The impact of MLI on Treaty Benefits
On 7 June 2017, in an effort to counter international tax avoidance, nearly seventy countries signed the Multilateral Instrument (hereinafter: MLI) in Paris. In the meantime, the number of countries that have signed up to the treaty has risen to almost 90, with the MLI having officially come into force on 1 July 2019. As of 1 January 2020, the MLI will also take effect for the Netherlands. A large number of aspects of the MLI’s substantive regulation, however, contain many uncertainties in practical application.
As already stated, the aim of the MLI is to counter tax avoidance, or, to be more precise, counter the abuse of tax treaties. A tax treaty prevents double taxation. This is because countries mutually agree on which country receives taxation on which income or capital. On the basis of such treaties, some companies manage to pay hardly any tax at all!
Only change in the case of covered tax agreement
The MLI requires you to be extra vigilant when making use of treaty benefits. In addition to consulting the tax treaty, in some cases you will now also have to consult the MLI. However, the MLI only modifies a tax treaty in the case of a ‘covered tax agreement‘. In such a case, both contracting countries have indicated that they will adjust the treaty applicable to them on the basis of the MLI. The adjustments that can be made on the basis of the MLI have been subdivided into the following areas: hybrid mismatches, prevention of treaty abuse, permanent establishments and dispute resolution.
The ‘principal purpose test‘ (hereinafter: PPT) forms an important part of the MLI. The PPT has been set out in art. 7 of the Multilateral Convention to Implement Tax Treaty Related Measures to Prevent Base Erosion and Profit Shifting. This test is used to prevent the granting of tax treaty benefits in certain situations. Treaty benefits are countered when a company aims to gain tax treaty benefits when setting up the structure. The measure has an open character, which makes the definition unclear. In addition, there are no specific guidelines for the use of the PPT. Two criteria must be used to test whether there is abuse of the treaty. In the first place, there must be a motivation requirement, that is, the main objective of the company is to obtain a tax advantage. Secondly, there must be the standard requirement, that is to say, the granting of benefits is contrary to the purpose and scope of the treaty provisions. The interpretation of the aforementioned criteria may differ per case. Each time, one will have to test on the basis of all facts and circumstances whether one can apply the treaty benefits.
Testing the PPT is not easy. It is advisable to call in a specialist for this. If you want to be sure that you can still make use of treaty benefits, please contact us.
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