Most of the OECD action plans target intra-group multinational tax planning. Action point 6 (AP6) is somewhat of an outlier; it has a potentially much wider impact. The final report was therefore awaited with interest.
On an initial reading, the proposals in the AP6 final report seem relatively concrete. Indeed, many of them are unsurprising given the previous draft reports on AP6. However, the key point to note is that this "final" report on AP6 is far from final; there are still material drafting, timing, implementation and guidance issues outstanding.
While there are a number of other proposals included in the report, the main focus of the report (and of this article) is in the area of "treaty shopping". This is a notoriously difficult term to define. What has been agreed is that, as a minimum, Member States should adopt one of the following three approaches in their treaties to prevent treaty shopping:
Option 1: incorporate a more general anti-abuse rule based on the principal purposes of transactions or arrangements (the principal purposes test or "PPT" rule);
Option 2: incorporate a specific anti-abuse rule based on the limitation-on-benefits provisions included in treaties concluded by the US and a few other countries (the "LOB rule") together with some, as yet undecided, anti-conduct mechanism; or
Option 3: incorporate both the PPT and LOB rules.
Put like that, the rules look pretty concrete but that hides the huge amount of detail that remains outstanding for a number of reasons.
First, some of the key questions about the application of these rules to CLOs, credit funds, private equity funds and other similar vehicles remain outstanding and will be the subject of a further report in 2016.
Second, and critically, the minimum standard above does not consist of a single set of changes to be made to all relevant treaties. Rather, the recommendation is that, as a minimum, each state adopt one of the above three options; different countries will obviously have different preferences. Moreover, when you dig into the 100-page report, each of those three options has some other drafting options or suggestions that needs to be considered.
So how will this all play out? The OECD's idea had been that all relevant bilateral tax treaties would be amended by one multilateral instrument. In principle, that would seem to be possible and we had hoped to see a draft imminently. Given the above, though, the drafting in the multilateral instrument is going to be materially more complex than the OECD had originally hoped.
One could imagine (though this is no more than supposition) that the multilateral instrument may allow each state to pick a particular set of default provisions that would apply when it is the country of source. But that could mean that two different countries pick different provisions. In theory, that may not matter, since the source of a particular cash sum would be in one country or the other but not in both. However, certain jurisdictions may want to be clear that they are not getting a "raw deal". If the default provisions for the source state are markedly different between the two jurisdictions, one could imagine at least one of the two jurisdictions wanting to negotiate a more balanced package just between the two of them. Given that circa 90 states (including the UK and the US) are discussing being a party to the multilateral instrument, that would be far more bilateral discussions than anyone would really want. In short, the process may drag on for some while longer.
The PPT rule
Where adopted, the PPT rule would deny treaty benefits if "it is reasonable to conclude, having regard to all relevant facts and circumstances, that obtaining [the treaty benefit] was one of the principal purposes [of the relevant arrangements] unless it is established that granting that benefit in these circumstances would be in accordance with the object and purposes of the relevant provisions of [the treaty]".
As the UK courts have found in cases such as Lloyds TSB Equipment Leasing (No 1) -v- Commissioners [2014] EWCA Civ 1062, a "main purpose" test can be a very blunt instrument in a complex world. Indeed, that is why the US, for one, has very much shied away from such a rule and included LOB clauses in many of its treaties instead.
Interestingly, back in August 2011, HMRC consulted on the proposed introduction of an anti-treaty abuse rule drafted similarly to the PPT rule that is now being proposed. Back in 2011, the issues and difficulties that a PPT rule would raise caused HMRC to announce they were dropping the proposal even before the consultation on it had ended. Four years on, the complications and issues that this sort of PPT rule would lead to have not reduced but the desire to deal with certain aspects of what is perceived as cross-border tax avoidance has changed out of all recognition.
The drafting of this PPT rule means that one needs to consider the purpose of a treaty. The introductory language is being clarified to state that the treaty is not designed to allow double non-taxation. However, again, that is a relatively blunt concept in a world of funds, multinationals and the free movement of capital. Entities investing in countries which have adopted a PPT will thus generally need to consider the relevant guidance in order to interpret it. There are some guidance examples in the AP6 Report but, as so often is the case, many are fairly clearly on one side or other of the line. The very need for guidance illustrates that different people can have differing interpretations of this sort of test.
The LOB rule
The intricacies of the LOB rule are beyond the scope of this article, particularly as parts of the rule will remain in draft until the implications of the recent US consultation on its own LOB rules can be absorbed. However, the US has incorporated a LOB rule in many of its treaties so it will be familiar to many. The advantage of a LOB rule is that it is a more prescriptive test which is therefore easier to apply to particular fact patterns. The disadvantage is that it can lead to some fairly arbitrary results which may therefore lead to a certain amount of restructuring.
Opting out?
All countries have agreed to adopt at least the minimum standard. However, the OECD report notes that those source states that are not "concerned by the effect of treaty-shopping on [their] own taxation rights … will not be obliged to apply … the LOB or PPT" as long as their treaty partner can impose the relevant requirement where that partner is the state of source.
Most countries would be concerned about transactions which they themselves consider to be "treaty shopping" but the real import of the above is that it allows certain source countries to be more relaxed about what actually constitutes "treaty shopping" if they so choose. That should mean that the UK could, if it so chose, continue to treat the arrangements set out in INTM332060 in the same way as currently.
Grandfathering
There is little indication of the final implementation timetable into domestic laws. However, there is one critical grandfathering point that relates to loan agreements. The drafting of many loan agreements effectively means that the borrower takes on any withholding tax change of law risk (though in many cases the intricacies of the drafting mean that that could be clearer). What that means in practice is that if AP6 were implemented in a way that prevented, for example, CLOs or credit funds from continuing to benefit from treaty relief, the CLO or credit fund itself would often be effectively protected. The way that works is that the CLO or credit fund would be entitled to a "gross up" from the relevant borrower. Thus, the impact would be that such borrowers in, for example, the UK, would immediately have a 25 per cent (or possibly only 20 per cent given a historic HMRC view) increased payment obligation under such loans. Of course, one might say that that could be dealt with through appropriate transitional rules, but that shows the other major impact, namely the reduction in credit availability that would result in certain markets if material numbers of CLOs or credit funds ceased to be able to benefit from treaty relief.
Implications for funds and CLOs
The report contains a number of options for Member States to consider in relation to how certain public mutual funds (e.g. UCITS funds) should be treated. The report calls these funds "CIVs" and sets out a number of options for Member States to consider. The position for private funds, such as private equity funds, real estate funds, credit funds and CLOs ("non-CIVs") is to be the subject of further work. There has been extensive feedback provided to the OECD that more clarity is required for such funds and a number of proposals have been sent to the OECD. Given that the OECD has not provided a single model proposal for CIVs, it may be that the OECD will struggle to do anything other than propose a broad range of options for non-CIVs.
Finally, it is also worth noting that the final report leaves open the question of whether source states ought to deny withholding exemptions where recipients benefit from "special" tax regimes in their state of residence. That rule could also impact a number of fund structures if implemented widely.
Next steps
We await the draft of the multinational instrument for a firmer indication of how AP6 will actually impact commonly seen structures.
Please click on the links below for the other articles in the November 2015 tax newsletter:
Keep up to date
Sign up to receive the latest legal developments, insights and news from Ashurst. By signing up, you agree to receive commercial messages from us. You may unsubscribe at any time.
Sign upThe information provided is not intended to be a comprehensive review of all developments in the law and practice, or to cover all aspects of those referred to.
Readers should take legal advice before applying it to specific issues or transactions.
