Multilateral Convention to Implement Tax Treaty Related Measures to Prevent Base Erosion and Profit Shifting
Background
2.1
The Multilateral Convention to Implement Tax Treaty Related Measures to Prevent Base Erosion and Profit Shifting (the Multilateral Tax Treaty) is:
…an innovative multilateral treaty designed to swiftly and efficiently modify the operation of a jurisdiction's existing bilateral tax treaties to give effect to the [base erosion and profit shifting] treaty related recommendations.
OECD base erosion and profit shifting report
2.2
International tax architecture is complex, with institutions and taxpayers responding to each other’s activities and developments in technology. To understand the Multilateral Tax Treaty, it is worth describing the context in which it has been negotiated.
2.3
The Organisation for Economic Cooperation and Development (OECD) and the G20 published their Base Erosion and Profit Shifting Report in October 2015. This Report contained the OECD’s and G20’s response to an estimated annual tax revenue loss by OECD member states of between US$100 and US$240 billion as a result of ‘base erosion’ and ‘profit shifting’.
2.4
‘Base erosion’ and ‘profit shifting’ (collectively referred to as BEPS) are terms used to describe strategies used by international entities to minimise their tax obligations by shifting profits between jurisdictions, and exploiting gaps and mismatches in the tax rules.
2.5
The OECD’s Report contains 15 actions designed to target different types of behaviour by international entities. The actions are designed to be implemented domestically and through tax treaty provisions in a coordinated manner, supported by targeted monitoring and improved transparency.
2.6
These actions, which include negotiating the Multilateral Tax Treaty, establish a framework which countries can use to limit base erosion and profit shifting. The 15 actions are as follows:
1
identifying the difficulties posed by the digital economy for the application of existing international tax rules;
2
limiting the use of ‘hybrid’ entities and instruments using common treaty provisions and recommendations for common domestic rules.
A ‘hybrid’ in this context is a multinational entity or financial instrument that is structured to minimise its tax obligations by exploiting differences in how entities are defined for tax purposes across different jurisdictions.
For example, a hybrid entity may be incorporated in a jurisdiction where corporations do not pay much tax and a partnership in another jurisdiction where tax rules favour partnerships;
3
strengthening the rules regarding ‘controlled foreign companies.’
A ‘controlled foreign company’ refers to an entity based in one jurisdiction that is owned by shareholders in another jurisdiction. The shareholders can reduce their tax obligation in their home jurisdiction by moving their profits to the controlled foreign entity.
The OECD Report discusses:
how to determine when shareholders in one jurisdiction have sufficient control over an entity in another jurisdiction for it to be a controlled foreign company;
how to determine the amount of the controlled foreign company’s income that is taxable; and
ensuring that, in changing these rules, the shareholders are not subject to double taxation;
4
using best practice to design rules to prevent base erosion by entities making excessive interest deductions.
In essence this means preventing multinational entities from structuring their debt in such a way as to minimise tax obligations.
The best practice rules would prevent multinational entities from using:
related party and third party debt finance to exempt or defer taxation on income; and
other financial payments that are economically equivalent to interest payments to minimise taxable income;
5
countering the exploitation of ‘preferential regime’ arrangements by multinational entities;
A ‘preferential regime’ is a jurisdiction that structures its tax rules in such a way as to attract multinational entities wishing to establish themselves in a low tax environment.
There are two parts to this action:
making sure that tax rulings in one jurisdiction are transmitted to other jurisdictions as a matter of priority to enable those other jurisdictions to take appropriate action; and
requiring a multinational entity that claims to be based in a preferential regime to undertake a substantial proportion of its profit making activity in that jurisdiction;
6
working to prevent treaty abuse by developing model treaty provisions and recommending domestic rules to prevent granting treaty benefits to multinational entities in inappropriate circumstances;
7
preventing the artificial avoidance of ‘permanent establishment status’ by changing the definition of permanent establishment;
This action refers to a range of tax avoidance practices generally called ‘commissionaire’ arrangements.
When a multinational entity establishes a sales operation in a jurisdiction, it is considered to have established a permanent presence in the jurisdiction and is therefore liable to pay tax in that jurisdiction. This is called ‘permanent establishment status.’
Commissionaire arrangements allow multinational entities to avoid this status by operating in a jurisdiction using a mechanism that technically avoids meeting the requirements of a permanent establishment.
Action 7 involves changing the definition of ‘permanent establishment’ so that multinational entities cannot use these technical mechanisms to avoid taxation in a jurisdiction where their products are sold;
8
developing rules about moving ‘intangibles’ between jurisdictions, including: developing a consistent definition of intangibles; ensuring that the profits resulting from intangibles are declared in the jurisdiction were the value creation occurs; developing consistent transfer pricing rules for hard to quantify intangibles; and updating guidance on cost contribution arrangements;
An ‘intangible’ in this context is a thing that is capable of being owned and controlled for commercial benefit and is saleable, but is not a physical or financial asset. Intangibles might include, for example, patents, trademarks, specific sets of skills or experience, and ownership of licences.
Action 8 should ensure that, for tax purposes, the costs and benefits that accrue from intangibles in multinational entities are correctly attributed to the jurisdictions were the costs and benefits were accrued;
9
developing rules to prevent tax evasion by transferring risk or allocating excessive profits to ensure the returns claimed by a multinational entity are made in the jurisdiction in which the value is created;
10
developing rules to prevent tax evasion using transfers that would not, or would rarely, take place between third parties.
This measure will target tax minimisation mechanisms such as inaccurate cost allocation across international supply chains and the allocation of management and head office expenses;
11
collecting and analysing data on base erosion and profit shifting, including the scale and economic impact of base erosion and profit shifting, and the actions taken to address it.
This Action will ensure that tools are available to monitor and evaluate the effectiveness and economic impact of the actions taken to address base erosion and profit shifting;
12
obliging multinational entities to disclose their aggressive tax planning arrangements using mandatory disclosure rules for aggressive or abusive transactions, arrangements or structures.
This Action will also take into consideration the administrative costs for tax administrations and businesses by using experiences from other countries that have such rules;
13
re-examining ‘transfer pricing’ documentation and developing rules for transfer pricing to improve transparency, taking into consideration compliance costs for business;
‘Transfer pricing’ refers to the price a multinational entity charges itself to transfer assets between jurisdictions. For tax purposes, transfer pricing should be consistent across the entity, should be reported accurately in the relevant jurisdictions, and should reflect the actual value of the items being transferred.
14
making dispute resolution mechanisms more effective to prevent obstacles to countries solving treaty related problems, especially in those cases were treaties do not contain arbitration provisions; and
15
developing a multilateral instrument to modify bilateral tax treaties to enable countries to implement the OECD’s recommendations on base erosion and profit shifting.
2.7
The OECD places particular emphasis on actions 5, 6, 13 and 14, which the OECD believes constitute four minimum standards to tackle issues in cases where inaction by some countries or jurisdictions would create loopholes that impact on other countries. According to the OECD report:
Their consistent implementation will allow countries to protect their taxable base.
The Treaty
2.8
At the moment, the international legal framework preventing base erosion and profit shifting is based on an agreed standard for tax information exchange developed by the OECD and endorsed by the G20 in 2004. The resulting agreements are generally referred to as bilateral double taxation agreements.
2.9
According to Treasury:
The OECD has estimated that there are something like 3,000 bilateral tax treaties in existence in the world. Many of those are based on the OECD model tax treaty.
2.10
Treasury states that Australia is party to 44 such agreements.
2.11
The new Multilateral Tax Treaty:
…is an innovative multilateral treaty designed to swiftly and efficiently modify the operation of a jurisdiction's existing bilateral tax treaties to give effect to the BEPS treaty related recommendations.
2.12
According to the OECD, 103 jurisdictions were involved in the negotiations for the Multilateral Tax Treaty.
2.13
At the public hearing on 11 September 2017, Treasury advised the Committee that:
To date, 71 jurisdictions have signed the multilateral instrument and a further six jurisdictions have expressed their intent to sign it. In our case, the multilateral instrument is expected to modify 30 of Australia's 44 tax treaties.
2.14
The Multilateral Tax Treaty targets a range of tax avoidance activities, including:
the use of ‘fiscally transparent entities’ for tax avoidance purposes. A ‘fiscally transparent entity’ is a trust or partnership of an entity based in another jurisdiction that is used to minimise the entity’s taxation obligations in the jurisdiction were it is based;
‘dual resident entities.’ A ‘dual resident entity’ is an entity with a presence in two jurisdictions which shifts profits from one jurisdiction to another for tax minimisation purposes. The Multilateral Tax Treaty has expanded the current definition of a dual resident entity (called the ‘place of effective management test’) to allow consideration of other relevant factors in determining where the entity is actually located;
treaty abuse, referring to treaty shopping by entities to find the most favourable tax arrangement for their needs;
dividend transfer transactions, referring to the opportunistic purchase and sale of shares in a jurisdiction where an entity is not based for tax minimisation purposes;
avoiding capital gains taxes on the sale of shares or entities deriving their principal value from immovable property. This means preventing foreign entities from minimising capital gains tax by adding non-immovable assets to a land rich asset shortly before sale of that asset;
anti-abuse rules for permanent establishments situated in a third jurisdiction. This will prevent an entity from using a bilateral double taxation treaty to avoid tax obligations by declaring income in one of the bilateral treaty jurisdictions that was actually derived in a third jurisdiction.
For example, an entity based in Australia cannot move profits derived in one jurisdiction with which Australia has a bilateral double taxation agreement to another jurisdiction with which Australia has a bilateral double taxation agreement because the double taxation arrangements between Australia and the third jurisdiction are more favourable for the entity;
the artificial avoidance of permanent establishment status through commissionaire arrangements and similar strategies. This will prevent entities from using arrangements that enable it to sell products in a jurisdiction while technically avoiding having an actual presence in the jurisdiction;
the artificial avoidance of permanent establishment status through the specific activity exemptions. This will prevent an entity from fragmenting its activities, for example by shipping manufactured goods to another country for packaging and warehousing, specifically to minimise taxation; and
splitting up of contracts. This provision prevents entities from dividing building or construction related contracts into discreet parcels to avoid time related taxation rules. For example, an entity established to construct a manufacturing plant in a foreign country cannot avoid taxation by splitting the construction process amongst several related entities.
2.15
The Multilateral Tax Treaty also includes a number of provisions to improve outcomes for multinational entities that are unfairly obliged to pay taxes on the same profits in a number of jurisdictions. This situation in generally referred to as double taxation.
2.16
The double taxation issues addressed in the Multilateral Tax Treaty include:
methods for eliminating double taxation, such as requiring jurisdictions to credit foreign tax imposed on the income of an entity when calculating the entity’s tax obligations;
clarifying that the purpose of a bilateral tax agreement is expressly to ‘eliminate double taxation without creating opportunities for non-taxation or reduced taxation through tax evasion or avoidance;’
making it clear that a bilateral double taxation agreement does not restrict a jurisdiction’s right to tax its own residents as it sees fit;
establishing procedures to ensure that bilateral double taxation agreements are consistently and properly implemented; and
ensuring that a party to the Multilateral Tax Treaty reduces the tax burden on the profits of transactions between an entity in its jurisdiction and a related entity in another Multilateral Tax Treaty jurisdiction to reflect the tax burden applied in the other jurisdiction. Essentially this means that international entities cannot be taxed twice on profits from cross border transactions.
2.17
The Multilateral Tax Treaty also incorporates a dispute resolution mechanism through mandatory binding arbitration if parties cannot reach agreement on a case presented by a taxpayer.
2.18
The Treasury described how the mandatory binding arbitration process would improve dispute resolution:
Generally speaking, the treaty requires the two countries to consult with each other to endeavour to resolve the dispute, but there is no obligation to actually resolve it. That can mean in practice that disputes remain unresolved and the taxpayer might suffer double taxation, for example. In about 2010, or possibly 2008, the OECD introduced an arbitration provision into its model tax convention, which allows the taxpayer then to refer that dispute to independent arbitration, if it remains unresolved after two years … under the multilateral instrument it was an opportunity to implement arbitration rules much more broadly with other countries.
Application
2.19
As already discussed, the Multilateral Tax Treaty modifies Australia’s existing bilateral tax treaties. Its application in relation to those bilateral tax treaties is therefore a significant matter.
2.20
The Multilateral Tax Treaty will only apply to Australia’s bilateral double taxation agreements with those parties that have also ratified the Multilateral Tax Treaty.
2.21
According to the National Interest Analysis (NIA):
The extent to which each of these bilateral tax treaties will be modified is likely to vary. Parties to the proposed treaty can apply various choices and/or reservations to limit the extent of their adoption of its provisions.
2.22
Parties are required to apply their chosen provisions consistently across all their affected bilateral double taxation treaties.
2.23
The Multilateral Tax Treaty will only modify a bilateral treaty to the extent that both parties’ choices and reservations align. If they do not, then the provisions in the bilateral treaty will apply.
2.24
Australia has made a number of preliminary reservations to the application of the provisions of the Multilateral Tax Treaty. These reservations can be changed before Australia ratifies the Treaty. This will enable Australia to tailor its reservations in accordance with Government policy and the reservations made by other parties to the Treaty.
2.25
Australia’s preliminary reservations are as follows:
in relation to the transparent entities provisions (Article 3), Australia has lodged a reservation to preserve its bilateral arrangements with France and Japan;
in relation to dual resident entities (Article 4), Australia has made a reservation to the expanded criteria for determining a dual resident entity’s country of tax residence;
in relation to Article 5, which relates to the methods for the elimination of double taxation, Australia has lodged a reservation as this provision already exists in all Australia’s bilateral double taxation arrangements;
Australia has decided to invoke a reservation on Article 12, relating to artificial avoidance of permanent establishment status through commissionaire arrangement and similar strategies, based on Government policy;
in relation to artificial avoidance of permanent establishment status through the specific activity exemptions (Article 13), Australia has made a reservation to prevent two parties from being able to grant treaty benefits to an entity in the absence of a bilateral double taxation agreement;
in relation to splitting up of contracts (Article 14), Australia has made a reservation to prevent this provision from applying to offshore natural resources activities; and
Australia has made a reservation in relation to Article 17, relating to corresponding adjustments, to restrict its application to bilateral double taxation treaties that do not already contain these provisions.
2.26
In effect, the Multilateral Tax Treaty will result in different interpretations of existing double taxation agreements.
2.27
According to the Treasury:
The way in which this treaty will work is that it will not amend our bilateral treaties; it will just modify their application.
2.28
Once in force, it will be necessary to examine the Multilateral Tax Treaty and the relevant bilateral treaty to determine its effect.
2.29
Possible disputes over the interpretation of the combination of the Multilateral Tax Treaty and the bilateral treaty should not occur because the bilateral treaty will only be modified to the extent agreed by the parties to the bilateral treaty.
2.30
The changes to each of Australia’s bilateral tax agreements are too extensive to summarise here, but their extent is demonstrated by the fact that:
a party’s reservations to the provisions in the Multilateral Tax Treaty can be amended up to the time of ratification, to give parties the ability to tailor their reservations to accord with the reservations notified by other parties; and
while the Multilateral Tax Treaty is expected to be revenue positive for Australia, the quantum of revenue cannot be determined at this stage.
Conclusion
2.31
The OECD and G20’s Base Erosion and Profit Shifting Report addresses a significant and complicated problem in an environment where multinational entities exist in multiple jurisdictions and are flexible enough to make the most profitable use of taxation differences between those jurisdictions.
2.32
The complexity of the problem is reflected in the approach adopted in the Multilateral Tax Treaty, which will act in conjunction with Australia’s existing bilateral tax agreements.
2.33
While the Committee understands why the approach to adopting the Multilateral Tax Treaty is complex, the Committee considers that the Australian Government should take some care to ensure that implementing the Treaty does not result in onerous compliance costs.
2.34
Aside from the matter of compliance costs, the Committee supports this important step in ensuring every entity meets its tax obligations.
2.35
The Committee supports the Multilateral Convention to Implement Tax Treaty Related Measures to Prevent Base Erosion and Profit Shifting and recommends that binding treaty action be taken.