BEPS Actions 6 and 7 substantially amend the tax environment for the international investment and participation management. The recommendations of the OECD are not implemented yet. However, the new international tax rules should already be considered in the tax strategy, particularly, if new fund structures are being implemented or if cross-border asset management agreements are concluded.
The OECD and the G20 agreed on fifteen different actions aiming to restrict base erosion and profit shifting (BEPS). The set of measures is to be implemented directly in the domestic laws and/or through amendments to double tax treaties.
In the following, the BEPS Actions 6 (Treaty Abuse) and 7 (Permanent Establishments), which are of great importance for investment and participation management, are explained. Both actions are to be implemented through amendments to double tax treaties or through changed interpretation of the OECD model commentary.
1. Action 6 – Risk of higher tax burden on the return
The aim of action 6 is to combat the unjustified claiming of double tax treaties’ benefits (“treaty shopping”). For this purpose the OECD proposes the introduction of the following anti-abuse rules:
“Limitation of benefits” rule (LOB)
The inclusion of the LOB rule should preclude unauthorized subjects from benefiting from treaty entitlements and withholding tax reductions on dividends, interest payments and licenses. While individuals, public entities and publicly traded companies in general meet the criteria of the LOB rule and don’t require further verification, non-listed companies need to pass one of four tests:
1. Ownership test
The entity is entitled to benefit from the treaty if more than 50% of its shares are held directly or indirectly by a person entitled to treaty benefits.
2. Derivative benefits test
If treaty entitlements for more than 75% of directly invested beneficial owners of the entity are better or at least equally good as treaty benefits achieved via holding the entity’s shares, the entity is entitled to benefit from the treaty.
3. Activity test
Provided the entity is engaged in the active conduct of a business in its state of residence AND the income achieved in other member state is derived from that business, the entity can apply the treaty with regard to that income.
4. Discretionary relief test
In case the tax subject passes none of the aforementioned three tests, an application for granting the treaty benefits can be filed. It is, however, at the authority’s discretion whether the treaty benefits are granted. For instance an entity which is fully controlled by foreign investors and doesn’t achieve income from active conduct in its state of residency, would not be entitled to benefit from the treaties benefits.
“Principal purpose test” rule (PPT)
The PPT rule denies treaty benefits if the main purpose of the transaction or arrangement is to obtain those benefits. Tax authorities may be entitled to assume treaty abuse if one of the main purposes of an arrangement or transaction is of a fiscal nature. The tax payer would have to provide prove that the chosen structure is in accordance with the purpose and objective of the treaty. In Austria this is not a new approach as a number of treaty cases has already been denied by referring to national anti-abuse rules. However, whereas now the tax payer can provide evidence via provision of material, non-fiscal motives, under the application of the PPT rule the burden of proof would increase significantly.
LOB: Impact on fund structures
The introduction of the LOB rule would have a huge impact e.g. on existing fund structures. The main goal of international funds is to enable joint investments for investors from different nations, whereby the investors are commonly not residents of the fund’s state of residence.
Thus, the OECD allows derogations, applying for instance to
- Investment funds with a large number of investors and a widely dispersed investment; such investment funds should be able to benefit from treaty entitlements;
- Investors if they were entitled to obtain comparable or better benefits under other applicable treaties (e.g. of their home states).
For funds a PPT rule would be easier to apply. However, the classification of certain fund structures as abusive will depend on the interpretation of the PPT rule by the respective national tax authorities.
It is recommended to conduct a tax screening of investors if a new fund is established in order to increase chances of obtaining treaty benefits in the future.
2. Action 7 – Risk of permanent establishments in target markets
Under the current double tax treaties, business profits of foreign enterprises are generally taxable in the state, in which the entity has its permanent establishment (PE) to which the profits are attributable. Thus, the tax treaties’ definition of PE is crucial when determining whether a non-resident enterprise must pay income tax in another state.
For the participation and investment management the definition of an agency PE is of great importance:
An independent agent (e.g. broker, manager or consultant) acting on behalf of the principal in the ordinary course of his business, to date does not create a PE.
BEPS Action 7 provides regulations, according to which an agency PE will be created more easily due to the following amendments:
- A PE for an enterprise will be created if the agent, unless he is independent, acts in the principal role leading to the conclusion of contracts that are routinely concluded without material modification. Thus, in participation and investment management a PE can be created by an asset manager, consultant or other advisor, who in the course of their activity supervises the local asset and negotiates contracts. The PE would be created in addition to the already existing local subsidiary.
- The definition of an independent agent will be restricted significantly. If a person acts exclusively or almost exclusively on behalf of one or more enterprises to which it is closely related, that person shall not be considered to qualify as independent agent. The term “almost exclusively” is met if the agent achieves more than 90% of its revenue from its activity for enterprises to which it is closely related.
Due to the aforementioned restrictions, in the future it will be necessary to ensure that the wording in contracts with consultants (acting almost exclusively for an enterprise or a fund) is distinct. Otherwise discussions with tax authorities will be inevitable.
CONCLUSION – implementation of Action Points 6 and 7 open
The OECD published its report setting out its recommendations in relation to fifteen different BEPS actions. It remains to be seen whether and to what extent the actions are implemented by the Member States.
If the OECD does not succeed in concluding a multilateral tax treaty with numerous Member States, the implementation on the bilateral treaty level will be a tedious process. However, in order to be prepared for the amended framework’s consequences as well as possible, the potential effects of the amended tax treaties should be considered when setting up new enterprises or funds.
- Contact TPA experts for international tax structuring if you have questions on the OECD’s BEPS plan!
- Find out more about the 15 OECD BEPS actions: Base Erosion and Profit Shifting