OECD’s Multilateral Instrument Modifies Existing Bilateral Tax Treaties
Taxpayers concerned by the OCED's Base Erosion and Profit Shifting (BEPS) project should be aware of the signing of OECD's Multilateral Instrument (MLI). Currently, multinationals may use a combination of treaty shopping and hybrid mismatches to implement complex tax avoidance structures. The MLI aims to curb or prevent these practices when it enters into force.
The OECD defines “BEPS” as tax planning strategies that exploit gaps and mismatches in tax rules to artificially shift profits to low or no-tax locations where there is little or no economic activity, resulting in little or no overall corporate tax being paid. It estimates that governments lose between 100 to 240 billion dollars of revenue to BEPS. The OECD's BEPS project is a joint effort by more than 60 countries to tackle this revenue loss. The project developed 15 actions to improve the coherence of international tax rules and ensure a more transparent tax environment.
On June 7, 2017, representatives of 67 countries signed the MLI in Paris. Representatives of nine other jurisdictions expressed intent to become signatories. The MLI implements BEPS measures that require changes to existing bilateral tax treaties. In particular, it seeks to address the problem of treaty shopping and permanent establishment (PE) avoidance, principally by multinational enterprises. The MLI does this by updating the existing network of bilateral treaties. It also marks the first time in modern international law that a multilateral agreement will change bilateral treaties.
The MLI introduces new treaty rules on the establishment of a PE. Under the current OECD rules, a dependent agent can create a PE, and they must have the authority to conclude contracts. The new rules expand the definition of a dependent agent to one who habitually plays a principal role leading to the conclusion of contracts. This is significant and could potentially give rise to many more deemed PEs. In particular, the new definition aims to make commissionaire arrangements and other similar arrangements to avoid PE ineffective and obsolete.
Taxpayers should monitor the list of MLI signatories
The United States is not a signatory to the MLI. The Treasury Department believes that existing US tax treaty policy already encompasses the bulk of the MLI's provisions. However, some of the MLI's options regarding treaty abuse—the principal purpose test and the simplified LOB provision—were inconsistent with US treaty policy. While no US tax treaty will be affected by the MLI, some structures and transactions may rely on positions taken on treaties between two MLI signatories. Already, the MLI is set to modify over 1,100 bilateral tax treaties upon its entry into force. The OECD expects this number to increase as more jurisdictions sign the MLI by the end of 2017.
What Does CohnReznick Think?
CohnReznick believes that many US multinationals will be impacted by the MLI. Taxpayers who have structures and transactions that rely on commissionaire arrangements between two MLI signatories will be well advised to consider modifying their supply chain. As noted above, the MLI changes the qualification for treaty benefits in many cases, so taxpayers relying on treaty protection among MLI countries should monitor whether such qualification will still apply.
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