On 31 May 2022, the OECD published its Fifth Peer Review Report on Treaty Shopping. The report includes extensive information on tax treaties concluded by the countries that were members of the OECD/G20 Inclusive Framework on Base Erosion and Profit Shifting("BEPS") and assesses the implementation of the BEPS Action 6 minimum standard.
The report shows that member countries are keeping their promise to apply the basic rule against treaty shopping, and it highlights the significance of the multilateral instrument ("MLI") as the tool used by the majority of jurisdictions that have commenced implementation of the BEPS Action 6 minimum standard. This standard identified treaty abuse, particularly in the form of treaty shopping, as one of the main concerns to be addressed.
What is treaty shopping?
Treaty shopping occurs when there is an attempt to indirectly access the benefits of a tax treaty between two jurisdictions without being a resident of one of those jurisdictions.
The OECD states that, under BEPS, treaty abuse is highly undesirable for the following reasons:
- treaty benefits negotiated between the parties to a treaty are economically extended to residents of a third jurisdiction in a way the parties did not intend. The principle of reciprocity is therefore breached and the balance of concessions that the parties make is altered;
- income may escape taxation altogether or be subject to inadequate taxation in a way the parties did not intend; and
- the jurisdiction of residence of the ultimate income beneficiary has less incentive to enter into a tax treaty with the jurisdiction of source because residents of the jurisdiction of residence can indirectly receive treaty benefits from the jurisdiction of a source without the need for the jurisdiction of residence to provide reciprocal benefits.
What has been done to address it?
As part of the BEPS package and included as one of the four minimum standards, members of the BEPS inclusive framework are required to include provisions dealing with treaty shopping on their tax treaties to ensure a minimum level of protection against treaty abuse. Some flexibility is permitted in the implementation of the minimum standard as these provisions have to be adapted to each jurisdiction's specific circumstances and the negotiation of individual tax agreements.
Under the minimum standard countries must include two components in their tax agreements. Firstly, an express statement that their common intention is to eliminate double taxation without creating opportunities for non-taxation or reduced taxation through tax evasion or avoidance, including through treaty-shopping arrangements.
Secondly, they are required to include in the treaty provisions one of the following three methods:
- a principal purpose test ("PPT") equivalent to paragraph 9 of Article 29 of the 2017 OECD Model Tax Convention together with either a simplified or a detailed version of the limitation on benefits ("LOB") rule that appears in paragraphs 1 to 7 of the 2017 OECD Model;
- the PPT alone; or
- a detailed version of the LOB rule together with a mechanism (such as a treaty rule that might take the form of a PPT rule restricted to conduit arrangements, domestic anti-abuse rules or judicial doctrines that would achieve a similar result) that would deal with conduit arrangements not already dealt with in tax treaties.
Historically, countries have attempted to address treaty shopping by using different approaches. Reliance has been placed on specific anti-abuse rules based on the legal nature, ownership, and general activities of residents of the jurisdiction who are party to a tax agreement or who have utilised a general anti-abuse rule based on the purpose of transactions or arrangements.
What progress has been made?
The implementation of the Action 6 minimum standard is subject to a peer review process. Peer reviews were performed in 2018, 2019, 2020 and 2021. The peer review for 2022 is currently underway.
The latest peer review reveals that a large majority of Inclusive Framework members have modified or are in the process of modifying their tax treaty network to implement the minimum standard and other BEPS treaty-related measures. Several countries that have signed the MLI have listed almost all their treaties under the MLI.
For treaties for which the MLI is effective, tax authorities can now use effective treaty provisions to curb treaty shopping.
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