Multilateral instrument causes tax temperatures to fluctuate
Fred van Horzen, partner specialized in tax treaties, EU treaty freedoms and State aid, shares his views on tax temperature fluctuations.
This month (November 2019) Meijburg & Co is celebrating its 80th anniversary. In November 1939, Willem Meijburg, up until then an inspector of state taxes, established himself as an independent tax advisor. Much has changed in the tax practice during the last 80 years and Meijburg & Co has also undergone numerous transformations. Which, by the way, does not mean that everything would appear strange to Willem Meijburg should he suddenly return.
During the 1920s and 1930s, the League of Nations, an institution set up after the First World War and which was in fact the forerunner of the United Nations, studiously examined the contours of a model convention for the avoidance of double taxation. The work of the League of Nations was generally aimed at contributing to peace between states. The avoidance of double taxation and combating tax avoidance was already a hot topic in the 1930s and led to many discussions in which Willem Meijburg also actively participated. Moreover, as he had also spent some time as a tax inspector in the Dutch East Indies he was familiar with the problems of taxing companies operating in more than one jurisdiction. A large number of the solutions devised by the League of Nations at the time can still be found in the current OECD Model Convention. As part of the BEPS project (BEPS stands for Base Erosion and Profit Shifting), the OECD has for several years now been working on amending the tax rules for enterprises operating in more than one jurisdiction.
The Principal Purpose Test
For the international practice, the multilateral instrument (MLI) is the most tangible result of the BEPS project. The MLI will have a major impact on virtually all existing tax treaties, also those of the Netherlands. Especially the Principal Purpose Test (‘PPT’), a provision aimed at unintended use of tax treaties, should give cause to reconsider existing and new structures.
The PPT means that treaty benefits will not be granted if obtaining the treaty benefit was one of the main reasons for an arrangement or a transaction that triggers a treaty benefit. Therefore, before an arrangement is implemented or a transaction executed, the key question raised by the PPT needs to be considered: “Why would you do that?” A question the well-known Dutch singer Nielson also asks in his hit ‘Ice cold’. If the only reason you can think of is obtaining a tax benefit, then you’d be best advised not to attempt it. Existing arrangements should also be assessed along those lines.
The multilateral instrument is certainly not the final destination of the journey that began in the 1920s. The OECD is already well advanced with a project referred to as ‘BEPS 2.0’, which consists of two pillars. The first pillar is related to the issue of the digitalization of the economy. The second pillar is generally aimed at preventing the erosion of the tax base through the introduction of a minimum effective profit tax rate. The characteristic of both BEPS 1.0 and BEPS 2.0 is that the jurisdictions concerned want to prevent the erosion of their own tax base. Whereas the focus in the past was on stimulating free trade and globalization, the tax climate has already been cooling down for some time now. The focus is now on the protection of one’s own market and one’s own tax base. There is thus a certain parallelism between the BEPS project and the current trade wars.
MLI 2.0
Under the first BEPS 2.0 pillar, the right to tax is granted to the market jurisdictions from which large international enterprises realize turnover from or with the aid of consumers without having a physical presence or a subsidiary there. On the basis of formulas still to be determined, part of the enterprises’ surplus profits will be allocated to the market jurisdictions to the detriment of the jurisdictions where the enterprise is established. If agreement can be reached within the OECD, the OECD believes that an ‘MLI 2.0’ will be required to quickly and easily implement this system within the scope of tax treaties.
Withholding Tax Act 2020
The Netherlands is in principle in favor of the first pillar, subject to a number of conditions. According to Deputy Minister of Finance, Menno Snel, there must be increased clarity about definitions and formulas. As far as the second pillar is concerned, there is already a legislative proposal in the Netherlands, entitled ‘Withholding Tax Act 2021’. This bill aims to prevent the payment of interest and royalties to entities established in countries on the EU tax blacklist of non-cooperative jurisdictions and countries on the Dutch blacklist because they have a statutory profit tax rate of less than 9%. The Netherlands will then levy withholding tax of 21.7% from 2021. It should be borne in mind, however, that direct payments of interest and royalties to entities that are not on one of these blacklists may also be affected by this withholding tax, for example because of a payment to a hybrid entity or because of an abuse situation. According to the Deputy Minister, this could even be the case if the entity is established in a treaty country and a withholding tax rate of 0% on interest or royalties has been agreed in the treaty. In that case, could the Netherlands invoke the PPT in order to be able to implement the new withholding tax legislation? I don’t think so. This is because the entity is not in that country in order to obtain treaty benefits, but because the statutory profit tax rate there is at least 9%. The PPT cannot then be invoked to deny the right to treaty application. Would the tax authorities be warmed by this observation or would it leave them ice cold?
