AIRCRAFT FINANCING SUBCOMMITTEE 2017 ANNUAL MEETING Proposed Changes to Ireland s Double Tax Treaties and the U.S. Perspective on MLIs Chicago, Illinois 14 September 2017 Speakers: Mark Stone, Holland & Knight LLP, New York Amelia O Beirne, A&L Goodbody, New York 1
Background to the development of the MLI November 2012 Los Cabos G20 Summit UK PAC Hearings (Google, Starbucks, Amazon) June 2013 G8 Lough Erne Declaration Countries should change rules that let companies shift their profits across borders to avoid taxes October 2013 Launch of OECD BEPS Package May 2013 US Senate Hearings Apple July 2013 BEPS Action Plan released by OECD and endorsed by G20 2
Background to the development of the MLI OECD / G20 BEPS Project initiated by the OECD at the request of the G20 to tackle Base Erosion and Profit Shifting ( BEPS ) seeks to curtail some of the more aggressive elements of international tax planning by multinationals Output of BEPS Project BEPS Action Plan - 15 Actions to address aggressive tax planning strategies Recommendations to national governments to make changes to domestic law and double tax treaties to introduce new rules to counteract BEPS Some BEPS measures are minimum standards that countries have agreed must be implemented Other BEPS measures are best practices and countries have discretion as to whether to implement them Changes affect businesses in all sectors operating cross-border 3
What is the MLI? Final BEPS Package November 2015 Implementation requires Changes to domestic laws of participating countries Changes to bilateral tax treaties entered into by these countries > 3,000 bilateral tax treaties to be amended Bilateral negotiations would be slow and burdensome Solution development of a Multilateral Instrument ( MLI ) To enable countries to quickly modify a large number of existing bilateral tax treaties to implement BEPS related recommendations Sits alongside existing tax treaties and modifies their application 4
Who has signed up? Signing ceremony on 7 June 2017 at the OECD headquarters in Paris (at which Ireland signed the MLI) 71 signatories as of 17 August 2017 Has the potential to affect more than 2,000 bilateral tax treaties And some notable exceptions United States 5
Who has signed up? *Signatories to the MLI as at 17 August 2017 Andorra Cyprus India Malta Senegal Argentina Czech Republic Indonesia Mauritius Serbia Armenia Denmark Ireland Mexico Seychelles Australia Egypt Isle of Man Monaco Singapore Austria Fiji Israel Netherlands Slovak Republic Belgium Finland Italy New Zealand Slovenia Bulgaria France Japan Nigeria South Africa Burkina Faso Gabon Jersey Norway Spain Cameroon Georgia Korea Pakistan Sweden Canada Germany Kuwait Poland Switzerland Chile Greece Latvia Portugal Turkey China (PRC) Guernsey Liechtenstein Romania United Kingdom Colombia Hong Kong Lithuania Russia Uruguay Costa Rica Hungary Luxembourg San Marino Croatia Iceland Malta Senegal 6
Why does it matter? Many countries apply withholding taxes to outbound payment flows like, for example, Lease rentals Interest Dividends In many cases, double tax treaties reduce or eliminate withholding taxes on these crossborder payment flows Where two parties to a double tax treaty agree to adopt a measure outlined in the MLI, the double tax treaty between these countries will be amended in accordance with the MLI In some cases, this will have an impact on the ability for companies operating in these jurisdictions to avail of treaty benefits, e.g. to reduce / eliminate withholding taxes on cross border payment flows 7
What does it cover? The MLI covers a number of areas but key changes for the aircraft finance industry include changes that seek to prevent treaty abuse and treaty shopping Treaty abuse measures are a minimum standard so participating countries are required to implement them, but BEPS recommendations allow some optionality Broadly three options participating countries may choose to include: A detailed limitation on benefits clause ( LOB ) Which limits treaty benefits to entities that meet certain prescriptive conditions (e.g. in relation to their legal nature, ownership etc) OR A principal purpose test ( PPT ) A general anti-abuse rule that looks to the main purpose of the transactions entered into in determining whether treaty benefits should apply OR A combination of the LOB and PPT 8
What does it cover? Ireland has chosen to adopt a PPT for all relevant tax treaties The PPT denies treaty benefits if it is reasonable to conclude, having regard to all relevant facts and circumstances, that obtaining [treaty benefits] was one of the principal purposes of [the arrangement or transaction] Unless it is established that granting treaty benefits would be in accordance with the object and purpose of the treaty Some observations Tax treaty benefits need not be the sole or dominant purpose one of the principal purposes of the transaction Examples of good and bad fact patterns in OECD guidance but not very detailed and no borderline cases Guidance indicates that where an arrangement is inextricably linked to a core commercial activity and its form is not driven by considerations of obtaining treaty benefits, it is unlikely that its principal purpose will be considered to be obtaining that benefit Regional grouping example Likely to see divergence in how the PPT is applied by different jurisdictions 9
What treaties will be affected? Ireland currently has 73 tax treaties, 72 of which are in effect The Ireland / Netherlands tax treaty is currently being re-negotiated so this treaty is excluded from the application of the MLI Ireland s remaining 71 tax treaties may be amended (by the MLI) to include a PPT but only if The relevant treaty partner signs up to the MLI and The relevant treaty partner also opts for the PPT What is not affected? In general, outbound payment flows out of Ireland will be unaffected Ireland does not apply withholding tax on lease rental payments Irish domestic law exemptions from withholding tax on dividends and interest payments (generally no need to rely on tax treaties) In an Irish context, PPT will generally only be relevant with respect to inbound payment flows Tax treaties with countries that have not signed up to the MLI (e.g. the United States) remain unaffected 10
Impact on aircraft finance industry Anticipate greater scrutiny / focus on substance in some jurisdictions Some jurisdictions already applying increased substance requirements through beneficial ownership concept and others already apply main purpose test through domestic law Intermediate lessors / lease in lease out structures Impact on securitisation structures? some examples in OECD guidance but very fact specific 11
Impact on aircraft finance industry Some common good factors outlined in OECD guidance Jurisdictional factors Skilled labour force Reliable legal system Business friendly environment Political stability Sophisticated banking industry Substance factors Real business through which SPV exercises substantive economic functions, using real assets and assuming real risks Business is carried on by SPV through its own personnel located in country of residence - SPV possess the human and financial resources to perform its activities The activities constitute the active conduct of a business in country of residence 12
Impact on existing / future structures Who bears the risk where withholding tax is applied? Under Lease / Financing documents, lessee / borrower typically bears change of law risk Requirement to gross up for withholding tax in the event of a change of applicable law Structuring of future transactions What if withholding tax charge applies because of lack of substance in lessor entity? Impact on opinions / qualifications? Other important initiatives EU Anti-Tax Avoidance Directive to take effect in domestic law of EU countries beginning 1 January 2019 13
Timing At least 5 countries must ratify the MLI before it can become effective and then a three month waiting period must expire before it can enter into force for those 5 countries (on a staged basis for certain changes). Not yet clear when Ireland will ratify the MLI but expectation is sometime during 2018 Then a number of waiting periods will apply post-ratification before MLI becomes effective As a result, expectation is that MLI will likely begin to become effective for Ireland from 1 January 2019 (but timing remains uncertain as the ratification procedure is a multi-step process) BUT - if Ireland s treaty partner has not completed the ratification procedures then, notwithstanding that the MLI is generally effective in Ireland, it will still not have effect in respect of that particular tax treaty 14
U.S. Perspective on the MLI Generally The U.S. will not sign the MLI because it disagrees with two significant components of the MLI. First, the U.S. is of the view that the detailed objective standard to deal with treaty shopping, contained in the Limitation on Benefits ( LOB ) article of most of its tax treaties, is the only acceptable standard. Second, the U.S. disagrees with the MLI s low bar on Permanent Establishments ( PE ). An entity generally is subject to tax in the source State on its business income only if it conducts enough activity in the source State under the PE standard. Thus, the higher the PE bar, the more likely the entity is not subject to tax in the source State. A low bar will more likely subject source State activities to tax. 15
U.S. Perspective on the MLI Limitation on Benefits Generally The U.S. LOB treaty provision sets forth detailed objective tests to help ensure that a business entity has sufficient nexus to a resident State to claim treaty benefits from the source State. Eligibility for treaty benefits can be met under several separate and somewhat complex tests, varying by treaty, that include: Sufficient percentage ownership, generally 50% or more, by good resident or source State owners and no major base erosion. The U.S. Irish tax treaty has favorable good owners. Publicly held entities. Active resident State business activities connected to source State income. Derivative ownership (generally 95%) by treaty eligible good third state owners and no major base erosion. Certain pension and charitable entities. Intent, as in the principal purpose test, is not examined. 16
U.S. Perspective on the MLI Limitation on Benefits U.S. Model Income Tax Convention The U.S. Treasury Department from time to time, approximately every ten years, issues a Model Income Tax Convention that is the starting point for treaty negotiations. In 2016, Treasury issued a new Model to influence the ongoing OECD BEPS initiative. The 2016 Model, consistent with Treasury s view of the LOB Article, added greater complexity to the Article. The base erosion test would apply on a group basis. Public company subsidiaries would be subject to base erosion. Special tax regimes could limit eligibility. The active business test requires greater connection. The derivative benefits test requires qualified intermediate owners but does provide other benefits not in current treaties. 17
U.S. Perspective on the MLI Limitation on Benefits U.S. Model Income Tax Convention and the MLI The U.S. Model is not law and does not affect any U.S. bilateral income treaty. The MLI, to which the U.S. is not a signatory, does not affect any U.S. bilateral income tax treaty with any party that has signed the MLI. Thus, any existing structure qualifying under the U.S.-Ireland tax treaty remains qualified: For example, outbound lease payments for aircraft rentals by a U.S. lessee to an Irish lessor entity owned 60% by U.S. residents qualify for a 0% U.S. withholding tax rate as well as exemption from corporate income tax ( CIT ) under the Business Profits/PE and LOB articles regardless of the 2016 Model or Ireland s signing the MLI. Should the U.S. sign the MLI without any PE reservations, lease payments under this structure might (depending on the lessor s marketing, remarketing or other activities in the U.S.) not qualify for treaty benefits due to the low PE bar in the MLI and consequently be subject to the 30% U.S. withholding tax or CIT depending on facts. U.S. adoption of the MLI principal purpose option in lieu of, although not in addition to, the current LOB article may cause the transaction described above to fail to qualify for treaty benefits with the result that the 30% U.S. withholding tax or CIT, depending on facts, would apply. 18
U.S. Perspective on the MLI Treaty Practice Will adoption of the MLI by other countries affect U.S. tax opinion practice or tax indemnity provisions in lease agreements with U.S. lessees or loan agreements with U.S. borrowers? The adoption of the MLI by other countries may influence the structuring of lease transactions through intermediate lessees resident in countries that have adopted the MLI. 19
Aircraft Securitisation Sample Structure 20
Thank You Mark Stone Holland & Knight LLP New York mark.stone@hklaw.com Amelia O Beirne A&L Goodbody New York aobeirne@algoodbody.com 21