Tax insurance and the BEPS Multilateral Instrument

22 May 2018

The Organisation for Economic Cooperation and Development (“OECD”) announced the entry into force of the Multilateral Convention to Implement Tax Treaty Related Measures to Prevent Base Erosion and Profit Shifting (“MLI”) on 1 July 2018. This may significantly increase tax risks relating to the tax treaties of ratifying countries.

The MLI will modify existing bilateral tax treaties, in relation to hybrid mismatch arrangements, tax treaty abuse and permanent establishments, amongst others. Once all signatory countries have ratified the instrument, an existing network of approximately 1,100 tax treaties may be affected. (The UK is expected to ratify the MLI in 2018.)

From a tax insurance perspective, the following two tax risks introduced by the MLI are likely to be of interest:

Principal Purpose Test (“PPT”)

A so-called PPT, to test a taxpayer’s eligibility for tax treaty relief, is being adopted under the MLI. The PPT is an anti-abuse rule based on the principal purpose of a transaction or arrangements. Under the PPT, if one of the principal purposes of transactions or arrangements is to obtain treaty benefits (for example obtaining a lower withholding tax rate), these benefits would be denied unless it is established that granting these benefits would be in accordance with the object and purpose of the provisions of the treaty.

Before the introduction of the PPT, a taxpayer would often be entitled to tax treaty relief provided it had “substance” (e.g. office, employees etc.) in the other contracting state, irrespective of whether it had a principal purpose to invest via a particular country in order to obtain tax treaty relief.

Clearly the introduction of the PPT test by the MLI may create risks and uncertainties relating to the continued application of a particular tax treaty and its tax relief. Under certain circumstances, insuring against these risks may be an effective solution for taxpayers.

Permanent Establishment (“PE”)

In a tax treaty context, a non-resident corporate taxpayer will typically be taxable in a particular country if it has a PE (e.g. office, employees, dependent agent etc.) in that country. In order to avoid having a PE, taxpayers often used techniques to avoid the existence of the PE, for example through the replacement of distributors with commissionaire arrangements.

The MLI addresses challenges related to permanent establishments by modifying the PE definition and tightening it. A taxpayer may now suddenly risk having a tax exposure in a particular country, where this was not previously the case. Under certain circumstances, insuring against this risk may be an appropriate course of action.

For more information contact Leon Steenkamp, Head of Tax Insurance, on +44 20 7558 3994 or email leon_steenkamp@jltgroup.com.

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