Now that the multilateral instrument (MLI) (1) coordinated by the Organisation for Economic Cooperation and Development (OECD) has been signed by over seventy jurisdictions, (2) the new international tax agreement has moved to the implementation phase, with open issues and challenges ahead. The practical outgrowth of the OECD's project to address base erosion and profit-shifting (BEPS), this novel convention provides signatories with a streamlined process for implementing treaty-related measures from the BEPS action plan. Under a new choose-your-own-adventure approach, signatories agree to minimum standards but retain the flexibility to opt in or out of a series of provisions that modify the application of their bilateral tax treaties. Significantly, the changes implemented through the MLI go beyond mere tweaks. At a broad level, the MLI modifies a number of the substantive provisions in tax treaties and makes consequential changes to the express object and purpose of such treaties.
The OECD has historically focused on developing "soft law" instruments such as model agreements and agreed-upon guidelines (including in particular the OECD Model Tax Convention and the transfer pricing guidelines), which have served as models for the implementation and, in certain cases, the interpretation of domestic laws and bilateral agreements. In contrast, the MLI is a binding international legal instrument that represents a novel approach to implementing global consensus. Although the core concept of a multilateral instrument is not new, these instruments historically have constituted self-contained separate agreements, rather than acted as a clearinghouse for amending multiple existing treaties. The MLI, therefore, charts a new course that differs from both model agreements and other multilateral treaties. Upon ratification by signatories, it will serve as an independent and interdependent binding legal instrument that must be read alongside existing bilateral agreements. (3)
Upon ratification by signatories, the MLI could affect more than 1,100 existing bilateral treaties. (4) Although the United States notably has not signed the instrument, U.S. multinationals operating between jurisdictions that have signed the MLI will not be immune to the dramatic shift in the international treaty landscape that the MLI represents. The MLI's novel structure, in conjunction with its modification of long-understood standards and its injection of greater subjectivity into those standards, is likely to trigger unique issues, interpretive challenges, and, in some cases, traps for the unwary. This article identifies some of the issues and practical challenges the MLI raises and recommends ways to reduce uncertainty, anticipate pitfalls, and prepare for impact.
How Does the MLI Preamble Alter Covered Tax Agreements?
The MLI changes the object and purpose of bilateral tax treaties, modifying their interpretation and application at a fundamental level. As part of the minimum standard described in Action 6 of the Final BEPS Reports, (5) signatories to the MLI must include in their tax treaties an express statement that the intent of tax treaties is to "eliminate double taxation without creating opportunities for non-taxation or reduced taxation through tax evasion or avoidance" (emphasis added). (6) There are parallel paths to achieving this objective:
* Opting in to Article 6(1) of the MLI: Signatories lacking adequate preamble language in existing agreements must agree to Article 6(1) of the MLI, which provides specific treaty preamble language that signatories can use to supplement or supersede existing language.
* Keep existing adequate preamble language: Signatories can opt out of the MLI-prescribed language only if their tax treaties already contain adequate preamble language that covers the intent to "eliminate double taxation without creating opportunities for non-taxation or reduced taxation."
* Reliance on the MLI Preamble: All signatories to the MLI remain subject to language in the MLI's own preamble that is, in fact, more expansive than the option language contained in Article 6(1). As a result, the relevance of opting in or opting out of Article 6(1) is unclear.
Why does this matter to taxpayers? First, this convergence of MLI preamble language with the options offered to signatories to implement the minimum standard is a reminder to taxpayers that the MLI is itself a tax convention, the preamble of which applies to all signatories as a substantive overlay to the convention and provides context for its interpretation. (7) The Action 6 Final Report and the Explanatory Statement accompanying the MLI both underscore this intent.
Second, the MLI preamble itself goes beyond articulating the agreed-upon minimum standard regarding the purpose and object of treaties, adding the following condition that all signatories must agree to: "Recognising the importance of ensuring that profits are taxed where substantive economic activities generating the profits are carried out and where value is created."
While the goal of aligning profits with value creation has been an oft-mentioned driver for BEPS recommendations in commentary and discussion drafts, its inclusion in the MLI preamble represents the first time it has been given legal interpretive significance. Under the rules of the Vienna Convention, "[a] treaty shall be interpreted in good faith... in the light of its object and purpose," which includes its preamble. (8)
This new MLI preamble language, therefore, will present interpretative challenges. For example, how do you define "substantive economic activities"? What factors go into determining where value is created? Taxpayers...