The BEPS Multilateral Instrument (MLI), to be finalized and released by the OECD in November 2016, will allow participating countries to amend their bilateral tax treaties to implement various OECD Base Erosion and Profit Shifting (BEPS) recommendations. Because certain features of bilateral treaties may facilitate BEPS, and it may take countries several years to renegotiate their treaties to include relevant amendments, the MLI would allow countries to more swiftly address BEPS. Nevertheless, timing variations in domestic implementation of the MLI could be problematic.
The MLI is expected to be ready for signature by participating countries starting in the first half of 2017.
Thomson Reuters hosted an expert panel discussion during the 70th annual IFA Congress in Madrid, Spain on the following provisions that are expected to be implemented in the BEPS MLI:
- The treaty provisions developed under Action 2 (Neutralizing the Effects of Hybrid Mis-match Arrangements) of the OECD Model Tax Convention to address fiscally transpar-ent entities, and the measures to address issues with the application of the exemption method to relieve double taxation.
- The provisions developed under Action 6 (Preventing the Granting of Treaty Benefits in Inappropriate Circumstances), including the minimum standard on treaty abuse (e.g., treaty shopping), and the introduction of a “saving clause” to make explicit that treaties do not restrict a State’s (i.e., country’s) right to tax its own residents.
- The provisions developed under Action 7 (Preventing the Artificial Avoidance of PE Status), including (1) measures to address commissionaire arrangements and other dependent agent permanent establishment (PE) transactions, and (2) the anti-fragmentation rule, where activities previously considered to be preparatory or auxiliary may now be grouped together and be considered core business activities.
- Measures included in the minimum standards and best practices produced under Action 14 (Making Dispute Resolution Mechanisms More Effective) on mutual agreement procedure (MAP), including arbitration.
Expected MLI structure: Rocket booster for exiting treaties
Prof. Dr. Philip Baker, QC, Barrister and international tax specialist for Field Court Tax Chambers, said that the MLI is likely to be structured in a way that will allow for flexibility for countries to choose specific provisions that they would like to implement. The MLI is long overdue, and represents the first time that potentially all existing income tax treaties may be modified in one document.
Dr. Baker compared the possible MLI provisions to parents that are expecting birth of twins: the parents may not know the gender of the twins, and what the children may grow up to achieve in life. The MLI is also like a rocket booster that is expected to launch exiting tax treaties in a certain direction rapidly. One challenge will be for taxpayers to know the position of each MLI participating country on each MLI provision, unless each country makes its position known in writing. Even then, it will be useful for taxpayers to see existing tax treaties replaced with versions that contain the MLI provisions.
Mary Bennett, tax partner with Baker & McKenzie and former U.S. Treasury official, said that the corresponding explanatory statement being developed by the MLI will be critical in allowing all affected parties to better understand the meaning of the MLI provisions, and their impact on existing treaties. Ideally, each country that signs on to the MLI would explicitly indicate its position on the explanatory statement and corresponding MLI provisions. Whether that happens remains to be seen.
Treaty amendment options
We provided an overview of the three options the OECD considered during the BEPS Action 15 discussion draft phase before settling on the MLI route. The MLI approach better ensures that treaty changes are highly targeted and efficient. The OECD also considered adopting a “self-standing instrument” that would wholly supersede bilateral tax treaties, and govern relationships between all parties. A second option was to create an instrument that would operate like treaty amending protocols to each existing treaty.
The OECD found the self-standing instrument approach to be overbroad, given the importance of bilateral relations in international tax affairs and the importance of preserving tax sovereignty. It also viewed the amending protocol approach as technically complex and inefficient.
Impact on multinationals
The BEPS Action 7 and 14 provisions in the MLI are likely to be the most important for multinational enterprises (MNEs), as the former will create tax uncertainty for MNEs by having to monitor their employees’ global activities and warehouse functions, which may create permanent establishment (PE) issues that lead to increased tax and financial reporting requirements. It will be interesting to see how many additional countries sign on to the mandatory binding arbitration provisions that are expected to be included in the MLI. The BEPS Action 14 provisions of the MLI are expected to create more tax certainty for MNEs to limit inconsistent audit results by competent authorities.
Unlike the OECD BEPS final reports, MNEs are disadvantaged by not seeing a draft of the MLI prior to its finalization. Baker added that he would like to have seen input from MNEs during the MLI negotiations to better ensure that all parties’ interests are adequately reflected in the final MLI.
In response to an audience question, Baker and Bennett said that the MLI is likely to bring about some significant changes to existing tax treaties, but unless the MLI negotiation process is repeated down the road by the OECD and participating countries, the current practice of engaging in lengthy bilateral negotiations with treaty partners is likely to return.
Latin America impact
Enrique Diaz Tong, Associate with Transfer Pricing Consulting and Teacher of Transfer Pricing at ESAN, said that the BEPS MLI is not likely to have any near-term impact in Latin America because most countries in the region have only adopted transfer pricing rules over the past decade, and their tax authorities are not as sophisticated in transfer pricing. Also, several Latin American countries would require that the MLI be ratified by the national legislatures and executive branches, which is likely to slow down implementation. Any potential implementation in the U.S. of the MLI is also likely to be delayed, as evidenced by the income tax treaties that have been pending approval by the U.S. Senate since about 2010, due to challenges brought by Senator Rand Paul.
According to Tong, many taxpayers in the region may not even be aware that they may be subject to double taxation resulting from transfer pricing audits by multiple countries that they are operating in. Tong provided an example of a client whose tax liability has changed dramatically over several years by a certain Latin American tax authority due to inconsistent positions taken each year on audit by the tax authority in applying their transfer pricing rules.