Multilateral Instrument – An introduction

India along with around 90 other nations has entered in to the Multilateral Convention to Implement Tax Treaty Related Measures to Prevent BEPS (MLI). This brought to a culmination the various BEPS Action Plans agreed upon under the aegis of G20/OECD.

The purpose of MLI is to provide a more transparent tax environment and to tackle the Base Erosion and Profit Shifting (BEPS) tax planning strategies, wherein profits are shifted to jurisdictions having low tax or no tax, usually known as tax havens.

The MLI will serve to achieve BEPS outcomes across the network of existing tax treaty agreements without the need of bilaterally renegotiating the tax treaty entered into by each of the countries signatory to the MLI.

The extent to which the purpose mentioned above will be achieved is dependent on the instrument of ratification and list of reservations and notifications deposited by each of the signatories with respect to its notified covered tax agreement. India, on 25 June 2019, deposited its instrument of ratification for MLI, along with the list of reservations and notifications.

Covered tax agreement

Each country (i.e. signatory) will have to specify the existing list of tax treaties to which MLI provision would apply. The tax treaty of these countries is required to be read along with the ratified MLI. The list of tax treaties specified by signatories to MLI is known as Covered Tax Agreement (CTA). MLI provision will be applicable only when both parties have notified each other in the list of their CTAs. For example, India has notified tax treaties with Germany and Mauritius as CTA. However, Germany & Mauritius have not notified tax treaty with India as CTA. In such a scenario, the MLI provisions will not be effective between India and Germany and between India and Mauritius. The existing tax treaty between India and Germany; and that between India and Mauritius would prevail. It should be noted that USA has not become a signatory to the MLI and hence the question of India-USA treaty being a CTA does not arise at all.

Ratification of MLI

Ratification of an instrument helps each country to specify its definite position on each of the Articles of MLI.

India is the 28th country to have deposited its instrument of ratification with the OECD. This will modify India’s tax treaties with countries which have included India in their list of CTAs. While there are more than 20 countries which have listed India in their list of CTAs as of May 2020, this list will further increase as other countries deposit their instruments of ratification with OECD and notify India in the list of CTAs.

As on 1 April 2020, the following 21 treaties signed by India will change due to the MLI for both withholding taxes and other taxes:

In addition, MLI is effective for the following 7 treaties signed by India only for withholding taxes from 1st April 2020:

Canada; Denmark; Iceland; Latvia; Norway; Qatar and Ukraine

Indian tax department has put up Synthesised Text for its treaties with 19 countries as of May 2020. These texts provide a consolidated reading of the treaty provisions with that of the MLI.

Also, different effective dates being applicable for withholding taxes and other taxes needs to be kept in mind with respect to the additional 7 tax treaties listed above.

Impact of MLI

Analysis on treaty implications with respect to transactions involving the above listed countries will now have to factor in MLI provisions as well. MLI provisions have to be applied alongside the treaty provisions.

MLI contains 38 Articles, which can be classified into different buckets:

• Articles 1 and 2 dealing with the Scope and Interpretation of Terms used in the MLI
• Articles 3 to 17 contain substantive provision which deals and addresses specific BEPS concern over following parts:
  • Part II dealing with Hybrid Mismatches;
  • Part III dealing with Treaty Abuse and mandatory standards in that regard;
  • Part IV dealing with Avoidance of Permanent Establishment Status; and
  • Part V for Improving Dispute Resolution.
• Articles 18 to 26 contain provision related to mandatory arbitration, and
• Articles 27 to 39 contain final procedural provisions.

The changes, in brief, are:

Mandatory Minimum standard

Parties to MLI are required to meet certain prescribed minimum standards in their tax treaties. The following are minimum standards of MLI:

• Article 6 - Purpose of CTA

  Article 6 seeks to insert a statement in the preamble of the tax treaties to the effect that the purpose of the treaty is not to create opportunities for double non-taxation or reduced taxation through tax avoidance or evasion including treaty shopping. The countries may also make reference to the intention of developing economic relationship and enhancement of cooperation in tax matters.

• Article 7 - Prevention of treaty abuse

  BEPS Action Plan 6 states that countries, at a minimum, should implement one of the following three treaty abuse provisions:

  • Principal Purpose Test (PPT);
  • PPT plus either simplified or detailed Limitation of Benefit (LOB);
  • Detailed LOB supplemented by a mechanism that would deal with conduit arrangement.

  PPT is considered as default option under MLI. Parties to MLI are permitted to supplement the PPT by choosing to apply a simplified LOB provision. MLI does not include detailed LOB provision.

  India has notified application of PPT as an interim measure. India has further stated that simplified LOB provision will be adopted through bilateral negotiation where possible, as replacement or in addition to PPT.

• Article 16 - Mutual Agreement Procedure

  This article provides for mandatory inclusion of Mutual Agreement Procedure in CTAs.

  Parties to MLI can opt out of minimum standard in limited situations such as where the CTA already meets the minimum standards, if parties decide to reach a mutually satisfactory solution, etc.

Apart from the above Minimum Standards, the MLI has brought in several anti-tax avoidance rules through its following Articles:

1. Article 3: Concerning Hybrid Mismatches due to transparent entities. India has not opted for this Article.
2. Article 4: Determination of residence of dual resident entities by the Mutual Agreement Procedure.
3. Article 5: Dealing with elimination of double taxation so as to counter the problems created by exemption method in certain treaties.
4. Article 8: Countering dividend stripping transactions whereby a higher threshold requirement has been brought in.
5. Article 9: Bringing in an enhanced threshold for taxing capital gains in the country where immovable property is transferred through shares or interests of entities which derive their value from such property.
6. Article 10: Creating an Anti-abuse rule for Permanent Establishments situated in third country.
7. Article 12: Expansion of the Agency PE concept to include Commissionaire Arrangements which are not prevalent in India.
8. Article 13: Restricting the specific activity exemptions only to situations where the activities are preparatory or auxiliary in character.
9. Article 14: Anti-avoidance rules to block avoidance of a PE status through splitting up of contracts.

Through the MLI it is also sought that countries have an improved dispute resolution mechanism which has been bought in through:

1. Article 16: Enhanced access to Mutual Agreement Procedure available in the tax treaty.
2. Article 17: Providing for Corresponding Adjustments
3. Article 19: Mandatory Binding Arbitration as a tool to resolve disputes. However, India has not opted for this Article and hence there will not be a Mandatory Binding Arbitration as far as India is concerned.

How each of the above Article applies to India depends on what reservations and options India has given or selected and whether they match with those given or selected by the other country.

Reservation

For anything that is not a BEPS minimum standard, the MLI provides flexibility to opt out of provision entirely or, in some cases, partly through reservations. The reservations apply symmetrically i.e. if a party uses reservation to opt out of a provision, then that provision will not apply between the reserving party and all other parties to the CTA under the MLI. Party to MLI may reserve the right for provisions of the MLI not to apply to a subset of CTAs.

Optional provision

MLI provides flexibility with respect to application of optional and alternative provisions to address the same issue. Each signatory to MLI is required to notify the option it would like to choose. For an example, Article 13 – “Artificial avoidance of permanent establishment status through the specific activity exemptions” provides two options under Article 13(1), which are as under:

• Option A under Article 13(2) - provides exemption if activity carried on is preparatory and auxiliary in nature.
• Option B under Article 13(3) - provides automatic exemption to each and every activity covered under Article 5(4) of the Covered tax Agreement and the same is not subject to preparatory and auxiliary condition.

Parties to MLI are required to choose one of the options and notify the depositary of their choice. It may be noted that in case the position taken by one country on certain Articles of MLI Convention do not match with position taken by another country on the same Article, then the tax treaty between the countries would prevail over MLI. Thus, it is important to have matching concept on position taken by each of the signatories with respect to each other, for effective application of MLI.

Therefore, careful consideration of the above factors needs to be made before one can conclusively apply the MLI to a CTA. At the same time, it should be noted that the MLI does not cover all aspects of a treaty. For example, the rates as prescribed in a treaty are not impacted by the MLI and will continue as before.

Following documents can help in further study of the MLI and its impact:

From the OECD website – http://www.oecd.org/tax/treaties/multilateral-convention-to-implement-tax-treaty-related-measures-to-prevent-beps.htm

1. Multi-Lateral Instrument
2. Explanatory Statement to MLI; and
3. MLI Positions adopted and deposited by various MLI Signatories with OECD
4. MLI Application Toolkit and database to match positions for treaties vis-à-vis India
5. BEPS Action Plan 15

From the Indian income-tax department website: https://www.incometaxindia.gov.in/Pages/international-taxation/dtaa.aspx

1. The Synthesized text of treaties read with MLI – Indian tax department has put up synthesised text for its treaties with 19 countries till May 2020 which makes it easy for practitioners to understand the treaty as it reads after implementation of MLI.