminating abuse, there’s a real danger that they may undo much of the good that has been done in pursuit of that original goal. 

It seems likely that there will be significant push back on elements of these proposals from global businesses and that the journey from proposal to universal adoption between territories will not happen overnight.  The OECD is exploring some form of multilateral mechanism to allow mass adoption of the proposals.  But there remains some scepticism as to whether this is achievable and whether there will be the required consensus with respect to the detail of the proposals.  Piecemeal adoption would likely take significantly longer as it runs the risk of getting bogged down in other aspects of the treaty which particular territories may wish to renegotiate.

Despite the challenges outlined above, the OECD paper has raised the profile of the issue of treaty abuse significantly and this will not have escaped the notice of tax authorities both within the OECD and outside.  It’s fair to expect a heightened level of scrutiny of existing positions, even without any treaty change. 

The OECD’s paper also references work in recent years on the concept of beneficial ownership as a prerequisite for treaty relief.  A large proportion of existing treaties already incorporate this approach and, while not universally effective, it can be a powerful tool against the use of arrangements perceived as being mere conduits used to access treaty benefits.  The highlighting of this issue by the OECD will surely only increase the attention given to the point by tax authorities.

So, while work remains to be done to balance the desire to stamp out abuse with the underlying objective of facilitating global commerce, the need for taxpayers to assess their existing structures is an immediate one.

For more information, contact Mike Cooper at [email protected] or on 020 721 35212