In last few years BEPS, which stands for base erosion and profit shifting, has become a buzzword in the international tax community. It is referred to in almost every discussion on international taxation and BEPS related considerations are shaping national and international tax policies at a rapid pace.
The most recent and probably most important BEPS related development is the ongoing ratification process of the OECD Multilateral Convention to Implement Tax Treaty Related Measures to Prevent BEPS, commonly referred to as the Multilateral Instrument (MLI). This article is a first of a series of publications that aims at highlighting the features of the MLI.
In this publication we will tackle three questions regarding the MLI:
(i) WHY was the MLI signed?;
(ii) WHAT will the impact of the MLI be?; and,
(iii) WHEN will the changes brought about by the MLI come into force and start affecting taxpayers globally?
Why was the MLI signed?
To answer this first question we need to rewind to October 2015 when the OECD released a plan of 15 Actions developed in the context of the OECD/G20 BEPS Project. The BEPS Actions constitute a set of consensus-based rules that were designed to reform the international tax environment so that governments can effectively counter tax avoidance and protect their tax bases.
The Actions identified abuse of tax treaties as one of the main sources of BEPS and thus proposed a number of remedial measures in relation to the application of tax treaties. Given the large number of bilateral treaties in existence, the introduction of these measures through the bilateral re-negotiation of existing double taxation treaties (DTTs) would take years and in all probability give rise to inconsistency in the manner in which the measures were adopted. For this purpose, through BEPS Action 15, the OECD recommended an alternative approach - developing an instrument enabling countries to multilaterally amend their double tax treaties and streamline the implementation process.
Fast forward to Paris, 7th June 2017. After two years of work, over 70 Ministers and other high-level representatives participated in the signing ceremony of the MLI which in the words of the OECD Secretary-General Angel Gurría marked “a turning point in tax treaty history.” On 24th January 2018 a further six countries signed up to the MLI, bringing the total number of signatories to 78. Algeria, Kazakhstan, Oman and Swaziland expressed their intention to sign the MLI in the near future. Finally, on 22nd March 2018 the minimum of five ratification notifications was reached, thus triggering the countdown to the MLI’s entry into force. This means that the MLI is already a fact and will soon start shaping the tax environment worldwide.
What is the impact of the MLI?
The MLI was labelled a game-changer by the community of tax practitioners, and rightly so. It aims to be the biggest overhaul of international tax treaty system since the latter’s inception almost 100 years ago. The revolutionary change is the introduction of minimum standards that need to be adhered to by all parties to the MLI. This move will guarantee that the governments do not back out from measures that can work only if implemented by all parties.
The MLI introduces minimum standards in two key areas:
The first one is a prevention of treaty shopping, a form of tax treaty abuse that refers to artificial arrangements giving the taxpayer access to more favourable treaty benefits than those which would be available to them directly.
The second area is agreeing on best practices that shall allow for the timely resolution of treaty-related disputes through effective mutual agreement procedures.
Other notable measures introduced by the MLI apart from the minimum standards include those on hybrid mismatches, other forms of treaty abuse, avoidance of permanent establishment status and mandatory arbitration mechanisms. All the above mentioned changes shall be outlined separately and in more detail in further articles to be published in this series.
The MLI is expected to have a profound impact on international business. With the MLI in force businesses will need to analyse every cross-border transaction and arrangement to ensure compliance with the new rules. In some scenarios the restructuring of international operations and/or financing models may be necessary. Moreover, it will most likely result in a period of legal uncertainty until the application of new rules is fine-tuned through administrative and judicial practice. The changes introduced by the MLI may result in closer scrutiny by the tax authorities of past transactions and a potential clawback of benefits based on application of domestic anti-abuse rules.
The entry into force of the MLI will no doubt have positive effects as well. The facilitation of access to mutual agreement procedures and the arbitration mechanism applied by some parties will enable, at least on paper, swifter resolution of international tax disputes. Furthermore, it is hoped that the uniform introduction of minimum standards will bring more predictability to the business community in a long run.
When will the changes come into force?
There is no specific date for the entry into force of the MLI . A more complex mechanism was implemented in order to give the signatories enough time to prepare for adoption of the MLI. Hence, the MLI shall enter into force on the first day of the month following the expiration of a period of three calendar months following the deposit with the OECD Secretary-General of the instrument of ratification by a fifth signatory to the MLI. On 22nd March 2018 Slovenia deposited its instrument of ratification as the fifth country (joining Austria, the Isle of Man, Jersey and Poland). Consequently, the MLI shall enter into force in these five jurisdictions and in relation to the double tax treaties they have with each other on 1st July 2018.
For each country that ratifies the MLI after the fifth notification, the MLI shall enter into force on the first day of the month following the lapse of three calendar months after its deposit of the instrument of ratification in respect of the treaties which such jurisdictions have with the other countries which have ratified the MLI.
The list of signatories and parties to the MLI is available on the OECD is here
The MLI, however, will not automatically modify all treaties concluded between the MLI signatories. As a way of allowing some flexibility, it was agreed that each signatory shall list the covered treaties and that the MLI shall apply only to the treaties that are listed by all parties thereto. The signatories are also given an option to opt out of provisions outside the minimum standards entirely or partially through so-called reservations. Should any country want to make reservations to the MLI, it must notify them at the latest when depositing the instrument of ratification of the MLI with the OECD Secretary-General.
The MLI also stipulates that its various provisions shall become effective at a different times and thus:
• provisions relating to withholding taxes shall apply from the first day of the calendar year of the year after both parties to a DTT have the MLI enter into force (which would be the latest of the dates when the MLI enters into force for either of parties to such DTT).
• provisions relating to other taxes shall apply to taxable periods beginning after the lapse of a period of 6 months after the MLI enters into force with respect to the DTT.
The effectiveness of provisions relating to either withholding taxes or other taxes may however be expedited or postponed to some extent, through notifications or reservations made by the MLI parties (in some cases such changes are allowed solely for own application by the party to a DTT). Moreover, the abovementioned periods are modified with respect to DTTs to which the MLI shall apply by way of subsequent extension made by the parties to such DTT.
The MLI’s mechanisms relating to its entry into force and effectiveness of different provisions are explained in a diagram below which presents a hypothetical scenario where Malta is deemed to have deposited its instrument of ratification in 2018 as the sixth jurisdiction.
* The date of the deposit by Malta is hypothetical. It is also assumed that Malta shall not portpone or expedite effectiveness of the MLI provisions and shall choose a calendar year as a taxable period.
