OECD releases third annual peer review report and revised peer review documents on BEPS Action 6 relating to prevention of treaty abuse

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16 April 2021

Executive summary

On 1 April 2021, the Organisation for Economic Co-operation and Development (OECD) released two documents relevant for the implementation of the minimum standard on Base Erosion and Profit Shifting (BEPS) Action 6 relating to prevention of treaty abuse. The first document is the third annual peer review report (the Report) on the compliance by members of the Inclusive Framework on BEPS with the minimum standard. The OECD also released revised peer review documents on BEPS Action 6 which will be used to carry out the peer review process beginning in 2021.

The minimum standard on preventing treaty abuse 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 potential 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).

The Report includes information available as of 30 June 2020 (the cut-off date) and covers the 137 jurisdictions that were members of the Inclusive Framework by 30 June. Overall, the Report concludes that the majority of the Inclusive Framework members are translating their commitment to prevent treaty abuse into actions and are modifying their treaty networks. The Report covers 2,295 agreements in force among members of the Inclusive Framework, of which over 350 complied with the minimum standard by the cut-off date. In addition, over 1,300 of the 2,295 agreements were in scope of the Multilateral Convention to Implement Tax Treaty Related Measures to Prevent BEPS (MLI) and were thereby set to become compliant with the minimum standard and a further 17 agreements are in the process of being updated bilaterally.

The changes to the peer review documents relate to the methodology that sets out the procedural mechanism by which the review will be conducted. Changes to other sections of the peer review documents are mostly conforming in nature. The Action 6 minimum standard remains unchanged, and the terms of reference for the peer review also remain largely unchanged. The main change is the establishment of a framework through which, in certain situations, assistance would be given to an Inclusive Framework member that has non-compliant agreements.

Detailed discussion

Background

In October 2015, the OECD released the final reports on all 15 focus areas of the BEPS Action Plan.¹ 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, contains 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.²

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 for BEPS Action 6. 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.³Partially compliant agreements — agreements that contain only one element of the minimum standard — are shown as non-compliant. Further, the Inclusive Framework agreed to evaluate the methodology for the peer review of the minimum standard on treaty shopping in 2020 based on the experience of conducting reviews in 2018 and 2019.

The first peer review was conducted in 2018 and covered the 116 jurisdictions that were members of the Inclusive Framework on 30 June 2018.⁴ Following that, the second peer review was conducted in 2019 and covered the 129 jurisdictions that were members of the Inclusive Framework on 30 June 2019.⁵

Third Action 6 peer review report

On 1 April 2021, the OECD released the third Action 6 peer review report. The Report contains the following sections:

Executive summary
Implementation issues, the minimum standard and the MLI
Aggregate data on the implementation of the minimum standard
Difficulties in implementing the minimum standard
Conclusions and next steps
Data for each jurisdiction of the Inclusive Framework

The last section contains information for each jurisdiction 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 on 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.

Main findings

According to the Report, the 137 jurisdictions in the Inclusive Framework reported a total of 2,295 agreements between Inclusive Framework members, and 905 agreements between Inclusive Framework members and non-members. The Report includes the following aggregate data:

98 Inclusive Framework members had some agreements that already complied with the minimum standard or that were subject to a complying instrument and would therefore become compliant shortly.
An additional seven jurisdictions, namely the Bahamas, the Cayman Islands, the Cook Islands, Djibouti, Haiti, Honduras and Turks and Caicos Islands, had no comprehensive tax agreements in force subject to the peer review.
37 jurisdictions had not signed any complying instruments (i.e., the MLI or a protocol/treaty) to implement the minimum standard.

According to the Report, as of 30 June 2020, over 350 bilateral agreements between members of the Inclusive Framework complied with the minimum standard. An additional 20 agreements not subject to this review (i.e., agreements between Inclusive Framework members and non-members) also complied with the minimum standard. In all 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 those agreements, 31 supplemented the PPT with a limitation on benefits (LOB) provision.

As of 30 June 2020, over 1,300 of the 2,295 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 their provisions take effect. The Report also notes some gaps in the coverage of the MLI. About 200 bilateral agreements, concluded between pairs of signatories to the MLI that are members of the Inclusive Framework, would not be modified by the MLI because, at this stage, only one jurisdiction had listed the agreement under the MLI (one-way agreements). Also, there are about 325 agreements concluded between pairs of jurisdictions that are members of the Inclusive Framework where only one of them has signed the MLI (waiting agreements). None of these agreements would, at this stage, be modified by the MLI because one treaty partner has not signed the MLI.

The Report shows that jurisdictions that are members of the Inclusive Framework that did not sign the MLI or otherwise implement anti-treaty-shopping measures in their agreements have made no or very little progress in the implementation of the minimum standard. The Report thus highlights that signature and ratification of the MLI is an effective tool for jurisdictions that want to implement the minimum standard through the PPT. Furthermore, the Report encourages all signatories to the MLI that have not yet ratified it to do so. The Report also indicates that the OECD Secretariat has liaised with the signatories of the MLI that, at the time of the drafting of the Report, had not yet ratified it and notes that Bulgaria, Cameroon, Colombia, Croatia, Estonia, Greece,⁶ Hungary,⁷ Jamaica, Malaysia, Mexico, Morocco, North Macedonia, Romania, Senegal, South Africa, Spain and Turkey are aiming to deposit their instruments of ratification of the MLI by mid-2021.

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. During the course of the 2019 peer review, one jurisdiction raised a concern with respect to the Caribbean Community (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 and that could lead to treaty-shopping practices. This concern remained in 2020 as the parties to the CARICOM Agreement have not yet modified it.

Revised peer review documents on Action 6

The revised peer review documents on Action 6, which reflect the approach agreed by the Inclusive Framework for reviewing compliance with the Action 6 minimum standard from 2021 onwards, contain two sections:

The terms of reference, which are unchanged from the original mandate in 2017, and which set out the criteria for assessing the implementation of the minimum standard.
The revised methodology which sets out the procedural mechanism by which jurisdictions will complete the peer reviews from 2021. Changes were made in the methodology to establish a framework through which assistance by the Secretariat would be given to an Inclusive Framework jurisdiction that had non-compliant agreements that could, on its own assessment, create treaty-shopping opportunities and for which the jurisdiction had not yet taken steps to bring them into compliance with the minimum standard. The assistance would include a recommendation to formulate a plan if one was not already in existence.

The first step of the revised peer review process is carried out through a peer review questionnaire that each member jurisdiction of the Inclusive Framework is asked to complete before 31 May and that shows all the existing comprehensive treaties on income taxes of that jurisdiction that are in force at that time. For each tax treaty listed, members are to indicate whether it complies with the minimum standard. Members of the Inclusive Framework are requested to provide additional information for each tax treaty that is not compliant and not subject to a complying instrument, more specifically information on whether:

They plan to implement a detailed LOB provision.
They have taken steps to enable the tax treaty to become subject to a complying instrument.
It is established that a tax treaty does not give rise to material treaty-shopping concerns.

When a jurisdiction considers that a tax treaty could give rise to treaty-shopping opportunities and it has not yet taken steps to bring it into compliance with the minimum standard, it will formulate a plan to include the minimum standard in that tax treaty.

As part of the peer review process, the peer review documents describe that:

The Secretariat will contact the jurisdictions that have tax treaties for which a plan for the implementation of the minimum standard needs to be developed.
If a jurisdiction wants to implement the minimum standard through the PPT and some or all of its treaty partners are already signatories to the MLI, the Secretariat will provide support and encourage the jurisdiction to sign and ratify the MLI.
For tax treaties that will not become covered tax agreements under the MLI or that are not covered by a general statement on the negotiation of detailed LOB provisions, the Secretariat will encourage the treaty partners to develop a plan, and where possible a joint plan, for the implementation of the minimum standard.

If a jurisdiction does not make a plan (or provide an update on the plan) to implement the minimum standard, a recommendation to provide a plan will be included in the peer review report with respect to the tax treaty. Once a plan is in place, the jurisdiction will provide an annual update if changes occur. A jurisdiction that is facing any difficulty in implementing the plan will be able to report such difficulty to the Secretariat.

Any jurisdiction member of the Inclusive Framework on BEPS that is facing difficulties in getting agreement from another jurisdiction to amend an existing treaty in order to implement the minimum standard will be able to raise that issue with the Secretariat, which will ensure that the other jurisdiction is offered the opportunity to present its views and that the case is discussed at the subsequent meeting of the Working Party 1 on Tax Conventions and Related Questions. Any such case where Working Party 1 considers that a jurisdiction is unwilling to respect its commitment to implement the minimum standard on treaty shopping will be forwarded to the Inclusive Framework on BEPS as part of the annual report on the implementation of the minimum standard on treaty shopping.

Next steps

The progress of the assessed jurisdictions will be reflected in peer review reports for the following year. The next peer review will be launched in the first half of 2021 and will also include the review of the new members of the Inclusive Framework.

According to the Report, it is expected that the revised Action 6 peer review methodology will be reviewed again in 2026.

Implications

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.

As of 30 March 2021, 95 jurisdictions have signed the MLI, 65 jurisdictions have deposited their instrument of ratification⁹ and 1,700 tax treaties are covered by the MLI. By requiring Inclusive Framework members to develop specific plans to modify their non-compliant treaties and by offering assistance in the renegotiations, the OECD is enhancing compliance with the Action 6 minimum standard. The Action 6 minimum standard has several key impacts, including:

Structures developed before the widespread introduction of substantive anti-treaty-shopping measures should be reevaluated in light of the new developments in order to determine continued qualification for treaty benefits.
Many multinational enterprises have favored domestic dispute resolution processes for international tax matters because of the absence and/or unenforceability of effective bilateral Mutual Agreement Procedure (MAP) processes. As a consequence of BEPS Action 6 in the context of treaty-protected trade, MAP can be expected to improve, shifting the balance in controversy management from unilateral single-country approaches towards bilateral approaches such as MAP and/or arbitration.

Businesses should continue to monitor tax treaty developments with respect to BEPS Action 6 and the MLI.

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For additional information with respect to this Alert, please contact the following:

Ernst & Young Belastingadviseurs LLP, Rotterdam