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March 27, 2020
OECD releases second annual peer review report on BEPS Action 6 relating to prevention of treaty abuse
On 24 March 2020, the Organisation for Economic Co-operation and Development (OECD) released the second peer review report (the Report) relating to the compliance by members of the Inclusive Framework on Base Erosion and Profit Shifting (BEPS) with the minimum standard on BEPS Action 6 for prevention of treaty abuse. The Report includes information available as of 30 June 2019 (the cut-off date) and covers 129 jurisdictions1 that were members of the Inclusive Framework by the cut-off date.
Overall, the Report concludes that the majority of the Inclusive Framework members have begun to translate their commitment to prevent treaty shopping into actions and are now in the process of modifying their treaty networks. According to the Report, the peer review results show the efficiency of the Multilateral Convention to Implement Tax Treaty Related Measures to Prevent BEPS (MLI) in implementing the treaty-related BEPS measures. The Report also notes that the MLI is by far the preferred tool of the Inclusive Framework members for implementing the BEPS Action 6 minimum standard. By the cut-off date, 91 jurisdictions had some double tax agreements that either were already compliant with the minimum standard or were subject to a complying instrument (i.e., the MLI or a protocol/treaty). Once the complying instrument takes effect, the agreements that are subject to it will come into compliance with the minimum standard.
The minimum standard on treaty shopping requires jurisdictions to include two components in their tax agreements: (i) an express statement that their common intention is to eliminate double taxation without creating opportunities for non-taxation or reduced taxation through tax evasion or avoidance; and (ii) one of three methods to address treaty shopping. The Report indicates that, of the three alternative methods, the vast majority of the jurisdictions have chosen to implement a Principal Purpose Test (PPT).
In October 2015, the OECD released the final reports on all 15 focus areas of the BEPS Action Plan.2 The recommendations made in the reports range from new minimum standards to reinforced international standards, common approaches to facilitate the convergence of national practices, and guidance on best practices. The Action 6 report, titled Preventing the Granting of Treaty Benefits in Inappropriate Circumstances, contained model tax treaty provisions and related changes to the model commentary to address the inappropriate granting of treaty benefits and other potential treaty abuse scenarios.3
Minimum standards are the BEPS recommendations that all members of the Inclusive Framework have committed to implement, and they refer to some of the elements contained in: Action 5 on harmful tax practices, Action 6 on treaty abuse, Action 13 on transfer pricing documentation and Country-by-Country reporting and Action 14 on dispute resolution. The minimum standards are all subject to a peer review process. The mechanics of the peer review process were not included as part of the final reports on these Actions. Instead, the OECD indicated at the time of the release of the BEPS reports that it would, at a later stage, issue peer review documents on these Actions providing the terms of reference and the methodology by which the peer reviews would be conducted.
On 29 May 2017, the OECD released the peer review documents, (the Terms of Reference and Assessment Methodology (the Methodology)) for BEPS Action 6.4 The Terms of Reference reiterate that to be in compliance with the minimum standard on treaty shopping, jurisdictions are required to include in their tax treaties: (i) an express statement that the common intention of the parties to the treaty is to eliminate double taxation without creating opportunities for non-taxation or reduced taxation through tax evasion or avoidance, including through treaty-shopping arrangements; and (ii) an anti-abuse provision in the terms specified in paragraphs 22 and 23 of the Action 6 final report. Jurisdictions can meet the minimum standard either by renegotiating their bilateral tax treaties and protocols or through the MLI.5 Partially compliant agreements — agreements that contain only one element of the minimum standard — are shown as non-compliant.
The Inclusive Framework plans to evaluate the agreed methodology for the peer review of the implementation of the minimum standard on treaty shopping in 2020 based on the experience in conducting reviews in 2018 and 2019. That evaluation will be focused on the peer review methodology and not on the minimum standard of Action 6 itself.
The first peer review was conducted in 2018 and covered the 116 jurisdictions that were members of the Inclusive Framework on 30 June 2018. The report on that review was adopted by the Inclusive Framework in January 2019 and was published on 14 February 2019.6 During the course of the first peer review, all concerns raised by jurisdictions on the implementation of the minimum standard in their agreements had been resolved when the report was approved by the Inclusive Framework and therefore no recommendations came out of the first peer review.
Second Action 6 peer review report
On 24 March 2020, the OECD released the second peer review report on BEPS Action 6 prevention of treaty abuse. The Report is divided into the following sections:
The Report also contains annexes with background information and data for each of the assessed jurisdictions. Each jurisdictional section contains information on the progress made by the jurisdiction in the implementation of the minimum standard, any implementation issues that may have been reported, and a summary table of the jurisdiction’s response to the peer review questionnaire.
The Report reiterates that the BEPS Action 6 final report states that: (i) a jurisdiction is required to implement the minimum standard in a treaty only if asked to do so by another member of the Inclusive Framework; (ii) the decision on which of the three methods to adopt has to be agreed by the two jurisdictions (because a particular method cannot be forced upon a jurisdiction); and (iii) reflecting treaties’ bilateral nature, there is no time limit within which a jurisdiction must attain the minimum standard.
According to the Report, the 129 jurisdictions in the Inclusive Framework reported a total of 2,145 agreements between Inclusive Framework members, and about 1,020 agreements between Inclusive Framework members and non-members. Out of the 129 assessed jurisdictions and as of the cut-off date:
For a new tax agreement or an amending protocol to be considered compliant with the minimum standard, it should be in force by the cut-off date. Where the minimum standard has been implemented through the MLI, the relevant provisions of the MLI must have started to take effect as of 30 June 2019 for the agreement to meet the minimum standard. According to the Report, as of 30 June 2019, 86 bilateral agreements between members of the Inclusive Framework complied with the minimum standard. An additional 14 agreements not subject to this review (i.e., agreements between Inclusive Framework members and non-members) also complied with the minimum standard. In each of the 86 agreements between Inclusive Framework members that already comply with the minimum standard, the minimum standard has been implemented through the inclusion of the preamble statement and the PPT. Of these 86 agreements, 17 agreements supplement the PPT with a simplified limitation on benefits (LOB) provision.
As of the cut-off date, about 1,330 of the 2,145 bilateral agreements between Inclusive Framework members were set to become covered tax agreements under the MLI (i.e., because both Contracting Jurisdictions had listed the agreement under the MLI and, as a result, the MLI will modify the agreement once in effect) and were thereby set to become compliant with the minimum standard. The agreements that will be modified by the MLI will comply with the minimum standard once its provisions take effect. Around another 430 of these 2,145 bilateral agreements could be modified by the MLI in the future. This is because these agreements have been listed under the MLI by only one of the treaty partners and are waiting for a match. These include 175 “waiting” agreements between Inclusive Framework members that have signed the MLI and those that have not yet signed it. As things stand, the MLI will modify around 65% of all agreements between Inclusive Framework members. The Report indicates that six additional jurisdictions have expressed interest in signing the MLI and, if they do so and list all their agreements, that figure could be as high as 85%. By 30 June 2019, the MLI had already modified around 60 bilateral agreements.
According to the agreed methodology, a jurisdiction that encounters difficulties in reaching agreement with another jurisdiction to implement the Action 6 minimum standard has the opportunity to raise its concerns in writing to the Secretariat.7 In the course of the 2019 peer review, one jurisdiction raised a concern with respect to the CARICOM Agreement, which is a multilateral agreement concluded in 1994 by 11 jurisdictions,8 10 of which are members of the Inclusive Framework. Previous renegotiation attempts with respect to the CARICOM Agreement have proven to be difficult due to the fact that it contains several unusual features that are not found in the OECD Model Tax Convention or the United Nations Model Double Taxation Convention, which could lead to treaty-shopping practices. However, the Report notes that because most members of the CARICOM agreement are also members of the Inclusive Framework and have committed to implement the BEPS minimum standards, this is an opportune time to modernize the CARICOM Agreement.
Selected9 peer review country reports
The progress of the assessed jurisdictions will be reflected in peer review reports for the subsequent year. The next peer review exercise will be launched in the first half of 2020 and will also include the review of the new members of the Inclusive Framework.
The methodology used to conduct the review for subsequent years after 2020 will be evaluated in 2020.
The purpose of the peer reviews is to ensure the effective implementation of the agreed minimum standard on BEPS Action 6. However, the commitment to the minimum standard of BEPS Action 6 should not be interpreted as a commitment to conclude new treaties or amend existing treaties within a specific period of time. The peer review process will likely result in more countries renegotiating their tax treaties bilaterally and/or signing the MLI to meet the minimum standard.
The two BEPS minimum standards on treaties are: (i) provisions dealing with treaty shopping (BEPS Action 6); and (ii) more effective dispute resolution mechanisms through the Mutual Agreement Procedure (MAP) (BEPS Action 14). Some treaty changes to implement the minimum standard under BEPS Action 6 will be effective in 2020 and thus any conflicts that may occur from these treaty changes will have to be resolved through MAP. As of 24 March 2020, 94 jurisdictions have signed the MLI, 43 jurisdictions have deposited the instrument of ratification10 and the MLI has entered into effect for around 290 covered tax agreements. The two key impacts are:
Businesses may want to review their structures and should continue to monitor tax treaty developments with respect to BEPS Action 6 and the MLI.
For additional information with respect to this Alert, please contact the following:
Ernst & Young Belastingadviseurs LLP, Rotterdam
Ernst & Young Belastingadviseurs LLP, Amsterdam
Ernst & Young LLP (United Kingdom), London
Ernst & Young LLP (United States), Global Tax Desk Network, New York
Ernst & Young LLP (United States), Washington, DC