Interpretation and Application of the prevention of treaty abuse article in the MLI

[The article was published in the Tax Notes Internation on 20th June 2022.] -> download

 

Introduction

 

Action 6 of the BEPS project identified treaty abuse, and in particular treaty shopping, as one of the principal sources of BEPS concerns. In 2016, the OECD/G20 Inclusive Framework on BEPS was established. Countries and jurisdictions that have committed to the BEPS Project are required to meet the four minimum standards of the BEPS including the prevention of treaty abuse under the Action 6: 2015 Final Report – Preventing the Granting of Treaty Benefits in inappropriate Circumstances (the action 6 final report) and participate in reviewing and monitoring the implementation of the minimum standards. This article analyzes how the prevention of treaty abuse article in the MLI is structured to reflect the principles in articles 21(1) and 30(3) of the Vianna Convention on the Law of Treaties and how notification rules apply to the prevention of treaty abuse article.

 

In the following sections of this article, the word “party” is used interchangeably as a contracting jurisdiction to keep in line with the definition in the MLI. Detailed version of the limitation of benefit rules is not covered.

 

The action 6 minimum standard

 

As of 30th April 2022, 99 governments of the countries/jurisdictions already signed up the multilateral convention to implement tax treaty-related measures to prevent base erosion and profits shifting (the multilateral instrument, or the MLI). Signing the MLI enables a member country of the IF swiftly transposes the provisions against treaty abuse and other treaty-related measures of the MLI into their tax treaties.

 

The minimum standard on treaty shopping under action 6 of the BEPS project requires jurisdictions to include two components in their tax agreements:

 

  • an express statement on non-taxation (generally in the preamble);
  • one of the three methods or alternatives addressing treaty shopping.

 

An express statement (first component)

 

As set out in paragraph 22 of the action 6 final report, jurisdictions are required to include in their tax agreements 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, including through treaty-shopping arrangements. The following provision now appears in the Preamble of the 2017 OECD Model Tax Convention:

 

(State A) and (State B),

  • Desiring to further develop their economic relationship and to enhance their cooperation in tax matters,
  • Intending to conclude a Convention for the elimination of double taxation with respect to taxes on income and on capital without creating opportunities for non-taxation or reduced taxation through tax evasion or avoidance (including through treaty-shopping arrangements aimed at obtaining reliefs provided in this Convention for the indirect benefit of residents of third States)

 

The three alternative methods (second component)

 

Jurisdictions have also committed to implement that “common intention” through the inclusion of treaty provisions in one of the following three methods (3-pronged approaches):

 

  • a principal purpose test (PPT) either a simplified or a detailed version of the limitation on benefits (LOB) rule [denoted as “the PPT-plus” hereafter]; or
  • the PPT alone [denoted as “the PPT”]; or
  • a detailed version of the LOB rule together with a mechanism (such as a treaty rule that might take the form of a PPT rule restricted to conduit arrangements, or domestic anti-abuse rules or judicial doctrines that would achieve a similar result) that would deal with conduit arrangements not already dealt with in tax treaties [denoted as the “DLOB-plus”].

 

The Multilateral Instrument (the MLI)

 

Articles 6 and 7 of the action 6 final report bring the first two of these components into the text of the MLI. The Explanatory Statement to the MLI says in paragraph 110 that the term “a detailed limitation on benefit provision” in paragraph 15(a) of article 7 refers to a detailed provision of the type appearing in paragraph 1 through 6 of Article X (Entitlement to Benefits) of the OECD Model Tax Convention produced in paragraph 25 (page 21) of the Action 6 Report, which will be further developed in the course of the follow-up work on BEPS. The term “a principal purpose test” means a provision of the type described in paragraph 1 of Article 7.

 

Paragraph 25 of the action 6 final report also reads: “At the end of May 2015, however, the United States released a new version of the LOB rule included in its model treaty for public comments to be sent by 15 September 2015. When that new version was discussed, it was agreed that it should be further examined once finalized by the United States in the light of the comments that will be received on it.”

 

For that reason, neither the main texts of the MLI nor its Explanatory Statement provide the DLOB rules. However, one will see that the drafters of the MLI have allowed for a gateway to the DLOB in the analysis that follows. The MLI remains to be a powerful tool for the implementation of the action 6 minimum standard in terms of efficiency, clarity, and transparency. Paragraph 38 of the Prevention of Tax Treaty Abuse – Fourth Peer View Report on Treaty Shopping (the 4th peer review report), approved by the Inclusive Framework on 9 February 2022, is reproduced as follows:

 

“The MLI has proven to be an effective way – indeed, the preferred way – of implementing the minimum standard. However, a jurisdiction that prefers to implement the minimum standard through a detailed limitation on benefits provision cannot use the MLI to do so. Ninety-six jurisdictions have joined the MLI (including 93 members of the Inclusive Framework [99 members as of April 2022]), 68 have ratified it, and the MLI would, once fully in effect, implement the minimum standard in more than 1,700 bilateral agreements, thus modifying the majority of agreements concluded between members of the Inclusive Framework.”

 

The OECD Model Tax Convention

 

The two components in paragraph 22 of the action 6 report have been included in the preamble to, and also article 29 of, the 2017 OECD Model Treaty Convention.

 

The 2017 update of the OECD model tax convention includes:

 

“the addition of a new Article 29 (Entitlement to Benefits) and related Commentary, which includes in the OECD Model a limitation-on-benefits (LOB) rule (simplified and detailed versions), an anti-abuse rule for permanent establishments situated in third States, and a principal purposes test (PPT) rule. These provisions were contained in the Report on Action 6. As noted in that Report, the two versions of the LOB rule and the anti-abuse rule for permanent establishments situated in third States as presented in the Report were draft provisions subject to changes, in the light of the versions of those rules that would be included in the 2016 United States Model Income Tax Convention, which had not been finalized at the time the Report on Action 6 was approved. Those provisions, as they appear in the 2017 Update, have been finalized accordingly.”

 

Table 1: Sources of the legal texts of the Express Statement and the 3-Pronged Approaches for adoption by Inclusive Framework members to meet action 6 minimum standard)

 

 

Action 6 final report

Multilateral Instrument (MLI)

2017 OECD Model Tax Convention

Title

Section B - Title of the Convention in p91 [note (a)]

Article 6 – Purpose of a covered tax agreement

Title of the Convention

[note (a)]

Preamble

Section B - Preamble to the Convention in p92 [note (b)]

Article 6(1), and Article 6(3)

Preamble to the Convention

[note (b)]

 

Section A – cases where a person tries to circumvent limitation provided by the treaty itself

Article 7 - Prevention of treaty abuse

Article 29 - Entitlement to benefits

PPT

Paragraph 26, Section A(1)(a)(ii) containing examples (p54 – p69)

Article 7(1)

Article 29(9)

Simplified version of LOB (SLOB)

Paragraph 25, Section A(1)(a)(i) containing examples (p21 – p54); [note (c)]

Article 7(8) to (12), including definition in Article 7(13)

Articles 29(1) to (4), and Article 29(6)

Detailed version of LOB (DLOB)

N/A

Full text of DLOB in Commentary on Article 29(1) to (7) with examples (p519 to p584) [note (d)]

 

Notes to Table 1

 

(a)

Convention between (State A) and (State B) for the elimination of double taxation with respect to taxes on income and on capital and the prevention of tax evasion and avoidance

(b)

The Express Statement

“Desiring to further develop their economic relationship and to enhance their cooperation in tax matters.”

“Intending to eliminate double taxation with respect to the taxes covered by this agreement without creating opportunities for non-taxation or reduced taxation through tax evasion or avoidance (including through treaty-shopping arrangements aimed at obtaining reliefs provided in this agreement for the indirect benefit of residents of third jurisdictions)”

(c)

the DLOB article is a draft version only.

(d)

The full text of DLOB replicates the title to, and article 22 of, the 2016 US Model Tax Convention.

 

 

The Texts of Article 7(1) and Article (2)

 

Article 7(1) that provides the PPT rule as the default option, falls under the scope of the action 6 minimum standard that a party to the MLI must apply to its CTAs. Articles 7(1) is the operative clause and 7(2) is the compatibility (conflict) clause of the MLI, which modifies the application of article 7(1) to the relevant provision in a CTA, subject to any reservation made, if applicable. The texts of both articles are set out below:

 

“(1) Notwithstanding any provisions of a Covered Tax Agreement, a benefit under the Covered Tax Agreement shall not be granted in respect of an item of income or capital if it is reasonable to conclude, having regard to all relevant facts and circumstances, that obtaining that benefit was one of the principal purposes of any arrangement or transaction that resulted directly or indirectly in that benefit, unless it is established that granting that benefit in these circumstances would be in accordance with the object and purpose of the relevant provisions of the Covered Tax Agreement.”

 

“(2) Paragraph 1 shall apply in place of or in the absence of provisions of a Covered Tax Agreement that deny all or part of the benefits that would otherwise be provided under the Covered Tax Agreement where the principal purpose or one of the principal purposes of any arrangement or transaction, or of any person concerned with an arrangement or transaction, was to obtain those benefits.”

 

Article 7 – Prevention of Treaty Abuse - contains four reservation (opt-out) provisions that interact with the compatibility and the notification clauses:

 

The full text of article 7(15) provides that

 

“A party may reserve its rights:

 

  1. for paragraph 1 not to apply to its Covered Tax Agreements on the basis that it intends to adopt a combination of a detailed limitation on benefits provision and either rules to address conduit financing structures or a principal purpose test, thereby meeting the minimum standard for preventing treaty abuse under the OECD/G20 BEPS package; in such cases, the Contracting Jurisdictions shall endeavour to reach a mutually satisfactory solution which meets the minimum standard.

 

  1. for paragraph 1 (and paragraph 4, in the case of a Party that has chosen to apply that paragraph) not to apply to its Covered Tax Agreements that already contain provisions that deny all of the benefits that would otherwise be provided under the Covered Tax Agreement where the principal purpose or one of the principal purposes of any arrangement or transaction, or of any person concerned with an arrangement or transaction, was to obtain those benefits.

 

  1. for the Simplified Limitation on Benefits Provision not to apply to its Covered Tax Agreements that already contain the provisions described in paragraph 14 [of article 7].”

 

In accordance with article 7(15)(a), a party can reserve its right not to apply article 7(1) to its CTAs on the condition that it will adopt the detailed version of limitation of benefits in the CTAs (DLOB). Under article 7(15)(b) a party can reserve its right not to apply article 7(1) where its CTA already contains the identical provision as article 7(1); Under article 7(15)(c), party can reserve its right not to apply the SLOB rules under article 7(6) where its CTAs already contain identical provisions described under the compatibility clause in article 7(14). In addition, article 7(16) provides that a party who chooses to apply the SLOB under article 7(6) may reserve its right for the entire article 7 not to apply to the CTAs for which one or more parties has not chosen to apply the SLOB provision in article 7(6).

 

Both article 7(15)(a) and 7(15)(b) are the opt-out provisions that exclude the application of the compatibility clause of article 7(2) to the CTA provision that correspond to article 7(1). They differ in the following ways.

 

Article 7(15)(b) provides a partial reservation by which a party may reserve its right for article 7(1) not to apply to the CTAs that already contain the provisions addressing the same issue. In contrast, article 7(15)(a) is a full reservation. The scope of reservation under article 7(15)(a) not only applies to the CTA concluded between the reserving party and the other party but also to all the CTAs that a party has nominated in accordance with paragraph (1)(a) of article 2 – Interpretation of Terms or paragraph 5 of article 29 - Notification.

 

Paragraph 3 of article 28 – Reservations of the MLI, which is modelled on paragraph 21(1) of the Vienna Convention on the Law of Treaties (the VCLT 1969), [1] provides that:

Unless explicitly provided otherwise in the relevant provisions of this Convention, a reservation … shall:

a) modify for the reserving Party in its relations with another Party the provisions of this Convention to which the reservation relates to the extent of the reservation; and

b) modify those provisions to the same extent for the other Party in its relations with the reserving Party.

 

Second, where a party of the MLI makes the 7(15)(a) reservation, both parties must choose to adopt the DLOB-plus rules to meet the action 6 minimum standard. Paragraph 109 of the Explanatory Statement to the MLI provides that “given that there are multiple measures to meet the minimum standard under Action 6, and that reaching a mutually satisfactory solution solely through the efforts of one Contracting Jurisdiction would not be possible, this paragraph requires not only the reserving Party but also the other Contracting Jurisdiction to the relevant Covered Tax Agreement to endeavor to reach a mutually satisfactory solution that is in line with the minimum standard.” Where a party reserves its rights in accordance with article 7(15)(b), that party is not obligated to do anything.

 

Compliant vs non-compliant agreement

 

Article 7(15)(b) is an application of the later-in-time rule (lex posterior derogat legi priori) as laid down in article 30(3) of the VCLT 1969. A pre-existing CTA containing the provision that denies all or part of tax benefits granted in respect of an item of income or capital if it is concluded that obtaining that benefit was one of the purposes of any arrangement or transaction that resulted directly or indirectly in that benefit, to which article 7(15)(b) applies, is a compliant agreement.

 

The term “compliant agreement” is adopted in the 4th peer review report as a tax agreement that has met the peer review minimum standard under the inclusive framework on BEPS. The legal text of article 30(3) of the VCLT reads[2]:

 

When all the parties to the earlier treaty are parties also to the later treaty but the earlier treaty is not terminated or suspended in operation under article 59 (the Vienna Convention), the earlier treaty applies only to the extent that its provisions are compatible with those of the later treaty.

 

A pre-existing CTA containing the denial-of-benefit provision to which a reservation under article 7(15)(b) does not apply is a non-compliant agreement, in respect of which a party to the MLI is obligated to take steps to subject it to modification by article 7(2), if required by its MLI treaty partner having made the same commitment to the minimum standard and requested the inclusion of the BEPS measures by way of article 7(2).

 

Article 7(15)(c) is also the application of the later-in-time rule, which owes its legal base to article 30(3) of the VCLT. It provides a partial reservation by which a party may reserve its rights for the SLOB provision not to apply to its CTAs that already contains SLOB provision, and therefore the CTAs are excluded from modification by the compatibility article 7(14).

 

Application of the legal principle under the later-in-time rule

 

The legal principle under article 30(3) of the VCLT not only applies to article 7, but also applies to other articles of the MLI. This can be illustrated by the symmetrical arrangements in the texts of article 6 – the purpose of a covered tax agreement and article 7 – the prevention of treaty abuse. Articles 6 and 7 respectively carry the express statement and the three alternatives addressing situations of treaty abuse in paragraph 22 of the action 6 final report.

 

Table 2: Legal texts of articles 6 and 7

Article 6 – Purpose of a covered tax agreement

Article 7

1. A Covered Tax Agreement shall be modified to include the following preamble text:

“Intending to eliminate double taxation with respect to the taxes covered by this agreement without creating opportunities for non-taxation or reduced taxation through tax evasion or avoidance (including through treaty-shopping arrangements aimed at obtaining reliefs provided in this agreement for the indirect benefit of residents of third jurisdictions),”

6(1)

7(1)

2. The text described in paragraph 1 shall be included in a Covered Tax Agreement in place of or in the absence of preamble language of the Covered Tax Agreement referring to an intent to eliminate double taxation, whether or not that language also refers to the intent not to create opportunities for non-taxation or reduced taxation.

6(2)

7(2)

4. A Party may reserve the right for paragraph 1 not to apply to its Covered Tax Agreements that already contain preamble language describing the intent of the Contracting Jurisdictions to eliminate double taxation without creating opportunities for non-taxation or reduced taxation, whether that language is limited to cases of tax evasion or avoidance (including through treaty-shopping arrangements aimed at obtaining reliefs provided in the Covered Tax Agreement for the indirect benefit of residents of third jurisdictions) or applies more broadly.

6(4)

7(15)(b)

5. Each Party shall notify the Depositary of whether each of its Covered Tax Agreements, other than those that are within the scope of a reservation under paragraph 4, contains preamble language described in paragraph 2, and if so, the text of the relevant preambular paragraph. [first sentence] Where all Contracting Jurisdictions have made such a notification with respect to that preamble language, such preamble language shall be replaced by the text described in paragraph 1. In other cases, the text described in paragraph 1 shall be included in addition to the existing preamble language. [second and third sentences]

6(5)

7(17)(a)

[See below.]

 

Paragraph 17(a) of article 7 carries the same language as the first sentence in paragraph 5 of article 6, which reads: “Each Party … shall notify the Depositary of whether each of its covered tax agreements … contains a provision described in paragraph 2, and if so, the article and paragraph number of each such provision.”

 

That means that the CTA provision, to which the provision that conform with the later-in-time rule principle under article 30(3) of the VCLT does not apply, shall be modified by the compatibility provision in paragraph 6(2) or 7(2) respectively.

 

Choice between bilateral and multilateral routes

 

Article 7(16) of the MLI provides that: -

 

(16) Except where the Simplified Limitation on Benefits Provision applies with respect to the granting of benefits under a Covered Tax Agreement by one or more Parties pursuant to paragraph 7, a Party that chooses pursuant to paragraph 6 to apply the Simplified Limitation on Benefits Provision may reserve the right for the entirety of this Article not to apply with respect to its Covered Tax Agreements for which one or more of the other Contracting Jurisdictions has not chosen to apply the Simplified Limitation on Benefits Provision. In such cases, the Contracting Jurisdictions shall endeavor to reach a mutually satisfactory solution which meets the minimum standard for preventing treaty abuse under the OECD/G20 BEPS package.

 

Article 7(16) addresses the situation involving the interaction between a single contracting jurisdiction as one party and the contracting jurisdictions of a multilateral agreement having more than two members as the other party, in which a member not adopting the SLOB option in article 7(6) does not agree to adopt either article 7(7)(a) or (b). If that happens, then either of the parties that adopt the SLOB option in article 7(6) may reserve its right for the entire article 7 not to apply to the CTAs for which one or more members of the other party has not agreed to adopt the SLOB option in Article 7(6).

 

Article 7(16) specifically allows a party to reserve its right to opt out of the entire article 7. By comparison, the opt-out provision under article 7(16) is at variance with other reservation (opt-out) provisions under articles 7(15)(a), (b), and (c). This anomaly can be reconciled in what follows.

 

Paragraph 23 of the action 6 final report provides that “whilst the minimum standard will be included in the multilateral instrument that will be negotiated pursuant to Action 15 of the BEPS Action Plan, which will provide an effective way to implement it swiftly, this may not be sufficient to ensure its implementation since participation in the multilateral instrument is not mandatory and two countries that are parties to an existing treaty may have different preferences as to how the minimum standard should be met…”.  

 

A tax agreement will remain non-compliant with the minimum standard after one of the parties opts out of the entire article 7. Article 7(16), like article 7(15)(a), requires the reserving party and the treaty parties to reach a mutually satisfactory solution to fix it. They shall proceed with a bilateral agreement either by concluding an amending protocol or negotiating a new agreement that satisfies the action 6 minimum standard.

 

As noted in paragraph 22 of the action 6 final report, the minimum standard requires jurisdictions to do two things in their tax agreements: include an express statement on non-taxation (generally in the preamble); and adopt one of three methods of addressing treaty shopping. It does not specify how these two things should be achieved (for example, through the MLI or agreements other than the MLI). Thus, IF members or MLI parties who are also IF members can not only choose among the three methods that can meet the minimum standards, but also choose different routes to get there via bilateral agreement, regional multilateral agreement, or the MLI.

 

An example of an application of the bilateral route is the Korea-Singapore tax agreement. Singapore and Korea are parties to the MLI but do not include the other party in their respective list of CTAs. Instead, they have chosen to conclude a bilateral treaty to meet the action 6 minimum standard.

 

An example of the application of the regional multilateral route is the Nordic Convention whose members include Denmark, Faroe Islands, Finland, Iceland, Norway and Sweden. Except for the Faroe Islands, all the members are also parties to the MLI, but each of them does not include the rest of the parties in its list of CTAs. Instead, they have chosen to meet the action 6 minimum standards by including the express statement to the Convention and the PPT provision in the preamble and article 26(4) of the “Protocol on changing the agreement between the Nordic countries in order to avoid double taxation with regard to taxes on income and wealth”. [3]

 

 

Opt-in provisions under article 7

 

Article 7 of the MLI contains three optional articles that are designed to supplement the application of a main article and help expand one’s commitment to an objective: article 7(4) that modifies article 7(1) by providing an administrative discretionary relief to the taxpayer who is denied the treaty benefit after having failed to satisfy the requirement under the principal purpose test (the PPT); article 7(6) for a party that adopts the PPT to opt-in for simplified limitation of benefit provisions (the SLOB provisions) so that a party can achieve its commitment at a level that is above the minimum standard; and article 7(7) in the situation of a multilateral tax agreement in which some of the parties adopting the PPT but not choosing the SLOB option can reach an agreement to adopt the SLOB rules in the CTAs with the parties that adopt the PPT-plus rules under article 7(6), either symmetrically or asymmetrically.

 

A party of the MLI can adopt Article 7(4), which is optional, to modify the application of article 7(1) to its covered tax agreements (the CTAs). Article 7(4) provides that: -

 

“(4) Where a benefit under a Covered Tax Agreement is denied to a person under provisions of the Covered Tax Agreement (as it may be modified by this Convention) that deny all or part of the benefits that would otherwise be provided under the Covered Tax Agreement where the principal purpose or one of the principal purposes of any arrangement or transaction, or of any person concerned with an arrangement or transaction, was to obtain those benefits, the competent authority of the Contracting Jurisdiction that would otherwise have granted this benefit shall nevertheless treat that person as being entitled to this benefit, or to different benefits with respect to a specific item of income or capital, if such competent authority, upon request from that person and after consideration of the relevant facts and circumstances, determines that such benefits would have been granted to that person in the absence of the transaction or arrangement. The competent authority of the Contracting Jurisdiction to which a request has been made under this paragraph by a resident of the other Contracting Jurisdiction shall consult with the competent authority of that other Contracting Jurisdiction before rejecting the request.”

 

Both article 7(4) and paragraph 1 of article 16 (Mutual Agreement Procedure) contain the provision providing a remedy that the taxpayer can request the competent authority (CA) of either contracting jurisdiction of which he is a resident, to reconsider his case after the tax benefits have been denied. However, the provisions in the articles 7(4) and 16(1) differ in the following areas:

 

  • if the contracting jurisdiction does not choose to adopt article 7(4), the taxpayer does not have a way to make such a request. In contrast, the taxpayer’s access to MAP under article 16(1) is not optional and is provided by the MLI article that the contracting jurisdictions must adopt.
  • the taxpayer can only present his case to the tax authority of the contracting jurisdiction of which he is a resident under article 7(4) while the taxpayer may present his case to the tax authorities of either contracting jurisdiction under article 16(1).
  • an unresolved issue arising from request for tax benefits under article 16(1), if not settled within a time period, could be submitted to arbitration provided that both the contracting jurisdictions choose to adopt arbitration under Part VI of the MLI, while article 7(4) does not provide for such arrangements.

 

Articles 7(6), 7(7), 7(14) provide that, with parenthesis added: -

 

6. A Party may also choose to apply the provisions contained in paragraphs 8 through 13 (hereinafter referred to as the “Simplified Limitation on Benefits Provision”) to its Covered Tax Agreements by making the notification described in subparagraph c) of paragraph 17. [first sentence] The Simplified Limitation on Benefits Provision shall apply with respect to a Covered Tax Agreement only where all Contracting Jurisdictions have chosen to apply it. [second sentence]

 

7. In cases where some but not all of the Contracting Jurisdictions to a Covered Tax Agreement choose to apply the Simplified Limitation on Benefits Provision pursuant to paragraph 6, then, notwithstanding the provisions of that paragraph, the Simplified Limitation on Benefits Provision shall apply with respect to the granting of benefits under the Covered Tax Agreement:

a) by all Contracting Jurisdictions, if all of the Contracting Jurisdictions that do not choose pursuant to paragraph 6 to apply the Simplified Limitation on Benefits Provision agree to such application by choosing to apply this subparagraph and notifying the Depositary accordingly; or

b) only by the Contracting Jurisdictions that choose to apply the Simplified Limitation on Benefits Provision, if all of the Contracting Jurisdictions that do not choose pursuant to paragraph 6 to apply the Simplified Limitation on Benefits Provision agree to such application by choosing to apply this subparagraph and notifying the Depositary accordingly.

 

14. The Simplified Limitation on Benefits Provision shall apply in place of or in the absence of provisions of a Covered Tax Agreement that would limit the benefits of the Covered Tax Agreement (or that would limit benefits other than a benefit under the provisions of the Covered Tax Agreement relating to residence, associated enterprises or non-discrimination or a benefit that is not restricted solely to residents of a Contracting Jurisdiction) only to a resident that qualifies for such benefits by meeting one or more categorical tests.

 

Asymmetry in option choice

 

Article 7(7) addresses the following situation that provides that where some but not all of the parties adopt the SLOB option, all the parties not adopting the SLOB option, with respect to the granting of benefits under the CTA, may reach an agreement to adopt either Article 7(7)(a), under which the SLOB option shall apply to all parties symmetrically, or Article 7(7)(b) under which the SLOB option shall apply asymmetrically with respect to the party that has chosen the PPT-plus SLOB option.

 

Asymmetry in adopting the SLOB provision between treaty parties is at odds with the reciprocity principle in the public international law. As noted, some of the contracting jurisdictions may just choose the PPT-alone option because choosing the PPT alone is sufficient to meet the action 6 minimum standard while others may choose a combination of PPT and SLOB option (the PPT-plus). The asymmetry in the choice of the SLOB, if article 7(7)(b) is chosen, may result in the SLOB provision being applicable to some but not all contracting jurisdictions.

 

Notification

 

The full text of notification provisions from article 7(17)(a) to (17)(e), with parentheses added, is reproduced below for the analysis that follows:

 

  1. Each Party that has not made the reservation described in subparagraph a) of paragraph 15 shall notify the Depositary of whether each of its Covered Tax Agreements that is not subject to a reservation described in subparagraph b) of paragraph 15 contains a provision described in paragraph 2, and if so, the article and paragraph number of each such provision. [first sentence] Where all Contracting Jurisdictions have made such a notification with respect to a provision of a Covered Tax Agreement, that provision shall be replaced by the provisions of paragraph 1 (and where applicable, paragraph 4). In other cases, paragraph 1 (and where applicable, paragraph 4) shall supersede the provisions of the Covered Tax Agreement only to the extent that those provisions are incompatible with paragraph 1 (and where applicable, paragraph 4). [second and third sentences] A Party making a notification under this subparagraph may also include a statement that while such Party accepts the application of paragraph 1 alone as an interim measure, it intends where possible to adopt a limitation on benefits provision, in addition to or in replacement of paragraph 1, through bilateral negotiation. [fourth sentence]
  2. Each Party that chooses to apply paragraph 4 shall notify the Depositary of its choice. [first sentence] Paragraph 4 shall apply to a Covered Tax Agreement only where all Contracting Jurisdictions have made such a notification. [second sentence]
  3. Each Party that chooses to apply the Simplified Limitation on Benefits Provision pursuant to paragraph 6 shall notify the Depositary of its choice. [first sentence] Unless such Party has made the reservation described in subparagraph c) of paragraph 15, such notification shall also include the list of its Covered Tax Agreements which contain a provision described in paragraph 14, as well as the article and paragraph number of each such provision. [second sentence]
  4. Each Party that does not choose to apply the Simplified Limitation on Benefits Provision pursuant to paragraph 6, but chooses to apply either subparagraph a) or b) of paragraph 7 shall notify the Depositary of its choice of subparagraph. [first sentence] Unless such Party has made the reservation described in subparagraph c) of paragraph 15, such notification shall also include the list of its Covered Tax Agreements which contain a provision described in paragraph 14, as well as the article and paragraph number of each such provision. [second sentence]
  5. Where all Contracting Jurisdictions have made a notification under subparagraph c) or d) with respect to a provision of a Covered Tax Agreement, that provision shall be replaced by the Simplified Limitation on Benefits Provision. In other cases, the Simplified Limitation on Benefits Provision shall supersede the provisions of the Covered Tax Agreement only to the extent that those provisions are incompatible with the Simplified Limitation on Benefits Provision.

 

Application of the notification provisions

 

Notifications are used to achieve the following purposes:

 

  • making the later-in-time reservation in accordance with article 28(8); and
  • triggering application of optional provision in accordance with article 29(1). The notification languages included in article 28 and article 29 are worded differently for different purposes.

 

Article 28(8) of the MLI provides that:

 

For reservations made pursuant to each of the following provisions, a list of agreements notified pursuant to clause ii) of subparagraph a) of paragraph 1 of Article 2 (Interpretation of Terms) that are within the scope of the reservation as defined in the relevant provision (and, in the case of a reservation under any of the following provisions other than those listed in subparagraphs c), d) and n), the article and paragraph number of each relevant provision) must be provided when such reservations are made: …

d) Paragraph 4 of Article 6 (Purpose of a Covered Tax Agreement);

e) subparagraphs b) and c) of paragraph 15 of Article 7 (Prevention of Treaty Abuse); …

 

With respect to the denial-of-benefits provision [or the SLOB provision] in the CTA, article 7(17)(a) provides that a party is required to notify the Depositary of whether the each of the CTAs, to which the later-in-time rule does not apply under article 7(15)(b) [or under article 7(15)(c)], contains a provision described in article 7(2) [or 7(14) respectively], and if so, the article and paragraph number for each such provision.

 

Table 3: Notification where the later-in-time rule article 7(15)(b) and (c) does not apply

 

 

Non-compliant provision

Notification 28(8)

When to give notice

(i)

PPT provision in article 7(1) to be modified by article 7(2)

Article 7(17)(a) if not subject to 7(15)(b), first sentence

On the date of deposit of instrument of ratification as per article 2(1)(a)(ii), and for addition of new agreements to the list notified under article 2(1)(a)(ii), article 29(5) applies

(ii)

SLOB provision in article 7(6) to be modified by article 7(14)

Article 7(17(c) if not subject to 7(15)(c), second sentence

(iii)

SLOB provision in article 7(7), agreed to be modified by article 7(14)

Article 7(17)(d) if not subject to 7(15(c), second sentence

 

Notification to take legal effect

 

Where a party to the MLI choose the discretionary relief option under article 7(4), the SLOB option under article 7(6) or 7(7), that party is required to give notification to the OECD Depositary in accordance with article 29(1) of the MLI. The purpose of serving a notification is for the opt-in articles to take legal effect, triggering the application of the opt-in article by each of the parties. The required notification is given in the standard language as provided in paragraph 7(17(b) for the discretionary relief optional provision in paragraph 4, and in paragraphs 7(17)(c) and 7(6) for the SLOB option in paragraph 6, as below: -

 

Table 4: Notifications to achieve legal effect and clarity

 

Optional provisions

Notification to take effect

Notification for clarity

[i]

Grant discretionary relief under article 7(4)

Article 7(17)(b): notify Depositary [first sentence] and apply only where all give matching notifications [second sentence].

Not applicable

[ii]

Adopt SLOB option under article 7(6)

Article 7(17)(c): notify Depositary [first sentence]; article 7(6): apply only where all give matching notifications [second sentence]

Article 7(17)(c), second sentence, unless article 7(15)(c) applies

[iii]

For each party not choosing SLOB option to adopt article 7(7)(a) or 7(7)(b)

Article 7(17)(d) notify Depositary [first sentence]; article 7(7)(a) and 7(7)(b) notify Depositary of agreement reached

Article 7(17)(d), second sentence, unless article 7(15)(c) applies

 

It is observed that the MLI distinguishes between the case in which all the parties have adopted a given option or provision and the other case in which the later-in-time rule does not apply to an opt-in provision. For article 7(4), or article 7(6) to apply, all the parties should give matching notifications in accordance with the first sentence of article 7(17)(b) or article 7(17)(c). In contrast, If the later-in-time rule does not apply, a party is required to give notification to the Depositary in accordance with the second sentence of article 7(17)(c) [article 7(17)(d)] for adopting articles 7(6) [and article 7(7)]. That notification shall include a list of CTAs that contain a provision described in article 7(2) [article 7(14)] as well as the article and paragraph number of each such provision.

 

Special application for the SLOB option

 

A party can either adopt the PPT-alone option or the PPT-and-SLOB option [the PPT-plus]. The following table shows the possible interactive relations between a contracting jurisdiction as one party that chooses the SLOB option and all the members of a multilateral agreement as the other party, of which some members agree to adopt the SLOB option while some other members do not.

 

Table 5 – Relationship of article 7(6) and 7(7)

Some, but not all, of the parties adopt the SLOB provision under Article 7(6), in a multi-lateral agreement setting

Do all the parties not adopting Article 7(6) agree to adopt Article 7(7)(a) symmetrically, or Article 7(7)(b) asymmetrically?

If yes for (a), does either party make reservation not to adopt SLOB under Article 7(15)(c)?

If yes, Article 7(7)(a) shall not apply

Notify application of article 7(15)(c), as per article 28(8).

If no, Article 7(7)(a) shall apply in place of, or in the absence of, a SLOB provision symmetrically

Notify Depositary pursuant to Article 7(17)(d) which CTA article and paragraph will be modified.

If yes for (b), does either party make reservation not to adopt SLOB under Article 7(15)(c) and has given notification?

If yes, Article 7(7)(b) shall not apply

Notify application of article 7(15)(c), as per article 28(8).

If no, Article 7(7)(b) shall apply in place of, or in the absence of, a SLOB provision asymmetrically

Notify Depositary pursuant to Article 7(17)(d) which CTA article and paragraph will be modified.

If no agreement is reached, does either party adopting Article 7(6) make reservation for entire Article 7 not to apply, pursuant to Article 7(16)?

If yes, Article 7 does not apply, subject to a mutually satisfactory solution reached that meets the minimum standard.

If no, the SLOB option does not apply because the condition in second sentence of article 7(6) cannot be satisfied.

 

According to the information kept by the OECD Depositary as of 30 April 2022, Article 7(7) applies with respect to the CTAs of 6 contracting jurisdictions provisionally, with Denmark, Iceland, Jamaica (provisionally), and Norway adopting (7)(a), while Cote d Ivoire (to be confirmed) and Greece adopting (7)(b). [4] Demark, Iceland, and Norway are members of a multilateral agreement: the Convention Between the Nordic Countries for the Avoidance of Double Taxation with Respect to Taxes on Income and on Capital.

 

Application of the notification rule in a multilateral agreement

 

The design of the MLI provides for two scenarios that a party can conclude its agreement with its treaty partners. It can be done multilaterally or bilaterally. In a situation in which a party A signs and listed a CTA with one of the members to a multilateral agreement (Nordic Convention for example), the second and third sentence in article 7(17)(a) [or the first and second sentence of article 7(17)(e)] will apply in that bilateral relationship between party A and the multilateral agreement as party B only if both party A and all the members in that multilateral agreement have given matching notifications. Otherwise, the operating provision article 7(1) [or articles 7(8) to 7(13)] shall supersede the CTA provisions to the extent of incompatibility. If the CTA does not contain article 7(1) (or the simplified LOB provision described under articles 7(8) to 7(13)), the latter shall apply in the absence of such or be added to it. [5]

 

The 4th peer review report reported that there were 5 multilateral agreements among the IF members including the agreement among the members of the CARICOM (not compliant) and the Nordic Convention (becoming a compliant agreement on 6th Nov 2018).

 

Table 6: MLI and tax agreements signed by members of the Nordic Convention

 

MLI (multilateral agreement)

Nordic Convention (multilateral agreement)

Bilateral agreement with the U.K.

Denmark

Yes

Yes

Yes

Faroe Islands

No

Yes

Yes

Finland

Yes

Yes

Yes

Iceland

Yes

Yes

Yes

Norway

Yes

Yes

Yes

Sweden

Yes

Yes

Yes

 

As noted, the Faroe Islands is a member of the Inclusive Framework and a member of the Nordic Convention, but not a signatory of the MLI. The government of the United Kingdom has concluded a tax agreement with the government of the Faroe Islands. Assume that Nordic Convention signs up the MLI. In the bilateral relationship between the U.K. and the Nordic Convention, article 7(1) shall supersede the denial-of-benefit provision in the Nordic Convention to the extent of incompatibility because the Faroe Islands is not a party to the MLI, in accordance with article 7(17)(a).

 

Respectively in describing how the compatibility clause under article 7(2) [article 7(14)] modifies articles 7(1) [article 7(7)], the second and third sentences in paragraph 17(a) of article 7 [paragraph 17(e) of article 7] carry the same language pattern (see Table 7).

 

Table 7: Application in multilateral tax agreements

Article 7(17)(a)

Article 7(17)(e)

The provision shall be replaced by the provisions of paragraph 1 … In other case, paragraph 1 … shall supersede the provisions of the Covered Tax Agreement only to the extent that those provisions are incompatible with paragraph 1”.

Where all Contracting Jurisdictions have made a notification under subparagraph c) or d) with

respect to a provision of a Covered Tax Agreement, that provision shall be replaced by the Simplified Limitation on Benefits Provision. In other cases, the Simplified Limitation on Benefits Provision shall supersede the provisions of the Covered Tax Agreement only to the extent that those provisions are incompatible with the Simplified Limitation on Benefits Provision.

 

The same language pattern is also used in article 6(5) (see Table 2) and other articles in the MLI, to which the later-in-time rule does not apply.

 

Conclusion

 

As noted in the 4th peer review report, the MLI has proven to be an efficient way – indeed, the preferred way - of implementing the minimum standard. This is particularly true for the IF members that need to update the existing treaty network concluded over a long period of time in the past that vary in different ways from the OECD Model Tax Convention.

 

However, the MLI cannot come into play if an IF member does not sign it up. In addition, the MLI cannot help where the IF-members wish to adopt the detailed version of LOB rules for which the bilateral route must be used. Despite the above-mentioned limitations, a party that adopts the PPT alone can meet the action 6 minimum standard, which can be effectively achieved by signing the MLI. Lastly, article 7(17)(a) provides that the MLI is not exclusive in that a party can declare that while it accepts the application of PPT alone as an interim measure, it intends where possible to adopt a detailed LOB option, in addition to or in replacement of the PPT option, through bilateral negotiation. 

 

Alfred Chan

China Tax & Investment Consultants Ltd

www.china-tax.net

 

 

 

 

 

 

 

 

[1] https://legal.un.org/ilc/texts/instruments/english/conventions/1_1_1969.pdf

[2] For an in-depth analysis of the rules, see Alfred Chan, “A New Interpretation of the Capital Gains Article in the MLI,” Tax Notes Int’l, Nov. 29, 2021, p. 1023.

[5] For the elaboration on the interaction between multilateral and bilateral agreements, see Alfred Chan, “A New Interpretation of the Capital Gain Article in the MLI”, TNI, Volume 104, 29 Nov 2021, p1027-p1028.