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Out-Law Guide 6 min. read

The Multilateral Instrument (MLI) to amend double tax treaties


The MLI is an agreement by over 70 countries which will enable over a thousand double tax treaties to be interpreted in a way that implements the recommendations of the Organisation for Economic Cooperation & Development (OECD) which require changes to double tax treaties. The changes relate to hybrid mismatches, treaty abuse, artificial avoidance of permanent establishments and improving dispute resolution. This is part of the OECD's base erosion and profit shifting (BEPS) project to prevent international tax avoidance by multinational companies.

This guide was updated in August 2018.

All members of the OECD are obliged to implement the OECD recommendations which are minimum standards, but they do not have to sign the MLI. The US for example has not signed the MLI, but this is not a significant concern because the US's treaties already include many of the required provisions.

The MLI avoids the need for each country to separately renegotiate all its double tax treaties to make the changes, which would be a very time-consuming process.

Why is it important/why does it matter?

It matters because any person relying on a double tax treaty (DTT) after the MLI comes into force will need to check whether, and how, the treaty is affected by the MLI. This could affect both new arrangements and existing structures to the extent that income is received after the changes take effect.

A particular area which could affect many users of DTTs is the introduction of new provisions designed to prevent treaty abuse. The majority of DTTs are likely to need interpreting as if they contain a principal purposes test, and treaty benefits will be denied if this purposes test is failed.

The changes include improvements to the resolution of DTT disputes. This should be good news for taxpayers if it speeds up the resolution of DTT disputes or it enables resolution of disputes which would not otherwise be resolved and would therefore result in a taxpayer being taxed on the same income or gains in more than one country. The introduction of mandatory binding arbitration by some of the MLI signatories will be a particularly interesting and helpful development.

What do you need to know?

DTTs are changing in the areas of hybrid mismatches, treaty abuse, artificial avoidance of permanent establishments and dispute resolution. The published texts of DTTs will not tell the whole story; the MLI requires that the DTT should be interpreted in accordance with the MLI. It will be important to know whether (and when) the jurisdictions have ratified the DTT.

The MLI will not affect every DTT in the same way. The MLI provides for a degree of optionality and each jurisdiction can make choices as to how the MLI applies to amend DTTs.

What does it mean if a country has signed up to the MLI?

Signing up to the MLI does not mean that all of a particular country's DTTs will be affected by it. Each country may choose the DTTs to which it wishes the MLI to apply, those DTTs being 'covered agreements'.

Even when a DTT is a covered agreement, the MLI gives a considerable amount of flexibility to countries to choose how and whether many of the MLI provisions apply.

Some of the OECD recommendations which the MLI implements are minimum standards which means all OECD states must sign up to them. Others are recommendations so countries can opt out of applying them or make 'reservations' on certain aspects, so that not all signatories will be signed up to everything.

Article 28 of the MLI sets out the specific provisions in respect of which countries may make reservations. For example, countries may make reservations so that Article 4 of the MLI does not apply it its covered agreements. Article 4 would otherwise provide that where a company is dual resident, the relevant countries decide where the company in question is resident based on all relevant factors - which is much more vague than the existing test which in many cases looks solely at the location of a company's effective management.

Many articles of the MLI set out options which countries may choose. For example Article 5 provides for 'Application of Methods for Elimination of Double Taxation', and sets out a variety of options: a party may choose to apply Option A, Option B, Option C, or may choose to apply none of the Options. This is an example of where a notification is required to state which option the county has chosen.

The reservations and notifications provided by each jurisdiction at the time of signing have been published by the OECD – and these are updated as countries finalise that list when they deposit their instrument of ratification.

How is it going to work?

The MLI will apply to treaties between countries where both (a) they have chosen to apply the MLI to the relevant treaty and (b) any options they have chosen are compatible.

For example, the MLI requires the incorporation in DTTs of anti-abuse provisions which are intended to prevent treaty misuse for tax avoidance purposes. The default position is a principle purpose test, which looks at the purpose of the arrangements. But there is an option to adopt a simplified limitation of benefits (SLOB) test in addition, a substance based test which looks at a company's presence in the relevant country, based on their legal nature, ownership and activities. The US has favoured such limitation of benefits clauses in its treaties for a number of years (though note that it has not signed up to the MLI). A SLOB will only apply if both jurisdictions choose a SLOB or if one does and the other state has opted to apply a SLOB if its counterparty has chosen that option.

The MLI does not amend the text of an affected treaty; instead it provides that the treaty should be interpreted in accordance with the MLI. Working out how a treaty should be interpreted can be complicated. Having located the relevant treaty, you need to check whether and when each party ratified the MLI to establish when it comes into force; and when the provisions take effect and then establish which provisions of the MLI apply to the treaty.

You also need to work out how the particular MLI provision affects the treaty; some apply in place of the existing provision, some modify it and some only apply in the absence of a provision in the DTT. The OECD is developing an online 'matching database' (see http://www.oecd.org/tax/treaties/mli-matching-database.htm) to assist with this process.

How are they going to implement it?

The MLI will come into force gradually on a jurisdiction by jurisdiction basis. Signing up to the MLI is only a first step – the MLI will only take effect in relation to a particular country's DTTs once it has been ratified by that country and it will only apply to the treaties specified. This process will vary according to each jurisdiction and its legislative processes.

As with other international measures, there will likely be some countries which felt they had to be seen to sign up to the MLI but may take their time on going through the ratification process.

How are countries putting it into their tax treaties?

The UK has said it will in due course publish versions of UK treaties as they fall to be interpreted in the light of the MLI. This will of course make the treaties much easier to interpret and it may be that other countries do the same.

As treaties get amended for other reasons, BEPS compliant provisions will be incorporated into the wording of the treaties themselves, so these treaties will no longer need to be subject to the MLI. For many treaties, the MLI will therefore just be an interim solution. We can see this by the fact that the UK has removed the UK/Germany treaty from its list of covered treaties, because it is going to enter into a bilateral agreement to make the necessary changes.

A practical timeline

The MLI itself entered into force on 1 July 2018 for the earliest signatories, the trigger being prior ratification by five jurisdictions. The fact that the MLI has entered into force does not mean that it applies yet to interpret individual double tax treaties. As far as individual countries are concerned, the MLI 'comes into force' (as distinct from 'takes effect') on the first day of the month following the end of the period of three months after they have deposited their instrument of ratification with the OECD (or if later on 1 July 2018).

So in many ways, signing up to the MLI was a statement of intent. It is only when a country ratifies the MLI pursuant to its own legislative processes that the countdown starts for the specified date when that country's DTTs will be affected by the MLI.

The provisions will not apply immediately from the date the MLI comes into force, the effective dates are slightly later. For withholding purposes, the MLI will take effect from the beginning of the calendar year after the MLI comes into force for each of the parties to the relevant treaty and for other taxes it will generally take effect from the beginning of the next fiscal year. The MLI will therefore not affect the interpretation of any of the UK's treaties before 1 January 2019 in relation to withholding taxes and 1 or 6 April 2019 for other taxes (assuming the instrument of ratification is deposited soon). The arbitration provisions are slightly different and generally come into force once the MLI is in force in both relevant jurisdictions.

Jeremy Webster is a corporate tax expert at Pinsent Masons, the law firm behind Out-law.com.

This guide is based on an article which first appeared on Bloomberg BNA and is reproduced with permission.

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