Abuse of tax treaties has been cited by Organization for Economic Cooperation and Development (OECD) as a key source of base erosion and profit shifting (BEPS). The Multilateral Instruments as Action 15 (MLI) helps the fight against BEPS by implementing the tax treaty-related measures developed through the BEPS Project in existing tax treaties in a synchronized and efficient manner. These measures include:
- Action 6: Prevent treaty abuse
- Action 14: Improve dispute resolution
- Action 7: Prevent the artificial avoidance of permanent establishment status and
- Action 2: Neutralise the effects of hybrid mismatch arrangements.
In addition, BEPS has been referred to tax planning strategies that exploit gaps and mismatches in tax rules to artificially shift profits to locations with no/low tax rates and no/little economic activity, resulting in the following outcomes:
- Little or no corporate tax being paid
- Annual revenue losses for governments of at least 100 – 240 billion USD, equivalent to 4-10% of the global corporate income tax revenue.
Recognizing that governments lose substantial corporate tax revenue because of aggressive international tax planning that has the effect of artificially shifting profits to locations where they are subject to non-taxation or reduced taxation, the Convention operates to modify tax treaties between two or more Parties to the Convention. It shall therefore not function in the same way as an amending protocol to a single existing treaty, which would directly amend the text of the Covered Tax Agreement; instead, it will be applied alongside existing tax treaties, modifying their application in order to implement the BEPS measures.
The Multilateral Instruments provides model rules to be adopted by jurisdictions in their bilateral treaties. These model rules include the following:
Part I. Scope and Interpretation of terms
- Article I – Scope of the convention: It defines the scope of application of the Convention. The Convention therefore modifies all Covered Tax Agreements as defined in Article 2(1)(a).
- Article 2 – Interpretation of Terms
- Covered Tax Agreement: has been defined as an agreement for the avoidance of double taxation with respect to taxes on income (whether or not other taxes are also covered)
- Party: is used throughout the Convention to refer to States, as well as jurisdictions which have signed the Convention
- Contracting Jurisdiction: has been referred to mean the States, jurisdictions or territories that are parties to a Covered Tax Agreement.
- Signatory: refers to States and jurisdictions that have signed the Convention.
Application in Kenya
- Pursuant to Article 2, Kenya has wished the following agreement(s)to be covered by the Convention: Canada, Denmark, France, India, Italy, Mauritius, Netherlands, Norway, Qatar, South Africa, Sweden, United Kingdom, Seychelles and United Arab Emirates.
Part II. Hybrid Mismatches.
- Article 3 – Transparent entities: The Action 2 Report which reads “Neutralising the Effects of Hybrid Mismatch Arrangements”, produced new Article 1(2) of the OECD Model Tax Convention, which addresses income earned through transparent entities. The text of that new Article 1(2) reads;
“For the purposes of this Convention, income derived by or through an entity or arrangement that is treated as wholly or partly fiscally transparent under the tax law of either Contracting State shall be considered to be income of a resident of a Contracting State but only to the extent that the income is treated, for purposes of taxation by that State, as the income of a resident of that State”
- Article 4- Dual Resident Entities: modifies the rules for determining the treaty residence of a person other than an individual that is a resident of more than one Contracting Jurisdiction, and is based on the text of Article 4(3) of the OECD Model Tax Convention.
- Article 5- Application of Methods for Elimination of Double Taxation
Application in Kenya
- Pursuant to Article 3(6) of the Convention, Kenya has confirmed that all Covered Tax agreements (Canada, Denmark, France, India, Italy, Mauritius, Netherlands, Norway, Qatar, South Africa, Sweden, United Kingdom, Seychelles and United Arab Emirates) do not contain the provision described in Article 3(4) [that is not subject to a reservation under Article 3(5)(c) through (e).
- Pursuant to Article 4(4) of the Convention, Kenya has considered that the following agreement(s) contain a provision described in Article 4(2) that is not subject to a reservation under Article 4(3)(b) through (d).
- Pursuant to Article 5(8) of the Convention, Kenya reserves the right for Article 5 not to apply with respect to all of its Covered Tax Agreements.
Author: Eddie Opiyo