In September 2014 the OECD released a Report on BEPS Action 6 (the 2014 Report). In this 2014 Report a draft treaty provision on the Entitlement to benefits was introduced (Article X) which combines a Limitation on Benefits (LOB) rule in paragraphs 1-6 and a Principal Purpose Test (PPT) in paragraph 7. In the Report, it was recommended that treaties include the combination of the LOB rule and the PPT, and at a minimum, either the inclusion of the PPT or the LOB rule supplemented by a mechanism such as a restricted PPT applicable to conduit financing arrangements or domestic anti-abuse rules.

Furthermore other situations where a person seeks to circumvent treaty limitations were addressed.

On 21 November 2014, the OECD released a discussion draft that identified remaining issues. Public comments on this discussion draft were invited and also abundantly received. In March 2015 the Working Party on Tax Conventions and Related Questions agreed on how to address the majority of these issues. Their conclusions and proposals reached are reflected in this revised discussion draft, which was released on 22 May 2015.

The revised discussion draft deals with several issues relating to the LOB provision, the PPT and other issues. Below we will discuss a selection of relevant conclusions and proposals relating to the LOB provision, the PPT and other issues.

LOB provision

The revised discussion draft contains an alternative, simplified LOB rule, which is intended to be used in combination with the PPT rule. The main difference with the LOB rule under the 2014 deliverable is that the various tests (such as the publicly traded companies exception, the ownership test, active business test and the equivalent beneficiaries test) are less detailed and less complicated (e.g. no base erosion test under the ownership test and the derivative benefits provision). Furthermore the simplified LOB rule does not contain provisions for pension funds, fund of funds and collective investment vehicles (CIVs). Under the simplified LOB rule the most obvious cases of treaty-shopping would be dealt with (other cases being dealt with under the PPT). The LOB rule as included in the 2014 Report would be more appropriate for countries that would prefer to meet the minimum standard through the combination of an LOB rule and a mechanism dealing with conduit arrangements (instead of the combination of an LOB rule and the PTT). It is suggested to incorporate the simplified LOB rule into the OECD Model Convention by describing the main features of the LOB in the Articles of the Model and presenting the alternative formulations in the Commentary.

Furthermore several issues related to the LOB provision are addressed, for example the position of CIVs and REITs. There appears to be general support for the conclusions of the 2010 CIV Report concerning the treaty entitlement of CIVs.Since subparagraph 2 f) of the LOB rule dealt with the application of the LOB to CIVs in a way that reflected the conclusions of the 2010 CIV Report, there was no need for additional changes to the 2014 Report on Action 6. Unlike the conclusions of the 2010 CIV Report, the conclusions of the 2008 REIT Report were not confirmed. The Working Party agreed to further discuss, at its June meeting, proposals intended to (i) add a specific reference to the conclusions of the REIT Report, and (ii) ensure that a pension fund should be considered to be a resident of the State in which it is constituted (irrespective whether it benefits from a limited or complete exemption).

In the context of the derivative benefits provision, two US proposals are mentioned, which were not included in the 2014 Report and on which comments are invited: a proposal for a new treaty provision on “special tax regimes” and a proposal for a treaty rule to make a treaty responsive to future changes in domestic laws (i.e. future exemptions for foreign source income).


Discretionary relief under the PPT

According to the 2014 Report, application of the PPT would result in the (complete) denial of the application of treaty provisions and the income in question would become taxable under the provisions of the national law of the Contracting States. However, as observed in the November 2014 discussion draft, it would be more appropriate to provide some form of tax relief. This could for example be the case when a taxpayer engages in an avoidance transaction to transform what would normally be a cross-border dividend (taxable at source under the provisions of Art. 10(2)) into a capital gain on shares (exempt from source taxation under Art. 13(5) of the Model Tax Convention). In such a case, the application of the PPT rule would result in the denial of the benefits under art. 13(5). However, a tax administration may consider it appropriate to apply the relief provided for under Art. 10(2), which could be done in a manner similar to the discretionary relief provision of the LOB rule.

After consideration of the received comments the Working Party decided to introduce a new paragraph 8 to the article which introduces a discretionary relief. Based on paragraph 8 the competent authorities of the Contracting States could- in case a benefit is denied to a tax payer on the basis of the PPT (paragraph 7)- grant the benefits that the tax payer would have been entitled to in the absence of the transaction of arrangement referred to in the PPT. Based on paragraph 8 broad discretion is granted to the competent authority for the determination on whether (or not) to grant this benefit. Nevertheless, the Competent Authority has to take into consideration all relevant facts and circumstances and has to consult the competent authority of the other Member State before rejecting a request made by a resident of that other State.

Alternative to the PPT for “conduit arrangements”

In the 2014 Report an alternative rule to the PPT was included in the Commentary on the PPT, that States may use to address treaty shopping commonly referred to as “conduit arrangements”, which would not be caught by the LOB provision (hereafter: the anti-conduit rule). Originally a very precise definition of “conduit arrangement” was proposed in this anti-conduit rule. Since this definition has been criticized by a number of commentators, it is now proposed to replace this precise definition and simply focus on general principles and include examples of transactions that the anti-conduit rule should address.

Additional examples on the PPT

In the 2014 Report the application of the PPT is illustrated through five examples included in the Commentary on the PPT. In the November 2014 discussion draft was suggested that additional examples should be added, which suggestion was supported by commentators. Therefore 4 additional examples have been included in the Commentary on the PPT. Based on these additional examples it seems crucial whether the transactions have taken place for commercial reasons. If that is the case, the PPT would not apply in the absence of other facts that would indicate that one of the principle purposes is to obtain the treaty benefits.

Other issues

Several other issues have been discussed in the revised discussion draft. However, the most important development is the adaption of the rule included in the 2014 Report to prevent the abuse of permanent establishments (hereafter: PE) in third States, where the profits are not adequately taxed. The tax benefits under the Convention will not apply to income, which is derived from the other contracting State and is attributable to a tax-exempted PE on which the effective tax rate on the profits of the permanent establishment in the third jurisdiction is less than 60 percent of the general rate of company tax in the State of the State of residence. However, this provision will not apply if the income is derived in connection with or is incidental to the active conduct of a business carried on through the PE.

Concluding remarks

Public comments on this revised discussion draft should be sent by 17 June 2015 at the latest and will be discussed at the Working Party meeting of 22-26 June 2015. Afterwards the Working Party will produce a final version of the report on Action 6 which will include the conclusions on these remaining issues as well.

Click here to download the memorandum in pdf format