OECD's draft proposal on treaty shopping, treaty abuse situations.

• Author: Mehta, Sushant
• Position: Organisation for Economic Co-operation and Development

PREVIEW

* The Organisation for Economic Co-operation and Development (OECD) is working to prevent multinational corporations from shifting profits to low-tax jurisdictions to reduce their taxes.

* Part of this effort aims to ensure tax is imposed on companies where the economic activities generating the profits are performed and where value is created.

* Proposed changes to the OECD Model Tax Convention are intended to prevent tax treaty abuse, including the addition of a limitation-of-benefits rule and a general anti-abuse rule.

In 2013, the Organisation for Economic Co-operation and Development (OECD) and G-20 countries adopted a 15-point Action Plan on Base Erosion and Profit Shifting (BEPS).The action plan aims to ensure that profits are taxed where the economic activities generating the profits are performed and where value is created. As a result, the plan provides for 15 actions to be delivered by 2015 on various issues. As part of this plan, the OECD recently issued a report, Preventing the Granting of Treaty Benefits in Inappropriate Circumstances, as part of Action 6 of the BEPS action plan.

The report includes proposed changes to the OECD Model Tax Convention, which are intended to prevent treaty abuse, and commentary on the changes. Some of the proposals included in the report are drafts that will be modified in the final report that will be issued in September. The OECD expects to work to address certain other parts of the BEPS Action Plan that are interrelated with this topic that will influence the final proposals. Even though the OECD's work is not finished, the draft proposals provide useful insights into how the OECD aims to address treaty abuse issues.

The report includes a number of recommendations to check treaty abuse under different situations. These broadly include:

1. The title and the preamble of a tax treaty should confirm that the purpose of the tax treaty is not intended to generate double nontaxation;

2. Incorporating a specific anti-abuse rule in the treaty in the form of a limitation-of-benefits (LOB) rule;

3. Incorporating a general anti-abuse rule that prevents the use of the tax treaty if one of the principal purposes of the transaction or the arrangement is to obtain the tax treaty benefit, unless it could be established that applying the treaty would be in accordance with the objectives of the treaty.

Limitation-of-Benefits Rule

The specific LOB rule proposed to be included in the convention is similar to the one that exists in the Model Tax Convention of the United States and is found in most tax treaties that the United States has entered into with other jurisdictions. This rule provides a set of objective tests that have to be satisfied as a primary condition before applying the tax treaty to a given transaction. Such a specific rule will address a large number of treaty-shopping situations based on the legal nature of...