Differences among national tax systems create arbitrage opportunities for taxpayers looking to minimize their tax burdens. While advantageous to the bottom line, these tax planning strategies are said to deprive public coffers of US$100 billion to US$240 billion each year – 4-10% of global corporate tax revenue, according to the Organization for Economic Cooperation and Development (OECD).
To combat this evasion, the OECD and G20 launched the BEPS initiative in 2015. An acronym for Base Erosion and Profit Shifting, BEPS represents the most significant overhaul of the international tax system in nearly a century. The package consists of fifteen “Actions” that provide minimum standards and best practices for closing loopholes and increasing transparency over international tax matters.
To streamline implementation, the project includes a “multilateral instrument” (MLI) that incorporates BEPS precepts into the existing tax treaties. Thanks to the MLI, 3000+ treaties can be amended simultaneously instead of renegotiated one-by-one. July 1, 2018 represents a milestone in implementation, as the MLI enters into force for the first countries that officially joined the agreement.
Below, we summarize how the July 1 affects the withholding tax universe, who is impacted by it, and what investors can expect in the coming year.
How does BEPS apply to withholding tax recovery?
Of the fifteen Actions, No. 6 is most directly applicable to GlobeTax and withholding tax recovery. Titled “Preventing the Granting of Treaty Benefits in Inappropriate Circumstances”, the Action seeks to eliminate double taxation without creating opportunities for reduced or non-taxation.
Considered broadly, the global tax treaty system exists to incentivize foreign investment by limiting double taxation of cross-border dividend and interest income. Although double taxation treaties are designed to only benefit residents of signatory nations, “treaty shopping” has become an increasingly common avoidance/arbitrage strategy. In this practice, investors leverage entities like shell companies, offshore funds, or other special purpose vehicles to obscure their residency and gain access to otherwise inaccessible treaty benefits.
When principles from Action 6 are incorporated into existing treaties, investors in transparent structures like partnerships should expect to contend with stricter beneficial owner identification requirements. In addition to understanding beneficial owners, tax authorities will analyze an entity’s “economic purpose” and deny entitlements if it appears that the entity’s main function is tax arbitrage. Authorities will also assess economic purpose at the tax reclaim level. Even if the entity’s overall purpose is sound, tax authorities will consider whether the investment was undertaken primarily for tax reasons.
In addition to fund structures, “substantial” investors will also be impacted by Action 6. Under these rules, stockholders who own more than a certain percentage of a company – often 5-10%, depending on treaty provisions – may need to meet minimum holding periods before securing access to favorable tax rates.
Who is impacted?
Although nearly 80 countries have signed on to MLI, the July 1 date does not immediately affect all signatories.
After signing the MLI, each country’s government must ratify the terms of the instrument. Once ratified, each country must then deposit their instruments of ratification with the OECD to officially join the agreement. In March, Slovenia became the fifth jurisdiction to deposit its instrument of ratification, joining Austria, Isle of Man, Jersey, Poland and triggering the July 1 entry into force. New Zealand, Serbia, and the United Kingdom have since followed suit, submitting their instruments in early June.
To be sure, the only treaties immediately impacted by the MLI are those that are considered “covered.” Signatories have the freedom to decide which of their treaties will be “covered” and, to date, that list only includes treaties between Austria, Isle of Man, Jersey, New Zealand, Poland, Serbia, Slovenia, and Sweden.
What to look for next?
While the MLI enters into force on July 1 for the first five countries to join the agreement (later dates will be announced for New Zealand, Serbia, Sweden, and United Kingdom), the withholding tax-related provisions will not be implemented in practice until January 1, 2019.
The list of impacted treaties is expected to grow as more jurisdictions complete the ratification procedures in 2018. For example, Lithuania has ratified the MLI in its home legislature, but has not yet deposited its instruments of ratification with the OECD. Any countries that submit their instruments before October 1, 2018 will see their treaties modified in January 2019 alongside those listed above.
As a closing note, the status of the United States bears mentioning, even if there is not much to report. The U.S. has signed onto BEPS’ Inclusive Framework, indicating a commitment to meeting a series of minimum standards. However, the U.S. has neither signed the MLI nor indicated plans to do so, citing the sufficiency of the language found in the country’s existing double taxation treaties. As a result, companies and investors who rely on U.S. tax treaties need not expect significant upheaval from this legislation, at least for the time being.