By Robyn Berger,Esther Geldenhuys Tuesday, June 30, 2020

The leaders of the G20 nations, in co-operation with the Organisation for Economic Co-operation and Development (OECD), initiated the campaign against ‘base erosion and profit shifting’ (BEPS) in 2012.

BEPS seeks to close gaps in international taxation for taxpayers that seek to avoid taxation or reduce their tax burden in their home countries by engaging in what is termed ‘tax base erosion’ structuring (i.e. structuring that lacks commercial substance).

The G20 leaders requested the OECD to prepare an Action Plan on BEPS. Specifically, this Action Plan should provide countries with domestic and international instruments that will better align rights to tax with economic activity.

The OECD published an Action Plan, which includes 15 action points to address BEPS in a comprehensive manner and sets deadlines to implement these actions.

Action Point 6 of the Action Plan aims to prevent the abuse of double taxation agreements (DTA) and to develop model DTA provisions and recommendations regarding the design of domestic rules to prevent the granting of DTA benefits in inappropriate circumstances.

One of the most important sources of BEPS concerns is the abuse of DTAs to avoid tax in the source countries. Since, the provisions of DTAs were negotiated prior to the development of the e-commerce industry, the current provisions allow a resident of a DTA country to conduct e-commerce business in the other contracting state without creating a tax presence in that state. 

Further, a resident of a third country often obtains access to the benefits of such a DTA by means of so-called ‘treaty shopping’, i.e. by creating an intermediary in a second country which has a beneficial DTA with the first country (source country) where the business is to be conducted.

The OECD Prevention of Treaty Abuse report recommended the following three-pronged approach to address treaty shopping situations:

  • First, a clear statement that the contracting states, when entering into a DTA, wish to prevent tax avoidance and, in particular, intend to avoid creating opportunities for treaty shopping will be included in DTAs;
  • Second, a specific anti-abuse rule based on the limitation-on-benefits provisions included in DTAs concluded by the United States of America and a few other countries (LOB Rule) will be included in the OECD Model; and
  • Third, in order to address other forms of treaty abuse, including treaty shopping situations that would not be covered by the specific LOB Rule described in the preceding bullet point (such as certain conduit financing arrangements), a more general anti-abuse rule based on the principal purposes of transactions or arrangements (the principal purpose test or PPT rule) will be included in the OECD Model. That rule will incorporate the principle that the benefits of a DTA should not be available where one of the main purposes of arrangements or transactions is to secure a benefit under a DTA and obtaining that benefit in these circumstances would be contrary to the object and purpose of the relevant provisions of the DTA.

To facilitate the swift implementation of the various measures proposed by Action Point 6, over 100 jurisdictions concluded negotiations in November 2016 on the Multilateral Convention to Implement Tax Treaty Related Measures to Prevent BEPS (MLI) to update the DTAs and lessen the opportunity for tax avoidance by multinational enterprises.

The MLI provides flexibility for a jurisdiction to determine which of its DTAs it would like to amend using the MLI and which of its provisions it wishes to implement. The MLI applies only to a DTA that has been specifically listed by the two contracting jurisdictions to the DTA and referred to as ‘Covered Tax Agreements’ in the MLI.

There are certain minimum standards that must be accepted by all parties and others which are elective. The MLI only impacts existing DTAs where both parties have elected the same changes under the Covered Tax Agreements (there are however certain elections that will apply only to the party that selects these, for example, measures relating to unilateral tax relief).

One of the most fundamental changes brought about by the MLI (which is a minimum standard, in other words, all parties must accede to this change in some form) is the inclusion of anti-treaty abuse provisions. In terms of the provisions, all Covered Tax Agreements under the MLI must include an anti-abuse rule to prevent treaty benefits from being granted in unintended circumstances (as per BEPS Action Point 6).

This may be the most far-reaching change arising from BEPS in the context of the impact it has on DTA benefits. Countries have the option to implement either the PPT, or a PPT and a simplified limitation-on-benefits provision, or a detailed limitation-on-benefits provisions. 

Most countries have elected to include the PPT. This test stipulates the following:

‘notwithstanding any provisions of a Covered Tax Agreement, a benefit under the Covered Tax Agreement shall not be granted in respect of an item of income or capital if it is reasonable to conclude, having regard to all relevant facts and circumstances, that obtaining that benefit was one of the principal purposes of any arrangement or transaction that resulted directly or indirectly in that benefit, unless it is established that granting that benefit in these circumstances would be in accordance with the object and purpose of the relevant provisions of the Covered Tax Agreement’. (emphasis added)

The test is clearly a game changer for various reasons. The most notable being that for the anti-abuse rule to apply, only one of the principal purposes of an arrangement must have been the resultant tax benefit.

Click here for a summary of the current poistion in key African markets with regard to:

  • the participation in OECD and the BEPS initiatives;
  • the participation in the MLI;
  • whether the MLI has become effective; and
  • the anti-abuse rule opted for.

For further information or assistance, please send an email to [email protected]