Treaty Abuse: BEPS Action 6 - Global Tax Update

Action 6 (Treaty Abuse) is a key element of the OECD's BEPS Project. Action 6 targets, in summary, "treaty shopping", i.e., where a person in country A, which is not, in principle, eligible to benefit from a given tax treaty with country B, invests through an entity in country C to benefit from the treaty. More generally, Action 6 intends to prevent the granting of treaty benefits in inappropriate circumstances.

The Original Action 6 Proposals

The original Action 6 proposal (published in September 2014) contained two approaches to the treaty shopping issue (either or both approaches could have been included in the treaties).

One approach was based on the so-called "principal purpose test" ("PPT") where the treaty benefit would be denied if it was viewed as one of the principal purposes of the relevant transaction; the second approach was a "limitation on benefits" rule ("LOB"), following essentially the typical clause included in treaties signed by the US, i.e., that only certain defined tax residents are eligible to the treaty benefit.

Each approach was criticised for its supposed weakness: the PPT was viewed as creating too many uncertainties for the market (i.e., subjectivity test), and the LOB was viewed as lacking flexibility and reflecting US domestic policy concerns. The inclusion of both approaches was a way to compromise and progress on the matter.

The Revised Proposal

Following extensive consultation and discussion, a new draft was released (May 2015) and a simplified LOB version was proposed to be used in combination with the PPT (as an alternative to the full LOB).

The simplified LOB would cover: individuals, governments, publicly traded entities, entities 50 percent or more beneficially owned by the above persons, active business, derivative benefits (i.e., entities owned 75 percent or more by equivalent beneficiaries) and competent authority discretionary relief (the relief being available where there are clear non-tax reasons, a potentially difficult hurdle, although the authorities are asked to deal "expeditiously" with the requests).

The idea behind a simplified LOB is that it may be more easily included in a "multilateral instrument", and the OECD members would then fine-tune it in their bilateral negotiations for their respective treaties. Also, a simplified LOB should be simpler than a full one, to the extent that the PPT could take care of the remaining complexities (e.g., no base erosion test would be needed, since the...