The global economy is growing rapidly coupled with integration of national economies and markets. This growth has created an opportunity for profit shifting by Multinationals from high-tax jurisdictions to low-tax jurisdictions through treaty shopping; which has been cited by OECD Inclusive framework as one of the major sources of BEPS concerns.
Against that background, OECD developed a 15-point action plan to address base erosion and profit shifting (BEPS) along three key pillars;
- Introducing coherence in domestic rules
- Reinforcing substance requirements in the existing international standards
- Improving transparency and certainty in the system
The BEPS have been designed to be implemented in the domestic tax laws via treaty provisions through multilateral instrument ratification. Therefore Action 6 identifies treaty abuse and in particular treaty shopping as one of the most important source of BEPS concerns. In order to safeguard against such strategies, the treaty abuse as an anti-abuse rule recommends the following:
- A clear statement that the states that enter into a treaty intend to avoid creating opportunities for non-taxation. This has been captured by article 6 Part III of treaty abuse under purpose of covered tax agreement with a preamble text that reads;
(State A) and (State B),
Desiring to further develop their economic relationship and to enhance their co-operation
in tax matters, intending to conclude a Convention for the elimination of double taxation with respect to taxes on income and on capital without creating opportunities for non-taxation or reduced taxation through tax evasion or avoidance (including through treaty-shopping
arrangements aimed at obtaining reliefs provided in this Convention for the indirect benefit of residents of third States)
- The second strategy has been captured well under article 7 prevention of treaty abuse in relation to specific and general anti-abuse rules.
- The specific anti-abuse rule, Limitation on Benefit (LOB) limits the availability of treaty benefits to entities that meet certain conditions. These conditions shall be based on the legal nature, ownership in and general activities of the entity.
- The general anti-abuse rules the principal purpose test (PPT) shall address other forms of treaty abuse not covered under LOB rule. They include treaty shopping situations. The rule asserts that if one of the principal purposes of transactions or arrangements is to obtain treaty benefits, 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.
- In summary, Countries are required to implement this common intention by including in their treaties: the combined approach of an LOB and PPT rule, the PPT rule alone, or the LOB rule supplemented by a mechanism that would deal with conduit financing arrangements not already dealt with in tax treaties.
- The other new anti-abuse rules have been put forth to be included in tax treaties in order to address other forms of treaty abuse. The targeted rules addresses;
- Certain dividend transactions as captured under article 8 which is intended to lower artificially withholding taxes payable on dividends
- Transactions that circumvent the application of the treaty rule that allows source taxation of shares of companies that derive their value primarily from immovable property under article 9 of MLI.
- Article 10 – Situations where an entity is resident of two Contracting State.
- Article 11,12 and 13 – situations where the State of residence exempts the income of permanent establishments situated in third States and where shares, debt-claims, rights or property are transferred to permanent establishments set up in countries that do not tax such income or offer preferential treatment to that income.
- The action 7 report cited that splitting up of contracts is a potential strategy for the artificial avoidance of permanent establishment status through abuse of the exception in Article 5(3) of the OECD Model Tax Convention.
- Lastly article 15 is intended to apply to provisions of a Covered Tax Agreement that have been modified by a provision of the Convention that uses the term “closely related to an enterprise”.
Few MLC Applications in Kenya Domestic Treaty
- Article 7 – Prevention of Treaty abuse: Pursuant to Article 7 of the Convention, Kenya has chosen to apply the Simplified Limitation on Benefits Provision pursuant to Article 7(6) to all Covered Tax Agreements and considers that the following agreement(s) contain(s)a provision described in Article 7(14). They include France, India and Qatar.
- Article 8 – Dividend Transfer Transactions: Pursuant to Article 8 of the Convention, Kenya has reserved the right for the entirety of Article 8 not to apply to its Covered Tax Agreements to the extent that the provisions described in Article 8(1) already include a minimum holding period shorter than a 365-day period. The agreements that contain provisions that are within the scope of this reservation include; Canada, Denmark, Italy, Norway and Sweden.
The agreements that do not contain reservation but contain a provision described in Article 8 include; France, India, Mauritius, Netherlands, Qatar, South Africa, Seychelles and United Arabs Emirates.
Author: Eddie Opiyo