The PPT, the BEPS Inclusive Framework and MLI

1. Background

Action 6 of BEPS introduced the principal purpose test (PPT) as one of the Minimum Standards to be implemented by the countries participating in the BEPS Inclusive Framework. The PPT has been also introduced in the Multilateral Instrument (MLI) in force since 1 July 2018. Even though the choice given to countries was either (i)  PPT (with or without detailed or simplified LOB) or (ii) detailed LOB with anti-conduit financing arrangements, the peer review report on Action 6 (March 2019) show that countries are choosing to implement option (i) and that option (ii) has  only be chosen until now by the United States (IRC § 1.881-3)  and section 3.2.2.  of the peer review report on Action 6).

Therefore, in principle, it can be argued that the PPT is one of the minimum international tax standards applicable by countries members of the BEPS Inclusive Framework and/or MLI (Cyprus is only signatory of the MLI). However, the implementation of the PPT raises questions about the uniformity in the application of the standard and the role of different actors (tax administrations, tax advisors, business, business associations, judges and academia) in the interpretation of this standard.

The impact of BEPS Actions and MLI in the treaty network will be one of the topics discussed at the Congress of the International Fiscal Association in 2020, and it has been also the topic of several conferences around the world organized by tax advisors, academia, business associations, and/or international/regional organizations. In this context, the following paragraphs will focus on some of the main issues that may need to be addressed in the implementation of PPT in the BEPS Inclusive Framework and in the MLI to achieve a minimum standard that contributes to global tax governance.

2. The PPT and the challenges

 2.1. Main elements of the PPT 

The PPT aims to tackle treaty abuse including treaty shopping and it is based to some extent in the guiding principle of the 2003 OECD Commentary to art. 1 (para. 9.5). However, unlike the guiding principle that was not extensively followed by countries, the PPT as one of the BEPS 4 minimum standards is at the time of writing followed by 129 countries (128 from the Inclusive Framework and 1 Cyprus in the MLI).

In a nutshell, the PPT aims to deny tax treaty benefits in case of treaty abuse and it consists of three main elements:

• A benefit under a tax treaty includes a tax deduction, exemption, deferral or refund. In the OECD Model, the benefit under tax treaty is found in the provisions of Art. 6 to 22, art. 23, and art. 24 of the OECD Model Tax Treaty. In addition, it can include a tax sparing credit (para. 175 Commentary to art. 29 2017 OECD Model).

• Subjective element: Tax administrations need to reasonable conclude, having taken into account all relevant facts and circumstances, that obtaining the benefit was one of the principal purposes of any arrangement or transaction that resulted directly or indirectly in that benefit.

• Objective element: The taxpayer needs to establish that granting that benefit in these circumstances would be in accordance with the object and purpose of the provisions of the treaty.

2.2. Challenges to the implementation of the PPT and the MLI

The literature highlighting the challenges in the implementation of the principal purpose test has been extensive. Therefore, to understand how the PPT works, it is necessary to read BEPS Action 6 report, several scholarly articles, the commentary to art. 29 2017 OECD Model, the terms of reference and peer review report of Action 6. In addition, some of the differences in implementation have been also highlighted by the CIAT in the BEPS Database.

The amount of the literature (more than 400 pages) shows the problems in the implementation the PPT. The first problem is the complex menu of options due to the introduction of the MLI. For countries participating in the inclusive framework but not signatories of the MLI, the PPT will be introduced following the amendment of the bilateral tax treaties.

For countries signatories of the MLI, the choices are either (i) to include the tax treaty as a covered tax agreement for the MLI or (ii) to negotiate tax treaty bilaterally. Some countries have decided to follow a mixed approach to include both choices, while other countries have decided to introduce the PPT bilaterally, very few countries have decided to apply the PPT in the MLI to all its tax treaties.

Despite these choices, the discussion of the MLI in the Parliament/Congress for ratification purposes can also result in different choices than the ones made by the Government. This is the case of for instance, the Netherlands. In spite of the choice of the Dutch Government for the application (opt in) of almost all provisions of the MLI, the Lower House of the Dutch Parliament decided to change the Government’s choice in the case of commissionaire arrangements in permanent establishment (PEs) available in the MLI by introducing a reservation to this provision. The main reason for this change was the uncertainty that the application of a commissionaire arrangement will bring for business. In this case, the Lower House decided that the Netherlands should opt out from this provision until there “is either sufficient clarity on profit allocation to agency PEs or that there is an effective dispute resolution mechanism in place with sufficient other MLI parties. If adequate progress is made, a legislative proposal to withdraw the Dutch reservation may be submitted by the end of 2020”.

Another problem are the mismatches between countries signing MLI. The choice made by a country will also depend on the choice of the other treaty country, and if there is a mismatch, the result will be multiple mini-treaty negotiations. Furthermore, countries may have decided to choose the PPT either with a simplified LOB or a detailed LOB, that also needs to be matched by the other treaty country. Following these choices, countries are having problems to manage these choices mainly due to capacity constrains and tax treaty policy choices, and in some cases countries signing the MLI are waiting for other countries’ choices before ratifying the MLI.

Until the time of writing only 29 of the 89 signatories countries have ratified the MLI, therefore only until all countries have ratified the MLI, it cannot be clearly established whether the PPT will contribute to more convergence or if the result is more complexity in the international tax system mainly due to these mini-treaty negotiations.

2.3. Discretionary relief in the application of the PPT and the MLI

Another feature of the MLI that is important to mention is the choice made by countries to apply the discretionary relief (art. 7(4) MLI). This relief allows a tax administration to grant the tax benefit but subject to consultation (no approval is required) to the other tax administration. However, this consultation also creates more delay in the application of a tax treaty, as well as more complexity in the way in which discretionary relief will be applicable by the tax administration. Since it is based in a discretionary power, it is not clear how tax authorities will use this relief in practice, and if this relief will also depend on the general features of the tax system of the country (e.g. depending on the formalistic approach of tax administration for instance in civil law countries such as Colombia, or France or in a more consensual approach for instance the “polder” model in the Netherlands that allows for open discussions between tax administrations , taxpayers and tax advisors).

To conclude, tax Administrations, law-makers, judges, tax advisers, taxpayers, business associations, scholarship in the countries members of the Inclusive Framework and/or signatories of the MLI will play an important role in the implementation of the PPT. Therefore, it is important to be aware of the problems highlighted by the literature in the implementation of the PPT.

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