Policy Proposals Business Law Comments on the Revised Discussion Draft on BEPS Action 6 (Prevent Treaty Abuse)
Marlies de Ruiter
Head, Tax Treaties, Transfer Pricing and Financial Transactions Division
Centre for Tax Policy and Administration
Organisation for Economic Co-operation and Development
Keidanren hereby submits its comments on the Revised Discussion Draft "BEPS Action 6: Prevent Treaty Abuse" published by the OECD on May 22, 2015.
We consider it fair to deny treaty benefits to any transaction or arrangement made through an entity that has been established solely to obtain such benefits and has no business substance. At the same time, it is equally fair for any genuine economic activity to be entitled to treaty benefits, as we stated in our April 2014 comment letter.
The Revised Discussion Draft has apparently given consideration to taxpayers, especially by leaving the structure of a limitation-on-benefits (LOB) provision up to individual contracting states, thereby avoiding uniform application of the overly strict LOB rule, and by providing additional illustrative examples on the principal purposes test (PPT). However, attention should be paid to an increase of the administrative burden for taxpayers because multiple choices regarding the structure of a LOB provision and complication of the rule are two sides of the same coin. And as for the PPT, the term "one of the principal purposes" stated in paragraph 7 of Article X in the Revised Discussion Draft should be changed to "the principal purpose" in order to ensure that the scope of the PPT will not be unreasonably wide.
In the Revised Discussion Draft, the treatment of some of the matters of concern to Japanese companies remains unsettled, while new proposals have been presented. In view of these, our comments below focus on the two issues we consider particularly important: regional headquarters, and the derivative benefits provision and special tax regimes.
1. Regional Headquarters
The Revised Discussion Draft has enhanced the Commentary on the PPT rule, adding Examples G and H that demonstrate it is not reasonable to deny treaty benefits to a company managing certain intra-group services or undertaking business developing activities within the region. Of these two, Example G raises some concerns, primarily because what "a real business" and "substantive economic functions" mean may not be uniformly interpreted by countries. Nevertheless, it is clear that, in both examples, the companies in question have no intention of abusing the tax treaty and are engaged in the active conduct of a business. We thus welcome the conclusions that the PPT rule would not apply to either of them. Going forward, more illustrative examples should be provided to clarify that the PPT rule does not apply to a regional headquarters that holds shares in multiple subsidiaries thereunder.
As for the LOB rule, meanwhile, the September 2014 interim report on Action 6 entitled "Preventing the Granting of Treaty Benefits in Inappropriate Circumstances" contains two relevant statements. The one is that "the business of making or managing investments" is not treated as "the active conduct of a business," laid down in subparagraph a) of paragraph 3 of Article X that is contained in the report's paragraph 16. The other is that "a headquarters operation is in the business of managing investments," set out in paragraph 48 of the report's Commentary on the LOB Rule. As a result of these, the issue remains that regional headquarters may not be entitled to treaty benefits.
In respect to this issue, the Revised Discussion Draft only mentions in paragraph 70 that the pros and cons of the issue were discussed at the March 2015 meetings of Working Party 1, without referring to any conclusion thereon other than the comment in paragraph 71 which stated that the Working Party agreed that the Commentary on the "active business" provision should clarify the concept of "business". From the perspective of consistency, though, given that the PPT rule does not apply to regional headquarters, under the LOB rule, regional headquarters should also be entitled to treaty benefits unless other facts indicate that it has been established solely for tax purposes.
There are some possible approaches to realize this. One is to recognize a regional headquarters operation as the active conduct of a business in subparagraph a) of paragraph 3 of Article X. A more desirable approach, however, is to recognize a regional headquarters itself as a qualified person under paragraph 2 of Article X without requiring an unduly strict condition, taking into account predictability to taxpayers.
2. Derivative Benefits Provision and Special Tax Regimes
We disagree with the proposal for special tax regimes that the Revised Discussion Draft presents in connection with the derivative benefits provision. What Action 6 aims for is the elimination of double non-taxation. Considering that aim, it would be overdone to resort to nullifying treaty benefits to entities that enjoy a preferential effective rate of taxation to income or profit on interest, royalties, and other income, so long as they are taxed accordingly.
Paragraphs 47 and 48 explain the proposal in the context of the interaction with Actions 5 (harmful tax practices) and 8 (intangibles). This suggests that the proposal has mainly stemmed from concerns over the transfer of intellectual property rights from the country of the head office to a lower-tax jurisdiction and the resultant granting of treaty benefits to base-eroding payments. However, such transfers of intellectual property rights, in particular wrongful ones, are expected to be deterred to a considerable extent by the rules pursuant to Action 5 and Actions 8 to 10, as well as Action 3 (CFC rules).
Tax treaties should, first and foremost, aspire to encourage economic exchange between the contracting states through the elimination of double taxation. It is not desirable for such treaties to institute measures that would overlap with measures taken under other Action items. Therefore, inserting new provisions into the articles of the OECD Model Tax Convention should be avoided, including those into Articles 3 (general definitions), 10 (dividends), 11 (interest), 12 (royalties), and 21 (other income). As for the derivative benefits provision, it is appropriate to be introduced as part of the LOB rule, without adopting the special tax regime rule.
Lastly, in the event that the number of tax treaties incorporating the LOB rule increases, the OECD will need to develop uniform guidelines on procedures for certificates of residence and other documentation in order to reduce the administrative burden on taxpayers and standardize enforcement by nations.
Subcommittee on Taxation