Policy Proposals Business Law Comments on the Public Discussion Draft on BEPS Action 6 (Prevent Treaty Abuse)
Tax Treaties, Transfer Pricing and Financial Transactions Division
Keidanren hereby submits its comments on the Public Discussion Draft "BEPS Action 6: Preventing the Granting of Treaty Benefits in Inappropriate Circumstances" published by the OECD on March 14, 2014.
A tax treaty allocates taxing rights and grants the residents various benefits, such as relief or exemption from source taxation, with a view to eliminating double taxation and thereby facilitating economic exchange between the contracting states. In this context, "benefits" are the result of such allocation of taxing rights and do not mean "preferential tax treatment". We believe that benefits of a tax treaty should be given to bona fide commercial arrangements of taxpayers.
On the other hand, it is only fair to deny such benefits to treaty-shopping situations, a typical example of which is a transaction that was conducted through a company with no business substance for the sole purpose of obtaining treaty benefits.
Action 6 of the Action Plan on Base Erosion and Profit Shifting ("BEPS") calls for the OECD to "develop model treaty provisions and recommendations regarding the design of domestic rules to prevent the granting of treaty benefits in inappropriate circumstances" and to "clarify that tax treaties are not intended to be used to generate double non-taxation." Keidanren supports these initiatives.
When establishing concrete rules for preventing tax avoidance, due consideration should be given to ensure that the new rules will not hamper normal business activities and not impose excessive compliance burden on taxpayers. Such consideration should also be given when creating rules related to the other Actions.
A. Entitlement-to-Benefits Provisions
The Public Discussion Draft proposes that, to address treaty-shopping situations, the OECD Model Tax Convention ("Model Convention") be revised to add entitlement-to-benefits provisions that consist of limitation-on-benefits provisions ("LOB provisions") and main-purpose test provisions ("MPT provisions").
As some countries have already concluded tax treaties that have both or either of LOB and MPT provisions, we have no objection to the introduction of entitlement-to-benefits provisions per se.
However, in view of the purpose of preventing treaty shopping by some entities, it seems somewhat excessive for the Model Convention to stipulate that both LOB and MPT provisions be included in tax treaties in principle. We believe that the Model Convention should be revised in a manner that allows a country to choose either LOB or MPT provisions for its tax treaties, though there is no need to go so far as to preclude the country's adopting both.
LOB Provisions (paragraph 11-17)
In general, it is desirable that LOB provisions be clearly and succinctly set forth. Article X, paragraph 3 of the Model Convention allows residents of a contracting state to qualify for treaty relief where the resident is engaged in the active conduct of a trade or business (other than making or managing investments for the resident's account—excluding banking, insurance or securities activities carried on by a bank, insurance company or registered securities dealer). We believe that such rule should be applied to other industries where the taxpayer has genuine economic substance, and that testing should be done at a group level rather than on a separate company basis.
Also, Article X, paragraph 4 of the Model Convention (determination by competent authority) should allow the granting of treaty benefits when the establishment, acquisition, or maintenance of the resident in question and the conduct of its operations have been made for business purposes.
When introducing LOB provisions, it is desirable that the OECD create a standardized format of procedures for certificates of residence and other documentation, from the perspective of reducing administrative burdens on taxpayers and standardizing enforcement practices among countries.
We support the inclusion of derivative benefits provisions as part of the LOB provisions in the Model Convention. With regard to the example given in paragraph 15 of the Public Discussion Draft, we think that the case cannot necessarily be determined to constitute BEPS if the conduct in question was made for business purposes.
MPT Provisions (paragraph 18-33)
When introducing MPT provisions, their application should be restricted to limited situations so that the vast majority of companies engaged in normal business activities will remain unaffected. In addition, clear operational guidelines must be developed and shared among countries to provide greater foreseeability for taxpayers.
In particular, conditions applicable to the MPT provisions needs to be defined by positive facts so as not to leave room for arbitrary administration. Countries should understand that in general, it is quite difficult to make the main purpose clear.
The definition "one of the main purposes" proposed in the MPT provision of the Public Discussion Draft is too wide in scope. It is a highly common practice for a company expanding its business overseas to take into account the taxation systems of individual countries including the existence and contents of their tax treaties. Viewing such practice as constituting treaty abuse is simply inconceivable. At least, the definition "one of the main purposes" should be changed to "the main purpose."
Similarly, reconsideration should be given to the phrases "need not be the sole or dominant purpose" and "sufficient that at least one of the main purposes was to obtain the benefit" in paragraph 31 of the Public Discussion Draft.
Paragraph 33 of the Public Discussion Draft invites comments on specific examples that illustrate cases in which the MPT provisions should and should not apply. With regard to this matter, as suggested in paragraph 32, the OECD should first establish the principle that the MPT provisions do not apply to a transaction or arrangement that was made for business purposes even if made also in consideration of a tax treaty.
Below are our views on Examples A through D in paragraph 33 of the Public Discussion Draft presented by the OECD to seek comments.
In each of these two examples, the conclusion is that, in the absence of other facts and circumstances showing otherwise, MPT provisions apply. However, in other words, this conclusion implies that MPT provisions do not apply if T Co.'s assignment of the right and provision of the usufruct to R Co. had business substance.
We agree with the conclusions that the MPT provisions do not apply to either case. Especially in example C, it is obvious that there is a genuine business purpose to establish a new plant. The OECD needs to clarify in the Commentary to the Model Convention that these cases do not constitute treaty abuse.
As to the relationship between LOB and MPT provisions, paragraph 23 of the Public Discussion Draft states that, even if a person is entitled to benefits under Article X, paragraphs 1 to 5 (LOB provisions) of the Model Convention, that does not mean those benefits cannot be denied under paragraph 6 (MPT provision) of said Article. We ask for clarification concerning a case in which a transaction conducted by a resident—who satisfies Article 4 of the Model Convention and has been determined not to be treaty abusive—is judged to be abusive under Article X, paragraph 6 of the Model Convention.
B. Minimum Shareholding Period to Qualify for Relief or Exemption from Source Taxation of Dividends (paragraph 43)
A period of six months seems appropriate and desirable as the length of the minimum shareholding period to qualify for relief or exemption from source taxation of dividends.
C. Source Taxation of Dividends Paid by Intermediary Entities (Paragraph 44-46)
The Public Discussion Draft proposes to introduce anti-abuse rules to deal with cases where certain intermediary entities established in the State of source are used to take advantage of the treaty provisions that lower the source taxation of dividends. However, we believe that investing in intermediary entities per se does not necessarily constitute treaty abuse. There should remain a business purpose exception so as not to hinder genuine business activities.
D. Determining the State of Residence of Dual-Resident Persons (Paragraph 53)
Regarding the tie-breaker rule related to a dual-resident person, it is proposed that Article 4, paragraph 3 of the Model Convention be revised to read that "the competent authorities of the Contracting States shall endeavor to determine . . . the Contracting State of which such person shall be deemed to be a resident" (italics added). Still, we believe a framework needs to be established to ensure the determination of the state of residence in such a case. Any agreements reached between contracting states should be swiftly notified to taxpayers.
Subcommittee on Taxation