Jelena Bartule, Tax Manager at BDO Latvia, considers why it is important for multinational corporations to assess the potential impact of the treaty changes resulting from the multilateral instrument in the article for the Bloomberg Tax.
The Latvian government ratified the Law on Multilateral Convention to Implement Tax Treaty Related Measures to Prevent Base Erosion and Profit Shifting (MLI) on July 8, 2019.
MLI provisions will be applied to the international bilateral agreements between the Republic of Latvia and other contracting states that have ratified the covered tax agreement (CTA) on the avoidance of double taxation and the prevention of tax evasion.
Depending on the 57 CTAs that Latvia has ratified, the MLI will enter into force with 44 of them, as all countries that Latvia has concluded tax conventions with have not yet submitted the relevant notification of applying MLI provisions.
The MLI, under Action 15 of the Organisation for Economic Co-operation and Development (OECD)’s Base Erosion Profit Shifting (BEPS) project, intends to implement the guidance provided and changes recommended by the OECD in the area of BEPS tax treaty-based measures in a highly efficient manner.
This is achieved through an innovative cooperation between states, whereby the MLI operates alongside the existing bilateral tax treaties without the requirement of individually renegotiating each bilateral tax treaty. The MLI is aimed at unifying the provisions of existing double tax treaties.
Since the MLI is a flexible instrument which will modify the CTA according to a jurisdiction’s policy preferences with respect to the implementation of MLI-related BEPS measures, certain articles are optional. However, some elements of the MLI are OECD agreed ‘’minimum standards,’’ including the provisions on the prevention of treaty abuse and dispute resolution, which must be adopted by jurisdictions participating in the BEPS initiative.
Latvia has opted to apply only those provisions of the Convention which ensure the implementation of the ‘’minimum standard.’’ The articles within the MLI introduce CTA changes with respect to the following:
- Article 6 of the MLI—Preamble (which, in addition to CTA, provides Prevention of Treaty Abuse, BEPS—Action 6);
- Article 7 of the Convention (Principal Purpose Test (PPT), BEPS—Action 6);
- Article 16 of the Convention (Mutual Agreement Procedure, BEPS—Action 14);
- Article 17 of the Convention (Corresponding Adjustments, BEPS—Action 14).
The preamble to the CTA is amended to clarify purpose, setting out the context for a tax treaty and taking into account when interpreting and applying the provisions of the relevant treaty. It states that tax treaties have been concluded for the purpose of preventing tax evasion, in particular to prevent improper use of the tax treaty (treaty shopping).
Principal Purpose Test
A significant provision is the introduction of the PPT. Action 6 of the BEPS action plan states that the most effective way to prevent treaty abuse (treaty shopping) is to perform and assess the merits of applying the tax incentives granted according to the PPT. However, given that there are jurisdictions that wish to apply a different method, the Limitation of Benefits (LOB), the Convention provides for the possibility of applying a simplified LOB, provided that, in addition to the simplified LOB, the PPT is also required.
According to this test, Latvia may deny treaty benefits, e.g. reduced treaty rates, if the tax authorities have reasons to conclude that the principal purpose, or one of the principal purposes, of the particular transaction/arrangement was to obtain those benefits, unless it is established that granting that benefit in these circumstances would be in accordance with the object and purpose of the relevant provisions of the treaty.
If a treaty benefit is denied as a result of the application of the PPT, the treaty benefit may be obtained if a person can establish that obtaining that benefit is in line with the object and purpose of the relevant provision, given the eligible evidence.
Mutual Agreement Procedure
Action 14 of the BEPS action plan aims to strengthen and ensure more effective application of the provisions of Article 25 of the OECD Model Tax Convention on Mutual Agreement Procedures (MAP), ensuring that issues are resolved by mutual agreement within a specified period, reducing the risk of uncertainty and eliminating unjustified double taxation, if any occurred.
The minimum standard for this activity is that residents of the contracting states have the right, within three years, to apply to one or other competent authority of a contracting state to deal with a situation which has led to, or is likely to result in, double taxation, and any such agreement reached by the tax authorities must be complied with irrespective of the time limits set by national law.
The minimum standard also includes a provision allowing the competent authorities to consult each other in order to prevent double taxation in the tax treaty for unforeseen occurrences.
Although the right of taxpayers to apply to the one competent authority or other of the contracting states is one of the elements of the minimum standard, contracting states are entitled to make a disclaimer in respect of this provision.
Such a disclaimer is only possible if a contracting state intends to comply with a minimum standard for improving dispute settlement under the BEPS project through bilateral notifications or by initiating a process of consultation with the competent authority of the other contracting state in matters of jurisdiction, in which the competent authority, to which the complaint was submitted for consideration in the MAP, does not consider the taxpayer’s objections justify.
Action 14 calls for a more efficient MAP for transfer pricing and corresponding adjustments.
If a contracting jurisdiction makes an appropriate adjustment to the amount of tax charged on the profits of an enterprise of the contracting jurisdiction, where the other contracting jurisdiction includes those profits in the profits of an enterprise and taxes those profits accordingly, the profits included are profits which would have accrued to the enterprise of the other contracting jurisdiction if the conditions made between the two enterprises had been those which would have been made between independent enterprises.
Planning Points
- It is important for multinational companies to assess the potential impact of the treaty changes resulting from the MLI on their business activities.
- Going forward, taxpayers will be able to present their cases not only to the tax authorities in their jurisdiction, but also to the tax authorities of the other contracting state.
- MAP introduces the elimination of economic or juridical double taxation.
- Taxpayers will have a more flexible resolution mechanism for CTA-related disputes.
- Implementation will provide a more efficient circulation of related information for companies.
Source: Bloomberg Tax