On 18 December 2017 the OECD released the 2017 edition of the Model Tax Convention. This edition incorporates measures outlined in the final reports from the action plan on base erosion and profit shifting.

The new edition reflects work on BEPS Action 2 (Neutralizing the Effects of Hybrid Mismatch Arrangements); Action 6 (Preventing the Granting of Treaty Benefits in Inappropriate Circumstance); Action 7 (Preventing the Artificial Avoidance of Permanent Establishment Status) and Action 14 (Making Dispute Resolution More Effective). Some important changes are as follows:

Changes to permanent establishment definition

The revised Article 5 of the Model Tax Convention reflects measures recommended in the final BEPS report to prevent attempts by multinational enterprises to avoid the creation of a permanent establishment in countries where they are operating. Article 5 (5) and 5 (6) are therefore revised to address commissionaire arrangements and similar strategies. Also the exceptions to permanent establishment status outlined in Article 5 (4) are modified to ensure that they are restricted to activities of a preparatory or auxiliary character.

The new paragraph 4.1 of Article 5 contains an anti-fragmentation rule that examines the overall activity resulting from the combination of activities of two enterprises at the same place, or the same or closely related enterprises at two places, to see if the combined activity is of a preparatory or auxiliary character.

Treaty anti-abuse rules in Article 29

Article 29 reflects work done by BEPS action 6 on preventing the granting of treaty benefits in inappropriate circumstances and contains new treaty anti-abuse rules to provide some safeguards against abuse of treaty provisions. Paragraphs 1 to 7 of Article 29 contain limitation on benefits (LOB) rules limiting the availability of treaty benefits to entities meeting particular criteria based on the legal nature, ownership and general activities of the entity. These conditions ensure a sufficient link between the entity and the contracting state of residence.

To combat other forms of treaty abuse, including treaty shopping that would not be covered by the LOB rule, Article 29 (9) of the OECD Model contains a principal purposes test (PPT) under which if one of the principal purposes of the transactions or arrangements is to obtain treaty benefits these will be denied; except where it is established that granting the benefits would conform to the object and purpose of the treaty provisions.

The new Article 29 gives the contracting parties some flexibility on how to implement the rules into their bilateral tax treaties. They could use the combined approach of LOB and PPT rules; use the PPT rule alone; or use the LOB rule supplemented by a mechanism to deal with conduit financing arrangements not already covered by other anti-abuse rules in the treaty.

Paragraph 187 of the commentary sets out the details of the anti-conduit mechanism. The rules deny some treaty benefits in relation to any income obtained under, or as part of, a conduit arrangement. The rules could also be framed as domestic anti-abuse rules or judicial doctrines achieving a similar result. The commentary gives examples of what would or would not constitute a conduit arrangement.

Changes to Article 25 and commentary

One result of the report on BEPS Action 14 on making dispute resolution more effective is that paragraph 1 of Article 25 has been amended to provide that a person may present his case to the competent authority of either contracting state, rather than just the contracting state of residence.

The second sentence of Article 25 states that “any agreement reached shall be implemented notwithstanding any time limits in the domestic law of the Contracting States.” Where a contracting state is unable to include this provision in its treaty the new edition of the Model Treaty contains provisions in the commentary to Articles 9 and 7 to provide for a bilaterally agreed time limit for profit adjustments of an enterprise or a permanent establishment, except in the case of fraud, gross negligence or willful default.

Paragraph 42 of the commentary to Article 25 has been amended to state that where the competent authority is not legally precluded from granting relief from taxation despite a Court decision that the taxation is in accordance with treaty provisions, nothing else such as administrative policy or practice should prevent the competent authority in that situation from reaching a mutual agreement under which taxation is relieved as it is not in accordance with the treaty provisions.

Further changes to the commentary to Article 25 emphasize that a taxpayer should be allowed access to the mutual agreement procedure for resolution of double taxation in the case of a bona fide taxpayer-initiated adjustment to amend a previously-filed tax return in relation to pricing of transactions or profits of a permanent establishment in accordance with the arm’s length principle, where all other obligations in relation to the income or profits have been property fulfilled.