Multilateral Convention to Implement Tax Treaty Related Measures to Prevent Base Erosion and Profit Shifting

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1 Multilateral Convention to Implement Tax Treaty Related Measures to Prevent Base Erosion and Profit Shifting A briefing note prepared for the Finance and Expenditure Committee Policy and Strategy, Inland Revenue January 2018

2 Introduction 1. This briefing provides a summary of the Multilateral Convention to Implement Tax Treaty Related Measures to Prevent Base Erosion and Profit Shifting (referred to as the Multilateral Instrument or MLI) which New Zealand signed on 7 June 2017 and is currently being considered by the Finance and Expenditure Committee (the Committee). 2. The MLI is a multilateral international treaty that will quickly and efficiently modify a significant number of double tax agreements (DTAs) to include the treaty-related recommendations coming out of the G20/OECD Action Plan on base erosion and profit shifting (BEPS). The BEPS Action Plan contains a range of recommendations to address tax avoidance by multinational enterprises. 3. Adopting the MLI is a core part of New Zealand s policy response to BEPS and the OECD s recommendations. BEPS measures will also be implemented through domestic law, namely, the Taxation (Neutralising Base Erosion and Profit Shifting) Bill (the Bill) which is also currently before the Committee. The briefing prepared for the Committee on the Bill outlines the background to the BEPS initiative in more detail. Purpose of the Multilateral Instrument 4. DTAs are bilateral international treaties designed to reduce tax impediments to crossborder services, trade, and investment without creating opportunities for non-taxation or reduced taxation through tax avoidance or evasion. DTAs also enable tax administrations to assist each other in the detection and prevention of tax evasion and avoidance. While DTAs are beneficial for taxpayers, investors, and governments themselves, there is the potential for these bilateral agreements to be misused to reduce or eliminate a multinational s worldwide tax. Misuse of DTAs in this way has been a feature of a number of cross-border tax avoidance arrangements. The BEPS Action Plan includes a number of recommend changes to treaties in order to prevent their misuse. 5. The treaty measures contained in the MLI are a combination of minimum standard and best practice provisions that amend DTAs to prevent them from being used to facilitate multinational tax avoidance. Countries that commit to solving BEPS are expected to adopt the minimum standard provisions and will be subject to OECD peer review to ensure they meet this commitment. 6. The minimum standard provisions apply automatically to a given DTA if the parties to the DTA sign the MLI. On the other hand, the best practice provisions are optional, and will only modify a treaty if both parties to a DTA sign the MLI and agree to adopt them. 7. This is a compromise between ensuring the MLI is as effective as possible in countering BEPS (which requires some provisions be mandatory), and promoting a wide uptake of the MLI (which requires some flexibility for countries to decide which provisions of the MLI they want to adopt). The best practice provisions, while optional for the MLI, now

3 form part of the OECD Model Tax Convention following the most recent update in December 2017 and New Zealand s negotiating model tax convention The measures in the MLI include: general treaty anti-abuse rules; rules to prevent the artificial avoidance of permanent establishment (PE) status (the existence of a PE of an enterprise in a country allows that country to tax the enterprise s profits, so avoiding having a PE in a country can allow a multinational to avoid tax in that country); rules to neutralise hybrid mismatch arrangements that have a treaty aspect; and improved mechanisms for dispute resolution. 9. There are currently 78 signatories to the MLI. This shows that even though the MLI is a novel legal instrument, there is significant commitment to the success of the instrument and the resolution of BEPS more generally. Advantages for New Zealand of entering into the Multilateral Instrument 10. The main benefit of the MLI is that it allows New Zealand to update and strengthen the majority of its DTAs, and meet the BEPS treaty minimum standards, without entering into bilateral negotiations with each of its treaty partners. This is significant given our limited negotiating resources. By strengthening our DTAs, New Zealand protects its tax base against multinational tax avoidance. 11. At the time of signing, New Zealand included 36 of its 40 DTA as agreements to be covered by the MLI, based on the jurisdictions expected to sign the MLI. At this stage, it is likely approximately 28 of New Zealand s DTAs will be amended by the MLI. New Zealand s approach to the MLI 12. Some jurisdictions have chosen to adopt only the minimum standard provisions, while others have chosen to adopt a combination of minimum standard and optional provisions. 13. In order to make the best use of the MLI to protect the New Zealand tax base from multinational tax avoidance, New Zealand s strategy is to adopt as many of the MLI provisions as possible (both minimum standards and optional provisions), where they are in line with New Zealand s overall treaty policy, which is based on the OECD Model Tax Convention. This will give New Zealand the best chance of strengthening its DTAs with as many jurisdictions as possible and will introduce consistency across New Zealand s treaty network. 14. As a small capital importing nation, the majority of the MLI provisions are in line with New Zealand s treaty policy and tax policy more generally, as they protect New Zealand s tax base. 1 New Zealand, like most of its treaty partners, bases its negotiating model on the OECD Model Tax Convention, with some differences to account for unique features of the New Zealand economy.

4 15. In particular, New Zealand has been a strong supporter of the work undertaken at the OECD (both as part of the BEPS project and outside the BEPS project) to ensure that a PE exists where there is adequate presence in a country. This protects New Zealand s right to tax the business profits of multinationals operating here, and is also consistent with the domestic law PE anti-avoidance measure contained in the Bill. Disadvantages for New Zealand of entering into the Multilateral Instrument 16. Some aspects of the MLI positions are likely to marginally increase compliance costs. For example, the new so-called dual-resident entity provision which applies when a nonindividual such as a company is tax resident in two different countries will require taxpayers to ask the relevant revenue authorities to decide on a single country of residence based on a number of different factors, whereas the current provision in many DTAs contains a black letter test that does not generally require taxpayers to seek approval from the revenue authorities (although 8 of New Zealand s DTAs already contain the MLI provision and it has not, to our knowledge, been problematic). To mitigate the compliance costs associated with the most common dual-residence scenarios, officials will seek to produce guidelines that streamline the process for determining residence. 17. Because the provisions in the MLI have been drafted more broadly than they otherwise would for an amending protocol (in order to take account of the fact that the MLI must be able to apply to not one DTA, but several thousand), there can be some ambiguity in how the MLI applies to a particular DTA. This again may increase compliance costs. 18. Commercial publishers are likely to produce consolidated versions of DTAs and the OECD has produced a comprehensive matching database that allows users to determine how any given DTA is modified by the MLI. The OECD has also produced guidance on the application of the MLI. 19. The MLI provisions are reciprocal and therefore would also affect New Zealand businesses operating overseas. Accordingly, by entering into the MLI, New Zealand businesses operating overseas may be more likely to, for example, have a PE in another country that will allow that country to tax some of its businesses profits. While this may be disadvantageous for some individual businesses, the new provisions are principled and represent a fair allocation of taxing rights between countries. It should be noted that historically New Zealand s approach in its DTAs to determining whether a PE exists has been broader than that contained in the OECD Model Tax Convention. 20. The new rules also resolve a longstanding difference in the way the previous PE provisions applied between common law and civil law jurisdictions, which meant they were not fully reciprocal. 21. As well as being incorporated into the new OECD Model Tax Convention, the new rules will also form the basis of New Zealand s future bilateral treaty negotiations and so are likely to become fairly standard treaty provisions over time. The new MLI PE rules are

5 also consistent with New Zealand s proposed domestic law PE anti-avoidance provision, and accordingly, it is principled to agree to the MLI provision to provide our treaty partners with reciprocity. On balance, the new PE and other optional MLI provisions are in New Zealand s overall interests. Next Steps 22. Following successful completion of Parliamentary Treaty Examination, New Zealand will give effect to the MLI under domestic law by means of an Order in Council. Following the completion of domestic entry into force procedure New Zealand will be required to ratify the MLI by depositing its instrument of ratification with the Depositary of the Multilateral Instrument, the Secretary-General of the OECD.