Master thesis. EUCOTAX Wintercourse LOB clauses in a Dutch and comparative perspective

Transcription

1 Master thesis EUCOTAX Wintercourse 2016 LOB clauses in a Dutch and comparative perspective Name: Manouk van Meer Faculty: Department of Tax Law, Tilburg University Study: Tax Law Administration number: Date: 2 nd of June 2016 Supervisor: Dr. C. de Pietro

2 Table of contents List of abbreviations 5 Acknowledgements 6 1 Introduction Introduction Relevance of the research Problem statement Research questions Methodology Research structure 9 2 International perspective Introduction The BEPS Project Action 6: Preventing the Granting of Treaty Benefits in Inappropriate Circumstances Treaty shopping LOB clauses in general The LOB clause proposed by the BEPS Project The PPT rule proposed by the BEPS Project Is an LOB clause needed at international level? Conclusion 23 3 European Union perspective Introduction Fundamental freedoms Residence test (paragraph 1) Stock exchange test (paragraph 2 section c) Ownership test (paragraph 2 section e) Base erosion test (paragraph 2 section e) Business activity test (paragraph 3) Derivative benefits test (paragraph 4) Sub-conclusion 30 2

3 3.3 ACT IV GLO-case Justification? Proportionate? European Commission s reasoned opinion concerning the LOB clause in the Dutch-Japanese Tax Treaty Gottardo-case Open Skies-case Consideration of the reasoned opinion of the EC Anti-Tax Avoidance Package of the EC State aid Conclusion 40 4 Dutch perspective Introduction LOB clauses concluded by the Netherlands United States of America Japan Ethiopia Panama Hong Kong Bahrain Amendments of tax treaties with developing countries Differences and analogies in the aforementioned LOB clauses Dutch tax treaty policy Is an LOB clause needed at Dutch level? GAAR in Dutch tax law Beneficial ownership Residence clauses Interim conclusions A mechanism that would deal with conduit financing arrangements Conclusion 60 3

4 5 Legal comparison between EUCOTAX countries Introduction The LOB clause in the US Model Treaty Legal comparison of already concluded LOB clauses Position of the participating countries concerning the BEPS recommendations Conclusion 68 6 Conclusion and recommendations Introduction Analysis The BEPS Project and the recommendations of Action International perspective Dutch perspective Legal comparison European Union perspective Recommendation Final conclusion 81 References 82 Case law list 84 Other sources 85 4

5 List of abbreviations BEPS BNB BO CITA CIV CJEU EC ECJ EU GAAR HR IBFD LOB MFN OECD OECD MC PE SAAR UK US Base Erosion and Profit Shifting Beslissingen in Belastingzaken. Nederlandse Belastingrechtspraak Beneficial ownership Corporate Income Tax Act Collective investment vehicles Court of Justice of the European Union European Commission European Court of Justice European Union General anti-abuse rule Hoge Raad International Bureau of Fiscal Documentation Limitation-on-benefits Most-favoured-nation Organisation for Economic Co-operation and Development OECD Model Tax Convention Permanent establishment Specific anti-abuse rule United Kingdom United States of America 5

6 Acknowledgements As Prof. mr. E.C.C.M. Kemmeren very good described at the first meeting of the EUCOTAX Wintercourse project: It is tough, but it is fun. This exactly summarizes the whole project. The project has been very tough for me, because of the several meetings and of course the Wintercourse week in Vienna in April But, I also had a lot of fun at the meetings and while working with the other participating students. Firstly, I would like to thank my supervisor dr. Carla De Pietro for her support and great helpfulness through the whole project of the Wintercourse and the master thesis together. I am very grateful for her valuable comments and she has been very open for questions and comments from my side. Then, I would also like to thank the other members of the EUCOTAX Wintercourse staff, namely prof. dr. P.H.J. Essers, prof. mr. E.C.C.M. Kemmeren, drs. C.A.T. Peters and prof. dr. mr. D.S. Smit for their participation and comments during the meetings. Also a word of gratitude to drs. M. Vitullo for his great help with improving my writing and presenting in English. I also would like to thank the Dutch EUCOTAX team: Margot Kamphuis, Eline Marteijn, Niels Zuurbier, Kalid Amezoug and Casper Barbier. Together we had a lot of fun during the meetings and also during the Wintercourse week in Vienna. Since the legal comparison is made in Vienna during the Wintercourse week, I would also like to thank my chairman in Vienna, Niels Bammens, and the other students of my subtopic that helped me during the Wintercourse week and also after this week, namely Alexandra, Anasztázia, Axel, Curtis, Daniel, Jeanne, Karolina, Marie, Margherita, Saskia and Scott. Finally, I would like to thank my parents, friends and flatmates for supporting me and always listening when I needed to share my thoughts. It was tough, but it was fun! 6

7 Chapter 1: Introduction 1.1 Introduction In an increasingly interconnected world, national tax laws have not always kept pace with global corporations, fluid movement of capital, and the rise of the digital economy, leaving gaps and mismatches that can be exploited to generate double non-taxation. This undermines the fairness and integrity of tax systems. This is the first phrase to be found on the website of the Base Erosion and Profit Shifting Project (BEPS Project) of the Organisation for Economic Co-operation and Development (OECD). 1 Countries all over the world face the problems that are described in this phrase. The BEPS Project is a project in which countries work together to counteract these problems. On the 5 th of October 2015, the project released the Final Reports on the fifteen Actions that this project contains. One of the fifteen Actions is Action 6: Preventing the Granting of Treaty Benefits in Inappropriate Circumstances. In this Action, the BEPS Project recommends countries to include a Limitations-on-Benefits (LOB) clause in their tax treaties or a Principle Purpose Test rule (PPT rule), or a combination of both. An LOB clause is a specific antiabuse rule (SAAR) which can be included in tax treaties. LOB clauses limit the right to enjoy benefits of a treaty for certain companies and individuals. Several types of LOB clauses are possible, depending on the needs of the treaty partners. Besides, the OECD states in this Action that an LOB clause will be included in the OECD Model Convention (OECD MC). A PPT rule is a general anti-abuse rule which can also be concluded in tax treaties. The Netherlands is a Member of the OECD and hence it is possible that the Netherlands will implement the recommendations of the BEPS Project. Therefore it can be questioned whether LOB clauses would have a positive effect for the Netherlands, in the sense that it will guarantee a more effective way of combating tax avoidance and it would be another opportunity to tackle treaty shopping. 1.2 Relevance of the research The recommendation of the BEPS Project to implement LOB clauses in tax treaties is published recently and up until now there has been done no research on the effect of LOB clauses in the Netherlands. The Dutch perspective on LOB clauses has not been analysed. Therefore, it is needed to analyse and evaluate the effect of implementing LOB clauses in the Dutch tax treaty network. If the Dutch tax treaty policy should be amended, depends on the effect of LOB clauses in the Netherlands. 1 Phrase to be found at: 7

8 Besides, LOB clauses have been under discussion at European Union (EU) level, since in literature LOB clauses are frequently considered to be incompatible with EU law. The purpose of this thesis is to analyse what the added value is of both the international perspective on LOB clauses and the EU perspective on LOB clauses. Also is aimed to find a solution for EU Member States, taking into account the evaluation of the international perspective on LOB clauses, to develop a possibility to implement LOB clauses within the scope of the EU. 1.3 Problem statement To examine whether the implementation of an LOB clause in tax treaties would have a positive effect for the Netherlands and will guarantee a more effective way of combating tax avoidance, the problem statement will be the following: What is the impact of the OECD BEPS Project specifically concerning LOB clauses on Dutch tax law and to what extent should the Netherlands follow the OECD position and recommendations, also in the light of European Union tax law? 1.4 Research questions In order to come to an answer, the following sub-questions will be discussed: What is the BEPS Project? What is exactly recommended in Action 6 of the BEPS Project? Is an LOB clause needed at international level? Is the LOB clause, as proposed by the BEPS Project, compatible with European Union law concerning the fundamental freedoms and the concept of forbidden state aid? What are the similarities between the LOB clauses already included by the Netherlands and the LOB clause proposed by the BEPS Project? Is an LOB clause needed at Dutch level? Are there similarities between LOB clauses concluded by the Netherlands and concluded by the other countries and what is the attitude of these countries towards LOB clauses? Here, the legal comparison made in the EUCOTAX Wintercourse week in Vienna will be discussed. 8

9 1.5 Methodology In this thesis, the effects of the potential implementation of the LOB clause proposed by the BEPS Project in Action 6 for the Netherlands will be examined. To determine what the effects will be, the international perspective, European Union perspective and Dutch perspective concerning LOB clauses will be discussed. The research will be done largely by using case law and literature. Besides case law and literature, the Final Reports of the BEPS Project will be used to determine the international perspective. Case law of the Dutch Supreme Court 2 and literature will be used to establish the Dutch position. Case law of the Court of Justice of the European Union (CJEU) will be examined to determine what already has been judged concerning LOB clauses and its compatibility with EU law. Also different positions of authors in literature concerning the compatibility of LOB clauses with EU law will be described and analysed. Besides, there will be held a comparative analysis. This analysis will be based on the legal comparison that will be made in the EUCOTAX Wintercourse week in Vienna, comparing the positions of all participating countries. This comparative analysis will be used to determine whether other countries experience problems with the implementation and application of LOB clauses. The objectives of countries whether to implement LOB clauses can be used to decide what the effects for the Netherlands will be. Also the attitude of the countries towards LOB clauses and the implementation of LOB clauses as result of the BEPS Project will be discussed. 1.6 Research structure To answer the problem statement, the structure of this thesis will be the following. In Chapter 2 I will describe the international perspective on LOB clauses. Here I will discuss the BEPS Project and the recommendations of Action 6. I will determine whether an LOB clause is needed at international level. In Chapter 3 I will discuss the European Union perspective. The compatibility of LOB clauses with the fundamental freedoms of the European Union, as well as the concept of forbidden state aid will be discussed. Then, in Chapter 4 the Dutch perspective will be illustrated. The LOB clauses already concluded by The Netherlands in tax treaties will be described and also the Dutch tax treaty policy. I will end the Chapter with the question whether an LOB clause is needed at Dutch level. Furthermore, the comparative analysis made in Vienna will be discussed in Chapter 5. Finally, Chapter 6 will contain conclusions and recommendations as far as needed. 2 Hoge Raad, which is the highest judicial body in tax law in the Netherlands. 9

10 Chapter 2: International perspective 2.1 Introduction In the last years, international tax law has been on fire. Multinational enterprises like Google, Starbucks and Apple were obviously present in the media for effectively paying almost no taxes because of tax schemes structured all over the world. This resulted in the need for a solution that would counteract base erosion and profit shifting by multinational enterprises. The Organization for Economic Co-operation and Development (OECD) 3 together with the G20 4 started the Base Erosion and Profit Shifting (BEPS) Project. This BEPS Project is aimed at combatting tax avoidance. As a measure to counteract tax avoidance, the BEPS Project recommends countries in the Final Report of Action 6 to implement an LOB clause, eventual in combination with a PPT rule. In this chapter, I will outline what is exactly recommended by the BEPS project. The purpose of this Chapter is to determine whether LOB clauses are effective at combatting treaty shopping and whether it is needed to implement an LOB clause at international level. If LOB clauses should be implemented in tax treaties, depends on whether LOB clauses are needed. Only when the implementation of an LOB clause is needed, then it will be relevant to investigate what the effects for the Netherlands will be. Whether an LOB clause is needed on Dutch level will be discussed in Chapter The BEPS Project The BEPS Project developed an Action plan that consists of 15 Actions. The goal of the Action plan is reforming the international tax system to tackle tax avoidance. The 15 Actions equip governments with domestic and international instruments to address tax avoidance and ensure that profits are taxed where economic activities generating the profits are performed and where value is created. All Actions have a different problem to address. The Action plan identified the 15 Actions along three key pillars: introducing coherence in the domestic rules that affect cross-border activities, reinforcing substance requirements in the existing international standards, and improving transparency as well as certainty. The BEPS Project started in On the 5 th of October 2015, the 15 Actions have been completed. The Project released a Final Report for each Action. The measures that are proposed in the Final Reports need to be implemented in the domestic law of the participating countries. The BEPS Project expects

11 that, after implementation of the measures, profits will be reported where the economic activities that generate them are carried out and where value is created. 2.3 Action 6: Preventing the Granting of Treaty Benefits in Inappropriate Circumstances Action 6 of the BEPS project 5 is aimed at preventing the granting of treaty benefits in inappropriate circumstances, i.e. to prevent treaty abuse. The BEPS Action plan identifies treaty abuse, and in particular treaty shopping, as one of the most important sources of the BEPS concerns. Treaty shopping involves strategies through which a person who is not a resident of a state attempts to obtain benefits that a tax treaty concluded by that state grants to residents of that state, for example by establishing a letterbox company in that state. 6 In other words, a person who shops into an otherwise unavailable tax treaty via complicated structures is considered to be undertaking treaty shopping. 7 First, in the Final Report of Action 6 is recommended that when states enter into a tax treaty, they intend to avoid creating opportunities for non-taxation or reduced taxation through tax evasion or avoidance. Besides, an LOB rule will be included in the OECD MC. That rule will be based on provisions already found in a number of tax treaties concluded by the United States, but also some treaties concluded by Japan and India. Also, in order to address other forms of treaty abuse, a PPT rule will be included in the OECD MC. Countries have committed to ensure a minimum level of protection against treaty shopping. This is called the minimum standard. Concerning Action 6, this minimum standard contains the following. Firstly, countries will include in their tax treaties an express statement for that their common intention is to eliminate double taxation without creating opportunities for non-taxation or reduced taxation through tax evasion or avoidance. Secondly, countries will include in their tax treaties a combination of an LOB clause and a PPT rule, a 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. In the Final Report is stated that both the LOB clause and the PPT rule have strengths and weaknesses. 8 LOB clauses provide more certainty than the PPT rule, which requires a case-by-case analysis. An LOB clause is useful as a specific anti-abuse rule which aims to counteract treaty shopping, but only focusses on treaty shopping and does not address other forms of treaty abuses. 5 OECD (2015), Preventing the Granting of Treaty Benefits in Inappropriate Circumstances, Action Final Report, OECD/G20 Base Erosion and Profit Shifting Project, OECD Publishing, Paris. 6 OECD (2015), Preventing the Granting of Treaty Benefits in Inappropriate Circumstances, Action Final Report, OECD/G20 Base Erosion and Profit Shifting Project, OECD Publishing, Paris, p Q. Jiang, Treaty Shopping and Limitation on Benefits Articles in the Context of the OECD Base Erosion and Profit Shifting Project, Bulletin for International Taxation 2015 (Vol. 69), No OECD (2015), Preventing the Granting of Treaty Benefits in Inappropriate Circumstances, Action Final Report, OECD/G20 Base Erosion and Profit Shifting Project, OECD Publishing, Paris, p

12 Also, a combination of an LOB clause and a PPT rule may not be necessary or appropriate for all countries. Some countries may already have developed other provisions that effectively address various forms of treaty abuses. Therefore, it is of importance to examine whether it is advantageous for the Netherlands to implement an LOB clause, eventual in combination with a PPT rule. 2.4 Treaty shopping Treaty shopping, that is, the use of tax treaties by persons the treaties were not designed to benefit, in order to derive benefits the treaties were not designed to give them, is thought to be an improper use of tax treaties 9, which affects international trade detrimentally, leading to tax avoidance and revenue losses. 10 According to Jiang 11, there are three rationales that can be used to explain the countering of treaty shopping. The principle of reciprocity is the first rationale. Tax treaties are bases on reciprocity, which means that contracting states make concessions to each other. A tax treaty is a result of negotiation between the two contracting states. The states negotiate for the purpose of benefiting their own residents and not the residents of third states. Treaty shopping breaches the carefully negotiated balance and reciprocity of tax revue sacrifices made by the contracting states. 12 Secondly, there is the doctrine of economic substance. When an entity has business activities in one state and does not transfer income to related third state entities, it is unlikely that they would wish to avoid taxes. It is commonly accepted that an entity with economic substance falls outside the scope of treaty shopping, and therefore an entity with not enough economic substance will fall in the scope of treaty shopping. But, when anti-treaty shopping provisions become too strict, this results in very few tax planning opportunities and high compliance costs. This demotivates investors from investing in the relevant contracting state. The third rationale is therefore encouraging direct foreign investment, by making not too strict anti-treaty shopping provisions. When treaty shopping is counteracted, then direct foreign investment will be encouraged. These rationales should be considered in a coherent and consistent way. 9 Commentary on the articles of the OECD Model Tax Convention, p C.H.J.I. Panayi, Limitation on Benefits and State Aid, European Taxation 2004 (Vol. 44), No Q. Jiang, Treaty Shopping and Limitation on Benefits Articles in the Context of the OECD Base Erosion and Profit Shifting Project, Bulletin for International Taxation 2015 (Vol. 69), No A. Wardzynski, The Limitation on Benefits Article in the OECD Model: Closing Abusive (Undesired) Conduit Gateways, Bulletin for International Taxation 2014 (Vol. 68), No. 9, p

13 The aforementioned rationales show why the BEPS Project is recommending countries to include LOB clauses in tax treaties. The purpose of Action 6 is counteracting treaty abuse, and especially treaty shopping. 2.5 LOB clauses in general LOB clauses are specific anti-abuse rules (SAAR s) which are currently predominantly present in tax treaties concluded by a limited number of countries including India, Japan and most notably the United States of America. 13 Limitation-on-benefits clauses (LOB clauses), as the term indicates, limit the right to enjoy benefits of a treaty for certain companies and individuals. Several types of LOB clauses exist with different wordings and scopes, depending on the needs of the treaty partners. According to the Commentary on art. 1 of the OECD Model Tax Convention, LOB clauses are aimed at preventing persons who are not resident of either Contracting States from accessing the benefits of a Convention through the use of an entity that would otherwise qualify as a resident of one of these States. 14 LOB clauses are used to prevent treaty shopping. As discussed in paragraph 2.4 of this thesis, treaty shopping typically involves persons who are residents of third states attempting to indirectly access the benefits of a tax treaty between two contracting states. 15 Because of the LOB clause, only qualified persons, that meet the requirements of the provision, have access to the benefits of the treaty. The non-qualified persons are deemed to not having sufficient economic nexus with one of the Contracting States to rely on the benefits of the treaty. 16 In this sense, LOB clauses heighten the threshold for taxpayers to gain access to the treaty s benefits, despite the fact that these taxpayers could in principle qualify as residents of the Contracting States for the purpose of the applicable treaty. LOB clauses can contain several tests to determine whether a person is qualified to access the tax treaty s benefits. These tests can be divided into three different categories. Firstly, there are structural tests that establish qualification for all treaty benefits, for example the publicly traded company test, and the ownership/base erosion tests, or a derivative benefits test. Secondly, an LOB clause can contain a business activity test to establish qualification for certain income relating to that business (which boils down to a check whether companies failing the structural test still have a sufficient economic nexus to the residence state). Finally, a general good faith clause (or a discretionary relief clause) can be included 13 F. Debelva, D. Scornos, J. van den Berghen & P. Van Braband, LOB Clauses and EU-Law Compatibility: A Debate Revived by BEPS?, EC Tax Review 2015, Commentary on the articles of the OECD Model Tax Convention, p Q. Jiang, Treaty Shopping and Limitation on Benefits Articles in the Context of the OECD Base Erosion and Profit Shifting Project, Bulletin for International Taxation 2015 (Vol. 69), No F. Debelva, D. Scornos, J. van den Berghen & P. Van Braband, LOB Clauses and EU-Law Compatibility: A Debate Revived by BEPS?, EC Tax Review 2015, 3. 13

14 which is in essence a safety valve to establish eligibility to treaty benefits when no other test is met. 17 This last clause can give the tax authority the opportunity to grant the treaty benefits (thus to the taxpayer s benefit), if the previous tests fail to filter bona fide taxpayers. 18 LOB clauses contain several tests which establish that persons which have enough economic nexus to the residence state will enjoy the benefits of the treaty. Therefore, LOB clauses seem to be a good remedy to prevent treaty shopping. As treaty shopping involves persons who are residents of third states attempting to indirectly access the benefits of a tax treaty between two contracting states, the strict tests of LOB clauses are able to counteract treaty shopping. The question is whether the specific LOB clause proposed in Action 6 of the BEPS Project is a good remedy to counteract treaty shopping. 2.6 The LOB clause proposed by the BEPS Project The following is the text of the LOB clause, as proposed by the BEPS project 19, in Action 6 20 : ARTICLE X ENTITLEMENT TO BENEFITS 1. [Provision that would deny treaty benefits to a resident of a Contracting State who is not a qualified person as defined in paragraph 2] 2. [Definition of situations where a resident would be a qualified person, which would cover a) an individual b) a Contracting State, its political subdivisions and entities that it wholly owns c) certain publicly-listed entities and their affiliates d) certain charities and pension funds e) other entities that meet certain ownership requirements f) certain collective investment entities] 3. [Provision that would provide treaty benefits to certain income derived by a person that is not a qualified person if the person is engaged in the active conduct of a business in its State of residence and the income is derived in connection with, or is incidental to, that business] 4. [Provision that would provide treaty benefits to a person that is not a qualified person if at least more than agreed proportion of that entity is owned by certain persons entitled to equivalent benefits] 5. [Provision that would allow the competent authority of a Contracting State to grant certain treaty benefits to a person where benefits would otherwise be denied under paragraphs 1 to 4] 6. [Definitions applicable for the purposes of paragraph 1 to 5] 17 J. Bates et al., Limitation on Benefits Articles in Income Tax Treaties: the Current State of Play, Intertax 2013 (Vol. 41), No. 6, p F. Debelva, D. Scornos, J. van den Berghen & P. Van Braband, LOB Clauses and EU-Law Compatibility: A Debate Revived by BEPS?, EC Tax Review 2015, There can be noted that the OECD takes the LOB clause in the US Model Treaty into account when finalising the proposed LOB clause. Therefore, this proposed LOB clause can be changed due to amendments in the US Model Treaty. 20 OECD (2015), Preventing the Granting of Treaty Benefits in Inappropriate Circumstances, Action Final Report, OECD/G20 Base Erosion and Profit Shifting Project, OECD Publishing, Paris, p

15 In the recommendations of Action 6, there is given the option for countries to implement a simplified or a detailed version of the proposed clause. Also, there is the option to include the proposed GAAR, the PPT rule, in paragraph 7 of this clause. I will describe the proposed GAAR in paragraph 2.7 of this thesis. As the first paragraph of the clause indicates, only residents which are qualified persons are entitled to enjoy the benefits of the tax treaty. Being a resident is the entry requirement to get access to the benefits of the treaty. This means that non-residents, for example permanent establishments, are not entitled to the benefits of the treaty. Then paragraph 2 section a) and b) stipulate that individuals and a Contracting State (and its political subdivisions and entities that it wholly owns) are always qualified as a qualified person. Paragraph 2, section c) includes what is formed a stock exchange test. This test simply requires that the shares of the company that is claiming the benefits be traded on certain stock exchanges that are recognized by the Contracting State and enumerated in a list. Only the principal class of the shares has to be traded on a recognized stock exchange. The terms recognized stock exchange and principal class of shares are defined in paragraph 6 of this clause. Here, the simplified and the detailed version of this section differ. The simplified version only requires that a company is a qualified person if the principal class of its shares is regularly traded on one or more recognised stock exchanges. The detailed version requires also that the principal class of the shares is regularly traded on one more recognised stock exchanges, but requires also that either the principal class of shares is primarily traded on one or more stock exchanges located in the Contracting State of which the company or entity is a resident or the company s or entity s primary place of management and control is in the Contracting State of which it is a resident. Countries can choose for the detailed version to establish that when a publicly-traded company or entity may be technically resident in a given state, but does not have a sufficient relationship with that state, the benefits of the treaty are not granted due to the stock exchange test. A company whose principal class of shares is regularly traded on a recognised stock exchange will nevertheless not qualify for benefits under this section, if it has a disproportionate class of shares that is not regularly traded on a recognised stock exchange. Also the term disproportionate class of shares will be defined in paragraph 6 of this clause. Section d) of paragraph 2 of the proposed LOB clause concerns certain non-profit organisations and pension funds. In this section, the contracting states can list entities that automatically qualify for the treaty benefits without regard to the residence of their beneficiaries or members. Besides this list, states can also include a subdivision which give requirements for the beneficial interests of the entity. For 15

16 example, there can be required that more than 50 percent of the beneficial interests are owned by individuals resident of either contracting states. Furthermore, there are two more tests included in paragraph 2, section e) of this clause. In this section, both an ownership test and a base erosion test are included. To qualify as a qualified person under section e), both of these tests have to be met. The ownership test requires that 50 percent or more of each class of shares in the person must be owned, directly or indirectly, on at least half of the days of the person s taxable period, by persons who are residents of the contracting state of which that person is a resident and that these persons themselves are entitled to the treaty benefits under the aforementioned sections of paragraph 2 of the proposed clause. So more simply said, the majority of the shareholders of the company must be residents of the same state as the company, and the shareholders also have to be entitled to the treaty benefits themselves. 21 The base erosion test is satisfied with respect to a person if less than 50 percent of the person s gross income for the taxable period is paid or accrued to persons (who are not residents of either contracting states entitled to benefits under the aforementioned sections of paragraph 2 of the proposed clause) in the form of payments deductible for tax purposes in the payer s state of residence. So there is required that the person does not pay more than 50 percent of its gross income to third-state residents. 22 Then section f) of paragraph 2 of the proposed LOB clause concerns collective investment vehicles (CIV). There is noted that whether a specific rule concerning CIV should be included, will depend on how the applicable tax treaty applies to CIV and on the treatment and use of CIV in each contracting state. According to the BEPS Project, CIV would not be a qualified person because in many cases the interests in the CIV are not publicly traded, the interests are held by residents of third states, the distributions made by the CIV are deductible payments and the CIV is used for investment purposes rather than for the active conduct of a business within the meaning if paragraph 3 of the proposed clause. 23 In the Final Report of Action 6 are therefore given multiple examples for this section concerning CIV and when a CIV will be entitled for the treaty benefits. When a person did not qualify as a qualified person under paragraph 2 of the proposed LOB clause, the person still might be entitled for the treaty benefits. In paragraph 3 and 4 are included two more tests to enable persons to qualify for the treaty benefits. 21 F. Debelva, D. Scornos, J. van den Berghen & P. Van Braband, LOB Clauses and EU-Law Compatibility: A Debate Revived by BEPS?, EC Tax Review 2015, F. Debelva, D. Scornos, J. van den Berghen & P. Van Braband, LOB Clauses and EU-Law Compatibility: A Debate Revived by BEPS?, EC Tax Review 2015, OECD (2015), Preventing the Granting of Treaty Benefits in Inappropriate Circumstances, Action Final Report, OECD/G20 Base Erosion and Profit Shifting Project, OECD Publishing, Paris, p

17 Paragraph 3 of the proposed clause includes an activity test: another resident can still be entitled to the benefits of the treaty with respect to a specific item of income, if that resident is engaged in the active conduct of a business in its residence state and if that item of income is derived in connection with, or is incidental to, that business. The test shall only be considered to be satisfied with respect to such item of income only if the business carried on by the resident in one contracting state is substantial in relation to the business carried on by the resident or related enterprise in the other contracting state. Whether a business is substantial for the purpose of this test, shall be determined on the basis of all the facts and circumstances. The term business is not defined, and therefore must be given the meaning that it has under domestic law. According to the Commentary in the Final Report of Action 6, a business activity generally will be considered to form part of a business activity conducted in the state of source if the two activities involve the design, manufacture or sale of the same products or type of products, or the provision of similar services. 24 The last test is included in paragraph 4 of the clause: the derivative benefits test. The simplified version of this test establishes that a resident that is not a qualified person shall still be entitled to a benefit that would otherwise be accorded by the applicable tax treaty with respect to an item of income if persons that are equivalent beneficiaries own, directly or indirectly, more than 75 percent of the beneficial interests of the resident. The detailed version of this provision includes again an ownership test and a base erosion test to fulfil this derivative benefits test. The ownership test requires that at least 95 percent of the active voting power and value of the shares is directly or indirectly owned by seven or fewer persons that are equivalent beneficiaries. The base erosion test requires that less than 50 percent of the gross income of the company is paid or accrued to persons who are not equivalent beneficiaries in the form of payments that are deductible. In other words, this test allows certain entities owned by residents of other states to obtain (all) the benefits which those residents would have obtained if they had invested directly. 25 The term equivalent beneficiary is defined in paragraph 6 of the proposed clause. Finally, paragraph 5 includes a safety valve. If a resident of a contracting state is neither a qualified person and also not entitled for the treaty benefits under paragraph 3 and 4, the competent authority of the contracting state from which the benefit is being claimed can determine, upon request of the resident, that the resident will be entitled for the treaty benefits. In other words, this safety valve gives the tax authority the opportunity to grant the treaty benefits if the previous tests fail to filter bona fide 24 OECD (2015), Preventing the Granting of Treaty Benefits in Inappropriate Circumstances, Action Final Report, OECD/G20 Base Erosion and Profit Shifting Project, OECD Publishing, Paris, p F. Debelva, D. Scornos, J. van den Berghen & P. Van Braband, LOB Clauses and EU-Law Compatibility: A Debate Revived by BEPS?, EC Tax Review 2015, 3. 17

18 taxpayers. 26 The competent authority will grant these benefits if, after considering the relevant facts and circumstances, it determines that neither the establishment, acquisition or maintenance of the resident, nor the conduct of its operations, had as one of its principal purposes obtaining benefits under the applicable tax treaty. So the resident will have to prove that there were clear non-tax business reasons for the activities of which it is claiming the benefits. Paragraph 6 of the proposed clause includes definitions for the purposes of this clause. 2.7 The PPT rule proposed by the BEPS Project Besides, the OECD proposes to insert the following PPT rule in this article, as a paragraph 7: Notwithstanding the other provisions of this Convention, a benefit under this Convention shall not be granted in respect of an item of income or capital if it is reasonable to conclude, having regard to all relevant facts and circumstances, that obtaining that benefit was one of the principal purposes of any arrangement or transaction that resulted directly or indirectly in that benefit, unless it is established that granting that benefit in these circumstances would be in accordance with the object and purpose of the relevant provisions of this Convention. 27 This is a general anti-abuse rule. Under this rule, 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. As the proposed Article X is aimed at preventing treaty shopping, the PPT rule fits logically in this article. The PPT rule also limits the access to benefits of the treaty for certain transactions or arrangements and due to a PPT rule this whole clause will cover the widest range of treaty abuse. Paragraph 7 supplements and does not restrict in any way the scope or application of the provisions of paragraphs 1 to 6. The term benefit includes all limitations (tax reduction, exemption, deferral or refund) on taxation imposed on the state of source under the Articles 6 through 22 of the OECD MC, the relief from double taxation provided by Article 23, and the protection afforded to residents and nationals of a contracting state under Article 24 or any other similar limitations. 28 According to the Commentary on paragraph 7 in the Final Report of Action 6, to determine whether or not one of the principal purposes of any person concerned with an arrangement or transaction is to obtain 26 F. Debelva, D. Scornos, J. van den Berghen & P. Van Braband, LOB Clauses and EU-Law Compatibility: A Debate Revived by BEPS?, EC Tax Review 2015, OECD (2015), Preventing the Granting of Treaty Benefits in Inappropriate Circumstances, Action Final Report, OECD/G20 Base Erosion and Profit Shifting Project, OECD Publishing, Paris, p OECD (2015), Preventing the Granting of Treaty Benefits in Inappropriate Circumstances, Action Final Report, OECD/G20 Base Erosion and Profit Shifting Project, OECD Publishing, Paris, p

19 benefits under the Convention, it is important to undertake an objective analysis of the aims and objects of all persons involved in putting that arrangement or transaction in place or being a party to it. 2.8 Is an LOB clause needed at international level? As described in paragraph 2.4, there are several reasons that confirm that the counteraction of treaty shopping is needed. The BEPS Project considers that an LOB clause will counteract treaty shopping. According to the OECD, the main objective of LOB clauses is to prevent treaty shopping, in a comprehensive way. 29,30 Therefore, the OECD recommends in the BEPS Project to implement LOB clauses in tax treaties. Hence, there can be questioned if an LOB clause is capable of counteracting treaty shopping, and therefore whether an LOB clause is needed at international level. As mentioned in paragraph 2.3 of this thesis, concerning the minimum standard of Action 6, in the Final Report is stated that both the LOB clause and the PPT rule have strengths and weaknesses. 31 LOB clauses provide more certainty than the PPT rule, which requires a case-by-case analysis. An LOB clause is useful as a specific anti-abuse rule which aims to counteract treaty shopping, but only focusses on treaty shopping and does not address other forms of treaty abuses. Also, a combination of an LOB clause and a PPT rule may not be necessary or appropriate for all countries. Some countries may already have developed other provisions that effectively address various forms of treaty abuses. As an LOB clause is intended to affect the subjective scope of a tax treaty, the LOB clause causes that residents only will be granted for the treaty benefits if they carry out real business activities, have sufficient nexus to their residence state or have bona fide motives. 32 These factors are embodied in the different tests that an LOB clause includes. Because of these different, specialised tests, LOB clauses are considered to imply a greater amount of legal certainty in granting treaty benefits. 33 However, the different tests also cause that the clause will become highly complicated. All different tests are illustrated and explained in more than 30 pages Commentary. According to Debelva e.a. 34, LOB clauses are not always capable for achieving the aim that they pursue. Debelva e.a. use the next simple example concerning the ownership test: a company with non-resident 29 Commentary on article 1 of the OECD Model Tax Convention. 30 Q. Jiang, Treaty Shopping and Limitation on Benefits Articles in the Context of the OECD Base Erosion and Profit Shifting Project, Bulletin for International Taxation 2015 (Vol. 69), No OECD (2015), Preventing the Granting of Treaty Benefits in Inappropriate Circumstances, Action Final Report, OECD/G20 Base Erosion and Profit Shifting Project, OECD Publishing, Paris, p L. de Broe & J. Luts, BEPS Action 6: Tax Treaty Abuse, Intertax 2015 (Vol. 43), No L. de Broe & J. Luts, BEPS Action 6: Tax Treaty Abuse, Intertax 2015 (Vol. 43), No F. Debelva, D. Scornos, J. van den Berghen & P. Van Braband, LOB Clauses and EU-Law Compatibility: A Debate Revived by BEPS?, EC Tax Review 2015, 3. 19

20 shareholders will not meet the test, while a company s ownership structure is not pertinent to know whether a company is engaging in legitimate economic activities. Vice versa, companies that meet the test are not necessarily bona fide. The same can be said about the stock exchange test: that a company is not trading its shares on a stock exchange which is recognized, does not mean that this company is shopping the treaty. According to Jiang 35, it is important to clarify the objective, purpose and rationale of LOB clauses, otherwise it is easy to get lost in the lengthy and sophisticated language of the articles. It is needed to have a detailed explanation of the underlying rationales of the several tests in LOB clauses, because the several tests have a significant effect on the threshold to treaty benefits. The rationale behind the stock exchange test in the proposed LOB clause is that as a general rule, because the shares of publicly traded companies and of some entities are generally widely held, these companies and entities are unlikely to be established for treaty shopping. 36 According to Jiang, this statement is short and unconvincing. Besides, he also points out that nowadays it is very common that a company in one jurisdiction is publicly listed in a stock exchange in another jurisdiction for the purpose of attracting worldwide investment. However, Jiang together with the American Law Institute is opined that the stock exchange test serves as a necessary rule of convenience, since this test is the easiest one to prove. 37 It can be questioned whether the scope of this test can conform to the objective of LOB clauses. According to Jiang, the stock exchange test has neither a direct connection with treaty shopping nor with economic substance. Using publicly traded companies as a conduit company for treaty shopping purposes is theoretically possible. Though, it is not commonly used and has higher operating costs compared to other treaty shopping structures. Also, it is not necessary that these companies have economic substance in the state where it is on the stock exchange. Besides, this test can never be used by individuals and only covers publicly traded companies or subsidiaries of publicly traded companies. Concluding, it can be argued that the stock exchange test does not serve the objective of LOB clauses 38, which is preventing treaty shopping. Bates e.a. 39 point out that in reality most of the shareholders might not be resident of the country where the company is trading on a stock exchange. However, publicly traded companies do not provide a ready vehicle for treaty shopping by third country residents, partly because publicly traded companies typically 35 Q. Jiang, Treaty Shopping and Limitation on Benefits Articles in the Context of the OECD Base Erosion and Profit Shifting Project, Bulletin for International Taxation 2015 (Vol. 69), No Commentary on article 1 of the OECD Model Tax Convention. 37 Q. Jiang, Treaty Shopping and Limitation on Benefits Articles in the Context of the OECD Base Erosion and Profit Shifting Project, Bulletin for International Taxation 2015 (Vol. 69), No. 3, p Q. Jiang, Treaty Shopping and Limitation on Benefits Articles in the Context of the OECD Base Erosion and Profit Shifting Project, Bulletin for International Taxation 2015 (Vol. 69), No. 3, p J. Bates et al., Limitation on Benefits Articles in Income Tax Treaties: the Current State of Play, Intertax 2013 (Vol. 41), No

21 are subject to securities law. This together with the fact of the attendant glare of public scrutiny make publicly traded companies not a good choice for treaty shopping, according to Bates e.a. Concerning the ownership test and the base erosion test, Jiang believes that these two tests go to the core of the treaty shopping problem, since these tests require both a sufficient percentage of local ownership and the absence of significant base erosion. 40 As the ownership test does not completely cover treaty shopping situations 41, it is combined with the base erosion test. These tests therefore serve the objective of LOB clauses. These tests can be seen as very strict, but taxpayers still have the other tests in the clause to be entitled for the treaty benefits, therefore Jiang states that this is not a problem. 42 According to Wardzynski 43, the two tests ensure that a majority of the equity (the ownership part) and non-equity (the base erosion part) owners are residents of the contracting states. These tests indicate awareness that debt instrument holders are entitled to the profits of a successful company in a comparable way as its ordinary equity holders. 44 The combination of these tests therefore counter treaty shopping situations. The Commentary on the proposed LOB clause in Action 6 does not provide a rationale for the activity test. However, it is logical that this test originated from the doctrine of economic substance. 45 When a company is engaged in an active trade of business in a state, it is evident that there is economic substance in that state and therefore this is outside the scope of treaty shopping. However, still problems can arise with this test. Jiang 46 states that wordings such as in connection with, or incidental to that business and substantial in relation to the business, can rise difficulties with the application of the test and the Commentary cannot cover all circumstances in which the test will be fulfilled. Another problem is that the test requires to verify each item of income individually. Jiang 47 suspects that this administrative burden is not proportionate to the objective of the test. Wardzynski 48 points out that by including this test in the proposed LOB clause, is signified that the OECD does not believe that treaty shopping is very likely in relation to active businesses. However, 40 Q. Jiang, Treaty Shopping and Limitation on Benefits Articles in the Context of the OECD Base Erosion and Profit Shifting Project, Bulletin for International Taxation 2015 (Vol. 69), No. 3, p As also stated by Debelva e.a. (F. Debelva, D. Scornos, J. van den Berghen & P. Van Braband, LOB Clauses and EU-Law Compatibility: A Debate Revived by BEPS?, EC Tax Review 2015, 3). 42 Q. Jiang, Treaty Shopping and Limitation on Benefits Articles in the Context of the OECD Base Erosion and Profit Shifting Project, Bulletin for International Taxation 2015 (Vol. 69), No. 3, p A. Wardzynski, The Limitation on Benefits Article in the OECD Model: Closing Abusive (Undesired) Conduit Gateways, Bulletin for International Taxation 2014 (Vol. 68), No. 9, p J. Bates et al., Limitation on Benefits Articles in Income Tax Treaties: the Current State of Play, Intertax 2013 (Vol. 41), No Q. Jiang, Treaty Shopping and Limitation on Benefits Articles in the Context of the OECD Base Erosion and Profit Shifting Project, Bulletin for International Taxation 2015 (Vol. 69), No. 3, p Q. Jiang, Treaty Shopping and Limitation on Benefits Articles in the Context of the OECD Base Erosion and Profit Shifting Project, Bulletin for International Taxation 2015 (Vol. 69), No. 3, p Q. Jiang, Treaty Shopping and Limitation on Benefits Articles in the Context of the OECD Base Erosion and Profit Shifting Project, Bulletin for International Taxation 2015 (Vol. 69), No. 3, p A. Wardzynski, The Limitation on Benefits Article in the OECD Model: Closing Abusive (Undesired) Conduit Gateways, Bulletin for International Taxation 2014 (Vol. 68), No. 9, p