The OECD has issued a consultation document inviting comments on issues arising from the tax treaty entitlement of non-CIV vehicles. This consultation follows on from the final report on action 6 of the project on base erosion and profit shifting (BEPS) which indicated that the OECD would continue to examine issues arising for the treaty entitlement of non-CIV funds as a result of the measures in action 6 on prevention of granting treaty benefits in inappropriate circumstances.

The document addresses concerns about how the provisions in BEPS action 6 would affect the treaty entitlement of non-CIV funds. One concern has been that the limitation on benefits (LOB) article in the report on action 6 would affect funds that have a geographically diversified base. One suggestion for overcoming this problem is that an exception could be included to the LOB rule in the case of funds that are subject to certain types of regulatory framework. Another possibility is that the fact that a fund is widely held is sufficient protection against treaty abuse, but an additional safeguard could be included in the form of a rule to deny treaty benefits if a certain percentage such as 10% or more of the fund was owned by a single non-equivalent beneficiary or its connected persons.

Derivative benefits rule

A suggestion was made in consultations on action 6 that the LOB should include a derivative benefits rule applicable to certain non-CIV funds under which such an entity would be entitled to treaty benefits under a tax treaty if it met certain conditions; and if it had a sufficiently high level of investors (e.g. 80%) who would be entitled to the same or better treaty benefits. The reason given for that suggestion was that investors in Alternative Funds are mainly institutional investors and are often entitled to benefits that are at least as good as the benefits that might be claimed by the Alternative Fund. The fact that Alternative Funds pool capital from investors and make investments in different jurisdictions should not cause investors to forfeit the treaty benefits to which they would be entitled if they invested directly.

The treaty benefits could therefore be granted to the fund on the basis of the treaty entitlement of the investors. Concerns about treaty shopping could be dealt with by restricting the application of this rule to funds meeting particular criteria and specific anti-abuse rules could be provided.

Substantial connection criterion

Another suggestion was that the LOB should not deny benefits to a non-CIV resident of a State with which the non-CIV has a sufficiently substantial connection. The definition of a sufficiently substantial connection could be based on criteria such as residence of the members of the Board of the fund or its manager or administrator, whether the fund has qualified personnel in the jurisdiction or whether Board decisions are taken there. A fund that meets the criteria could then satisfy the LOB by the addition of a derivative benefits provision.

However the OECD working party considered that by allowing treaty entitlement to a fund resident in a State that is effectively managed in the State but subject to low taxation there the provision would open the door to treaty shopping. The consultation paper is asking for practical suggestions on a substantial connection criterion that would not raise concerns about the possibility of treaty shopping or tax deferral.

Global Streamed Fund regime

The paper also asks for suggestions on a Global Streamed Fund approach under which investment income would be exempt from tax when derived by a qualifying fund – a Global Streamed Fund – but the fund would be required to distribute its income on a regular basis and the distributions would be liable to tax except where they are received by other qualifying funds. The liability to tax of the recipients would depend on the treaty entitlement of the ultimate investor under the relevant treaty between the investor’s State and the State of source of the income. This would be an option for closed-end non-CIVs.

PPT rule and non-CIV funds

There have been concerns that the Principle Purposes Test (PPT) proposed by BEPS action 6 could restrict the treaty entitlement of non-CIV funds where a large proportion of the investors in a non-CIV are residents of States that are not the State of residence of the fund. Commentators are invited to suggest new examples relating to the application of the PPT rule to non-CIV funds.

Anti-conduit rule and non-CIV funds

Some commentators are concerned that an anti-conduit rule should not apply to non-CIV funds and they are invited to send examples of situations where the PPT rule could apply to legitimate arrangements commonly entered into by non-CIV funds because they would be seen as conduit arrangements.

Special tax regime rule and non-CIV funds

The report on BEPS Action 6 mentioned that the finalization of special tax regime rules would be postponed until the new US Model Treaty was finalized. That final version was released in February 2016 so commentators are now asked to comment on whether they have concerns in relation to the different version of the special tax regimes proposal that is contained in the US Model.

Comments on the consultation document are invited by 22 April 2016.