BEPS: Tax treaties – do you have everything in place?

By Trudy Armstrong

We’ve now seen the culmination of an ambitious two year project to reform the international tax rules for business. The Organisation for Economic Co-operation and Development (OECD) has been poring over every aspect of tax that it feels isn't working for today's world, and we've now seen a number of recommendations.

The use of tax treaties is one area that the OECD has been looking at closely. Tax treaties aim to eliminate the double taxation of income or gains arising in one territory and paid to residents of another territory. The OECD is concerned that multinational groups may be structuring transactions to take advantage of more favourable treaties (treaty shopping) and/or engaging in tax planning using treaties in such a way that they result in no tax being due (double non-taxation). Action 6 of the OECD's plan to tackle base erosion and profit shifting (BEPS) calls for the development of model treaty provisions and domestic tax rules to prevent the granting of treaty benefits in inappropriate circumstances. 

One of the key recommendations is the inclusion of a limitation on benefits (LOB) provision in double taxation treaties. Such provisions are common in US treaties. An LOB contains a number of objective tests which can result in the prevention, or restriction, of treaty benefits. However, due to the mechanical application of these tests, in some circumstances treaty benefits can be denied even if there is no tax avoidance motive, for example where there are intermediate holding companies in a group structure.  

In addition, or as an alternative, to an LOB the OECD recommends that treaties should include a principal purposes test (PPT) designed to target transactions that have been undertaken purely to obtain a treaty benefit. The subjective nature of a PPT could result in uncertainty as to whether treaty benefits are available. 

The OECD has also recommended a number of other targeted anti-avoidance provisions to address treaty abuse.

These changes could impact on the ability of multinational groups to repatriate cash or reserves to parent companies or shareholders without additional tax costs resulting from the denial of treaty protection for:

• withholding taxes on dividends, interest and royalties; or
• capital gains tax levied on a foreign shareholder on the disposal of a local subsidiary.

So when and how will these changes be effected?

Double tax treaties are bi-lateral agreements between two contracting states, and it can take years of negotiation before agreement is reached. The OECD has therefore proposed the development of a multilateral instrument to implement tax treaty-related BEPS measures without the need to re-negotiate existing treaties. Work started earlier this year, with over 80 countries participating. The aim is to have open the multilateral instrument for signature by the end of 2016.

If you would like to discuss this further please get in touch or talk to your usual PwC adviser.

Trudy Armstrong

Director, International Tax & Treasury
Office: +44 207 213 5322
Email: [email protected]