Treaty shopping may see companies going home empty handed, says Deloitte
The implementation of stricter rules by the Organisation for Economic Cooperation and Development (OECD) surrounding tax treaty benefits could see these benefits not being granted as easily as they were in the past, says professional services firm Deloitte.
“The discussion surrounding ‘inappropriate circumstances’ relating to the issues of treaty shopping and treaty abuse that could give rise to double non-taxation and effectively erode jurisdictions’ tax bases, were addressed in the OECDs discussion draft of their action plan against base erosion and profit shifting, says Louise Vosloo, Director at Deloitte.
“The draft report focuses on three areas,” says Vosloo. The first is the development of treaty provisions and domestic rules to prevent the granting of treaty benefits in inappropriate circumstances. The second is focused on clarification of the fact that tax treaties are not intended to be used to generate double non-taxation. The third area concerns identifying the tax policy considerations that countries should assess before entering into a treaty with another jurisdiction.
The OECD identifies treaty shopping, which has been a long standing issue, as a primary area of concern that is most commonly caused by people trying to circumvent limitations provided in a treaty.
“Although the OECD has been fighting this battle for some time, they now aim to take action to deal with the problem. They intend to accomplish this by including in the preamble within treaties’ titles that the focus of Contracting States is on the prevention of tax avoidance. By adopting this approach they will specifically avoid the creation of opportunities for treaty shopping.”
“The OECD also intends to incorporate specific and general anti-abuse provisions in the treaties. One specific anti-abuse rule that is envisaged is that a benefit will not be granted in respect of an item of income if it is reasonable to
conclude that the benefit is one of the main purposes of any arrangement or transaction resulting directly or indirectly in that benefit,” continues Vosloo.
“The anti-abuse provisions discussed in the draft are similar to aspects seen in most of the US Model Tax Convention and recently negotiated US income tax treaties. The newly negotiated US tax treaties contain a “limitation on benefits” article which the OECD draft could include in their Model Tax Convention. However, the limitation of benefits rule that the OECD wishes to incorporate, is notoriously complex and places an extremely onerous compliance burden on the taxpayer,” says Vosloo.
Specific anti-avoidance rules that the OECD envisages incorporating include the deletion of the residency tie breaker clause that applies to dual-resident entities.
This clause confirms that where a company has dual residency, its residency is assumed to be located where their place of effective management is located.
The suggested deletion of this clause by the OECD sees residency of the entity being determined by mutual agreement between the relevant jurisdictions. Without such an agreement in place the company will not be entitled to any treaty benefits.
“The deletion of the tie breaker clause has already been incorporated in the newly negotiated Mauritius/South Africa treaty, which takes effect in January 2015. South African companies with an entity in Mauritius should therefore ensure that they do not create a dual residency for themselves by effectively managing the Mauritian entity from South Africa.”
“There is no guarantee how long these mutual agreement procedures may take. Companies therefore run the risk of finding themselves hanging without the benefit of any treaty relief if they are found guilty of treaty shopping for the most beneficial tax position without actually being a resident of the relevant state,” says Vosloo.