OECD makes blanket change to double tax treaties

Individual states will have to implement provisions to prevent entities from using tax treaties primarily to reduce their tax base. The multilateral convention offers numerous ways to achieve this. The simplest way, and the one likely to be preferred by many states, is the implementation of a ‘principal purpose test’ – the entity will not be allowed to apply the tax treaty if it is obvious that obtaining the benefit was one of the principal purposes of a transaction or arrangement. Above this basic rule, the states may also choose to apply a ‘Limitation of Benefits’ provision. This means that an entity would have to comply with detailed conditions to apply a tax treaty. Historically, such provisions have been a part of the double tax treaty between the Czech Republic and the U.S., for instance.

The states that join the multilateral convention also have to adopt measures regarding the resolution of disputes arising from double tax treaties. For instance, within a period of three years, a taxpayer believing tax withheld abroad to be at variance with the relevant tax treaty could apply for a review with a tax administrator in any one of the two states. Individual states will then have to attempt to settle the issue by mutual agreement; where an agreement is not reached, arbitration may follow.

Measures against hybrid mismatches address, e.g., the taxation of fiscally transparent entities, dual residency issues, and the application of methods for the elimination of double taxation where a payment reduces the tax base in one country but is not taxed in the other country. As for permanent establishments, the multilateral instrument stipulates, among others, the rules regarding commissionaire arrangements, activities of a preparatory or auxiliary character, and the time test for the origination of a permanent establishment. Neither the rules against hybrid mismatches nor the rules regarding permanent establishments are obligatory, meaning that the states may decide not to implement the proposed measures.

Although the Czech Republic has yet to issue its official standpoint, it is expected to join the multilateral convention. The instrument will thus also affect Czech entities with foreign business relations. At the moment it is not clear whether the Czech Republic will choose the ‘minimum standard’ approach and only accept the obligatory provisions (basically, the principal purpose test and the dispute resolution provision), or whether it will opt for a more extensive implementation.