On 22 May 2015 the OECD issued a new discussion draft on Action 6 of the action plan on base erosion and profit shifting (BEPS) dealing with the issue of preventing tax treaty abuse. This follows the release of a previous discussion draft on this subject on 21 November 2014, the consideration of comments received, and a public consultation meeting on 22 January 2015.

Simplified LOB rule

The first part of the new discussion draft deals with the alternative simplified Limitation of Benefits (LOB) rule in the OECD Model Tax Convention. The simplified LOB rule is intended to be used in combination with the Principal Purpose Test (PPT) rule to combat treaty shopping. The LOB rule would limit the treaty benefits to qualified persons, these being governments; local governments; central banks; persons or entities whose shares or beneficial interests are regularly traded on a stock exchange; individuals; or persons other than individuals where residents of the state own, directly or indirectly, more than 50% of the beneficial interests of that person.

Residents that are not qualified persons as defined above would be entitled to a benefit under a treaty in relation to an item of income if persons who are equivalent beneficiaries own more than 75% of the beneficial interests of that resident. An equivalent beneficiary for this purpose is a person who would be entitled to an equivalent (or more favorable) benefit in relation to an item of income under the domestic law of a State, international or treaty provisions; provided that if the person is not a resident of that contracting state there is an exchange of information agreement with that person’s state of residence.

A person not qualifying under any of these provisions could obtain treaty benefits if the competent authority of the State from which the benefit is claimed determines that the person’s acquisition, establishment or maintenance and the conduct of its operations do not have obtaining that tax benefit as one of their principal purposes.

Collective investment vehicles (CIVs)

Commentators to the previous discussion draft were generally in agreement that a flexible approach is required to CIVs as these vehicles vary in their structure, investor base and investment policy. A single approach to treaty entitlement would not therefore be suitable for them. Procedures for CIVs to obtain treaty benefits are however onerous in many countries. The conclusion is therefore that the LOB provisions in the first discussion draft dealt adequately with the application of treaty benefits to CIVs.

However the working party considers that the recommendations of the TRACE project should also be implemented. The OECD’s TRACE implementation package relates to the adoption of an authorized intermediary system that will provide effective withholding tax relief procedures for cross-border income.

Non-CIV funds

Non-CIV funds include Real Estate Investment Trusts (REITS), sovereign wealth funds, pension funds and alternative funds including private equity funds.

The OECD working party takes the view that a pension fund should be considered a resident of the State in which it is constituted regardless of whether it benefits from a limited or complete exemption from tax there. It will consider at its meeting in June 2015 a proposal for changes to the OECD Model to ensure that this is the case. With regard to non-CIV funds in general the working party wants to ensure their entitlement to treaty benefits where appropriate but emphasizes that there are treaty shopping concerns that must be dealt with.

Governments have two general concerns about granting treaty benefits to non-CIV funds. These are firstly that they may be used to provide treaty benefits to investors that are not themselves entitled to them, and that investors may defer recognition of income on which treaty benefits have been granted. The working party will discuss at its June 2015 meeting the possibility of adding a specific provision on non-CIVs to the LOB rule and adding some non-CIV examples to the commentary on the PPT rule.

The working party may continue work on these issues after the adoption of the final report on Action 6 in September 2015, but the work should be completed before the December 2016 deadline for negotiation of the multilateral instrument to implement the conclusions of the Action 6 work.

Other provisions

The new discussion draft also covers the following issues:

• Granting of discretionary relief by the competent authority under the LOB rules;
• Alternative LOB provisions for EU countries;
• The possibility for discretionary relief under the PPT rule;
• An alternative “conduit PPT rule” for States to use to address conduit arrangements;
• Inclusion of further examples in the commentary to the PPT rule; and
• Some other issues relating to the application of the PPT rule.

Comments on the new discussion draft should be submitted by 17 June 2015.