4 March 2016 Global Tax Alert OECD invites comments on discussion draft on treaty residence of pension funds EY Global Tax Alert Library Access both online and pdf versions of all EY Global Tax Alerts. Copy into your web browser: www.ey.com/taxalerts Executive summary On 29 February 2016, the Organisation for Economic Co-operation and Development (OECD) released a discussion draft on the treaty residence of pension funds (Discussion Draft on Treaty Residence of Pension Funds or Discussion Draft). The OECD invites comments on the Discussion Draft and comments must be submitted by 1 April 2016. Given the relatively short comment period, all interested parties including government and private pension funds, their primary administrators, and trustees or designated investment boards will need to quickly consider the proposed definition of recognized pension fund and the accompanying commentary in order to meet the comment submission deadline. Access to treaty benefits to reduce or eliminate withholding taxes on the return on and of capital with respect to foreign investments is important for pension funds seeking stable cash yields in order to meet their obligations to their beneficiaries. Under the current OECD Model Tax Convention and numerous bilateral tax treaties, in certain cases pension funds are being denied access to treaty benefits for one or more of the following reasons: (i) the fund, arrangement, and/or its beneficial owners are not considered a resident of the contracting state in which the fund is established; (ii) the fund s organizational structure is such that it does not meet the current definition of residency or
2 Global Tax Alert qualification under the relevant pension exemption article; or (iii) a residency certificate cannot be issued with respect to the arrangement, and administratively, it also cannot be issued with respect to the beneficiaries of the plan. In the EY Global Tax Alert OECD BEPS final reports have implications for sovereign wealth and pension funds issued in January 2016, pension funds and pension reserve funds (were) encouraged to provide input into the definition of a recognized pension fund to ensure that, where appropriate, their governance structure does not result in the pension fund or reserve fund being unintentionally denied access to treaty benefits. Some of that input has already been incorporated in the proposed draft, but there still remains much uncertainty. Although the OECD has received substantive comments to date from a number of pension funds, investment boards, and sovereign reserves in a handful of countries, many parties that could potentially be affected have not provided any comments on the proposed definition of a recognised pension fund. This is unfortunate as the lack of comments will increase the likelihood that enterprises will potentially be exposed to idiosyncratic risk. Now that the OECD has outlined the changes that they are proposing to the Model Tax Convention, interested parties should review the Discussion Draft and provide comments with respect to proposed definition of a recognized pension fund and the related commentary, and in particular consider whether the proposal would cause the respective pension fund to be excluded from the proposed definition. This Alert summarizes highlights of the proposed changes. Detailed discussion Background At the time of the release of the final report on Action 6 of the Base Erosion and Profit Shifting (BEPS) Action plan (Preventing the Granting of Treaty Benefits in Inappropriate Circumstances), paragraph 12 specifically stated that followon work would be done with respect to the treaty residence of pension funds. Specifically, paragraph 12 provides: Additional work will also ensure that a pension fund should be considered to be a resident of the State in which it is constituted regardless of whether that pension fund benefits from a limited or complete exemption from taxation in that State. This will be done through changes to the OECD Model Tax Convention, to be also finalised in the first part of 2016 that will ensure that outcome for funds that will meet a definition of recognised pension fund. The report also recognized that in addition to changes to the language in the Model Convention, detailed Commentary would accompany such changes to explain all of the requirements to satisfy the definition of a recognized pension fund. Proposed changes to the OECD Model Tax Convention The public discussion draft introduces changes to Article 3 and Article 4 of the OECD Model Tax Convention. In Article 3, where definitions are found, a new subparagraph (j) was added to paragraph 1 containing the definition of a recognized pension fund. In Article 4, paragraph 1 was amended to include a specific reference to a recognized pension fund of that State when describing what the term resident of a Contracting State meaning. In addition, several new paragraphs are added to the Commentary on Articles 3 and 4 that further provide guidance on the definition of a recognized pension fund as well as textual and contextual additions for purposes of interpreting the residency application. Under the proposed definition in Article 3, a recognized pension fund of a State does not have to be a legal entity established in a State, it can also be an arrangement as long as the arrangement is established in the Stated and treated as a separate person under the taxation laws of that State. Whether an entity or an arrangement treated as a separate person, the pension fund must be constituted and operated exclusively to administer or provide retirement or similar benefits to individuals, and it must be regulated as such by the State. Alternatively, an entity or an arrangement that is treated as a separate person can qualify as a recognized pension fund where such entity or arrangement is constituted and operated exclusively to invest funds for the benefits of regulated pension funds described in the preceding sentence. Several draft additions were added to the Commentary on Articles 3 and 4 to the OECD Model Tax Convention to clarify the definition of the term recognized pension fund, and to clarify the recognized pension fund will constitute a resident of a Contracting State. Given the considerable diversity in the legal and organizational characteristics of pension funds around the world, the intent of the changes to the Commentary with respect to the proposed changes to Article 3 is to provide detailed guidance as to how to
Global Tax Alert 3 interpret the various clauses constituting the definition of a recognized pension fund. The general themes contained in the Commentary are as follows: What arrangements can qualify as a recognized pension fund When will an entity or arrangement be considered to have been constituted and used solely for the purpose of administering or providing retirement or similar benefits to individuals When will an entity or arrangement be considered to be subject to an appropriate regulatory framework Examples of entities or arrangements that would qualify as a recognized pension fund, including an agency or instrumentality of a State set up exclusively to administer or provide retirement benefits under the social security legislation of that State, and a company or other taxexempt entity (irrespective of whether it is liable to tax) that is established in a State solely for the purpose of administering or providing retirement or similar benefits to individuals and whose only assets include assets of regulated retirement schemes which provide that the income from those schemes are exempt from tax When entities or arrangements that pension funds, discussed above, use solely as intermediaries for investing funds (often referred to as pooled funds) should themselves be treated as recognized pension funds With respect to residency, the Commentary on Article 4 removes any doubt about the fact that a pension fund that meets the definition of a recognized pension fund will constitute a resident irrespective of whether it benefits from a limited or complete exemption from taxation in the Contracting State where it is established. Does the phrase that is treated as a separate person under the taxation laws of that State deal adequately with pension funds established in your State? (The intention here is to ensure that pension funds are not excluded from the definition so long as the income is adequately attributed to the beneficiary of the plan and not another person.) Is the word exclusively in the context of constituted and operated exclusively to administer or provide retirement or similar benefits too restrictive? (The intention here is to capture not only retirement but also similar benefits, and to ensure the language will not go too far in limiting the types of pension funds that can qualify.) Are there examples of benefits that are typically granted by pension funds (beyond death, and disability) that should be covered by the phrase similar benefits? Where an intermediary of some sort is used, is the word exclusively in the context of that is constituted and operated exclusively to invest funds for the benefit of entities or arrangements too restrictive? Next steps The discussion draft and comments received will be discussed by the OECD Working Party 1 at its next meeting, when the Working Party will be asked to finalize the changes included in the draft. Accordingly, it is important to consider submitting comments so they may be taken into account by the Working Party as they finalize the work to ensure that pension funds may be considered to be a resident for treaty purposes. Comments should be sent by 1 April 2016 at the latest by e-mail to taxtreaties@oecd.org. Please contact EY if you are interested in making a submission. Specific areas for comment While the OECD is asking for any and all comments on the proposed changes to the OECD Model Tax Convention and the related Commentary, the OECD specifically posed the following questions to elicit comments:
4 Global Tax Alert For additional information with respect to this Alert, please contact the following: Ernst & Young Tax Co., International Tax Services, Tokyo Alex Postma +81 3 3506 1275 alex.postma@jp.ey.com Ernst & Young Belastingadviseurs LLP, Amsterdam Silvain Niekel +31 88 40 71675 silvain.niekel@nl.ey.com Ernst & Young LLP (Canada), International Tax Services, Toronto Sara Yamotahari +1 416 943 3288 sara.yamotahari@ca.ey.com
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