Action 15 of the Action Plan on Base Erosion and Profit Shifting (BEPS) calling for the development of a multilateral instrument to modify bilateral tax treaties and for the implementation of measures was approved by the Committee of Fiscal Affairs and has been endorsed by G20 leaders, concluding that it was not only feasible but desirable and that further negotiations for the instrument should be assembled quickly.
The Ad Hoc Group which was created in May 2015 with the objective of developing the multilateral instrument to modify existing bilateral tax treaties is now 96 countries strong, all on a level footing and aims to finalise results and presents its multilateral instrument for approval by 31 December 2016.
A public consultation on the multilateral instrument will be held in Paris at an OECD Conference on 7 July 2016.
The BEPS project was originally launched by the OECE and G20 in order to tackle “base erosion and profit shifting” therefore preventing multinational enterprises from shifting profits from high to low tax jurisdictions. Revenue losses from BEPS, at a conservative estimate are at USD 100-240 billion per annum, or 4-10% of global corporate income tax revenues, (CIT).
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The proposed measuresinclude a new OECD treaty definition of a “Permanent Establishment” (PE) – under BEPS Action 7, whereby negotiation of contracts could create a taxable PE.“As a preliminary matter, it appears clear that the negotiation of the multilateral instrument should include … the work to prevent the artificial avoidance of the PE standard under Action 7…” as conveyed in Action 15: A Mandate for the Development of a Multilateral Instrument on Tax Treaty Measures to Tackle BEPS.
Action7 seeks to deter multinational firms in foreign tax-treaty jurisdictions from using PE’s by significantly increasing taxation, unless businesses revise and restructure their operations or procedures, which will ultimately result in adhering to more stringent guidelines.
The OECDs current treaty provisions (and various tax jurisdictions including the UK), allows for a PE to be established if a non-resident company has a registered office or fixed place of business in a particular jurisdiction or a representative or agent to “conclude contracts” on its behalf in that jurisdiction, (referred to as the agency permanent establishment), unless the agent is economically and legally independent of the non-resident company.
In many cases many international firms have structured their affairs in such a way that the local investments management entity in another jurisdiction or affiliate “the agent”, is not deemed to be “concluding” relevant contracts in spite of substantial participation in contract negotiations by the investment management professionals or affiliate. This includes financial services firms, investment funds such as aircraft leasing and debt lending funds and private equity funds.
Under the current OECD Model, those who have adopted this tax regime model, achieves this by ensuring that the final approval regarding contract conclusions, is performed outside of their local jurisdiction, which the agent operates in e.g. an investment committee located in a another country, therefore creating an effective structure where substantial negotiations can be carried out in the affiliate or management entity jurisdiction without creation of a PE, as no contracts are “concluded” in that jurisdiction.
Whereas under the BEPS Action 7, the “agency” Permanent Establishment concept will change so that even the “mere negotiation”of contracts will create a taxable PE.
Such proposals will require changes in the PE in double-tax treaties worldwide, and as this will be required on a wide scale, this will be enforced by the use of a “multilateral instrument”, expected to be enforced by the latter part of 2016 or in 2017. Through this “multilateral instrument” all tax treaties with countries signing the agreement would be automatically be amended.
Although the finalisation of the “multilateral instrument” is still in the making, it may be prudent for international businesses to assess whether the proposed changes will affect them, and take the necessary measures to ensure smooth transition of any operational adjustments within a timely manner.
It should be noted that there are other proposed Actions that could have implications on the financial sector and investment management, in particular Action 4 on Interest payments and Action 11 on treaty abuse and may require a review of tax structures.
Should you like further information and would be interested in attending the public consultation meeting on the multilateral instrument, to be held in Paris at the OECD Conference Centre on 7 July 2016, register your interest online. This meeting will be broadcast live on the internet: http://video.oecd.org/.