Vittoria Di Gioacchino, BLP Attorney, prepares report for IBA
October 18th, 2017
This month, Vittoria Di Gioacchino, BLP Attorney and Tax expert, attended the International Bar Association’s 2017 Tax Committee Conference and prepared the official Conference Report.
The impact of the multilateral instrument on planning with income tax treaties
The multilateral instrument (MLI) was created with the purpose of implementing base erosion and profit shifting (BEPS) rules, into the already existing double taxation treaties between countries.
As a manner of introduction, BEPS was essentially created to prevent taxpayers from shifting profits to low or no-tax jurisdictions, where no economic activity exists. Based on this, the Organisation for Economic Co-operation and Development (OECD) developed 15 actions, including matters such as treaty abuse, permanent establishment and profit splits, and these actions are to be implemented into existing double taxation treaties. However, as there are thousands of treaties signed and in force as of today, and not all of them follow the OECD model, the OECD had to create a mechanism that would introduce this measure to bilateral treaties without it being a bilateral action. This was how the MLI was created. On 24 November 2016, the OECD presented the MLI after more than 100 countries collaborated in its development, and on 7 June 2017, over 70 jurisdictions participated in the signing of the MLI. As of today, the MLI covers 68 jurisdictions and over 2,000 tax treaties. Now, it is important to bear in mind that the MLI allows its signatories to choose which of their treaties will be modified by the MLI, and once both parties of any given treaty have listed the treaty, it becomes a treaty covered by the MLI. As of now, nearly 1,100 treaties have been matched, and are, therefore, covered by the MLI. The MLI essentially managed to do what otherwise would have taken decades if all treaties were to be negotiated separately, as pointed out by Daniel M Berman in the conference.
Latin American countries that are signatories of the MLI are Argentina, Chile, Colombia, Costa Rica, Mexico and Uruguay.
Measures included in the MLI aim to prevent, and end, treaty abuse; strengthen dispute resolution mechanisms; increase flexibility with respect to the implementation of BEPS and improve tax transparency. Nevertheless, it presents certain issues that could delay its implementation. For example, language. Bilateral treaties are implemented by the signatory parties in their official language, which could be something other than French or English (official languages of the OECD), hence, many interpretation issues could arise. What would happen if the tax authorities considered that a provision in one language means one thing and in another language means another thing. This is why official translations are so important.
Another issue is that not all tax treaties follow the same model: some are based on the OECD model, others on the United Nations model and so on. The MLI cannot amend a pre-existing treaty. This would only be possible if all treaties were exactly the same. Berman explained how MLI provisions are only ‘layered’ on top of existing provisions, ‘it fills in the blanks’.
Compatibility clauses are another issue to consider. Berman stated that ‘where the MLI offers alternative approval provisions, each signatory may select only one alternative for each provision, applying that alternative to all of its covered agreements.’ Essentially, each country is authorised to pick one option from the compatibility clauses; but, what would happen if two signatory countries of a bilateral treaty selected two different compatibility clauses?
Continuing with restrictions on reservations, the MLI allows countries to opt out of certain provisions, as established by Article 28, which includes the list of authorised reservations, and the MLI will only apply to provisions that both signatory countries of a given treaty have adopted without reservations. As you can see, this could represent another implementation issue for the MLI.
Treaty abuse: Article 7 MLI/BEPS Action 6 – the case of Argentina
As mentioned previously, one of the main purposes of BEPS, and the MLI, is the prevention of treaty abuse, as established in BEPS Action 6 and Article 7 of the MLI. María Paula Castelli from Argentina covered this subject at the conference. She explained that Argentinian legislation includes the ‘substance over form’ principle, and therefore, tax authorities can attack inadequate corporate structures who avoid taxes. This principle has been used as a general ‘anti-avoidance rule’ by the Argentinian tax authorities.
BEPS Action 6 includes the ‘limitation of benefits’ (LOB) clause to prevent treaty abuse. Castelli explained how Argentina denounced the treaty with Chile because of the lack of LOB provisions, which enabled the creation of corporate structures allowing a no-tax situation. This was the case of ‘Molinos Argentina’, where an Argentinian company incorporated a Chilean subsidiary that owned two operative entities in Peru and Uruguay. This structure allowed for dividends from Peru and Uruguay to flow through Argentina tax free using the Chilean subsidiary as a pass-through entity. Why? Because Chilean legislation (Law No 19840) establishes that dividends received from abroad are non-taxable, and due to the application of the tax treaty between Chile and Argentina, dividends paid from Chile to Argentina are also non-taxable.
After this case, Argentina denounced the treaty with Chile, and as of January 2017, Chile and Argentina have a new treaty that includes an LOB clause.
Permanent establishment: Colombian perspective
Permanent establishment (PE) considerations were presented by Andrés Becerra from Colombia. He mentioned that Colombia is being very pro-active in implementing new tax provisions because the country is trying to be a member of the OECD. As an example, controlled foreign corporation (CFC) rules were adopted in the 2016 tax reform; there are new transfer pricing obligations, such as the country-by-country report. In addition, measures to control the digital economy were adopted.
Regarding BEPS Action 7 (PE), the definition of a PE was amended to include the ‘commissionaire agreement rule’. A commissionaire agreement is an agreement by which a person sells products in his or her own name, but on behalf of a ‘non-domiciled’ entity. This would allow the ‘non-domiciled’ entity to sell products in Colombia without having a PE in Colombia.
However, after the MLI enters into force, because Colombia is a signatory country, the definition of a PE under a commissionaire agreement will change, and this type of agreement could result in a PE in Colombia for the ‘non-domiciled’ entity selling products through the commissionaire agreement.
Many of the tax treaties under the OECD model establish that when an agent has independent status, its actions should not generate a PE. However, the MLI says that if that agent is exclusive or almost exclusive on behalf of a ‘non-domiciled’, that person should not be considered an independent agent, as explained by Becerro.
It is important to bear in mind that the MLI would also restrict the list of activities that can be considered as auxiliary or preparatory.
Mexico’s stance before BEPS
Mexico’s stance before BEPS was presented by Mauricio Bravo Fortoul. He explained that because Mexico is a member of the OECD, and an eager participant in the tax committee, several changes in Mexico’s tax legislation introduced BEPS provisions in the 2014 tax reform. As a result, new deductibility rules apply after the adoption of BEPS; payments of interest, royalties or technical assistance services to a non-domiciled entity that controls or is controlled by the Mexican payer are not deductible when the non-resident is considered transparent for tax purposes. Some exceptions to this rule apply. In addition, when the payment is considered inexistent in the recipient country, or is not taxable, the expense would not be considered deductible for income tax purposes.
In addition, Bravo explained that, as of 1 January 2016, certain taxpayers must comply with the country-by-country report, master file and local file. Furthermore, he said that ‘of the 61 treaties Mexico has signed, over 40 would be considered covered tax agreements’ by the MLI.
Regarding treaty abuse, Mexico opted to include a LOB clause, instead of the principal purpose test. Argentina, Chile, Colombia and Uruguay also chose the LOB clause.
For matters related to PE, Mexico applies the dependent agent provision related to the commissionaire agreement, and also included a modification to the activities considered as preparatory or auxiliary.
Finally, Mexico also adopted the application of the mutual agreement procedure (MAP) for dispute resolution; however, arbitration provisions were not accepted.
Multilateral instrument: Chilean perspective
The Chilean perspective was presented by Manuel José Garces. He explained that because Chile is a member of the OECD, it has been very strict with the implementation of BEPS regulations. Taxpayers in Chile are required to report to tax authorities the tax information of the corporate group, overseas debt and cross-border operations. In addition, to apply for a benefit included in a tax treaty, the tax authorities carry out a substantial analysis of the effective beneficiary.
Chile has also adopted measures regarding PE rules and the MAP. Even though Chilean legislation does not include a definition of a PE, the tax authorities have established the elements to consider the existence of a PE in Chile, and does recognize that auxiliary and preparatory activities may not result in a PE. Nevertheless, a PE would be deemed ‘when business activities carried out by enterprises in the same country constitute complementary functions that are part of a cohesive business operation’, as explained by Garces.
Regarding the MAP, Chile opted out the application of Article 16.1, claiming that all current treaties signed by Chile include the required by BEPS on this regard.
Multilateral instrument: US perspective
Berman explained that the US does not consider that anything will be gained by adopting BEPS provisions regarding treaty abuse and PE rules, and even though it seeks to push the world towards a ‘mandatory arbitration’ scenario, it will not likely do it by signing the MLI.
To read the original article visit: International Bar Association