June 16, 2017 | KPMG LLP's Manal Corwin and Jesse Eggert discuss the June 7 signing of the OECD’s multilateral instrument (MLI) developed as part of Action 15 of the OECD’s BEPS action plan, addressing the implementation of the MLI’s minimum standard, changes to the permanent establishment standard, MLI’s improvements to mutual agreement procedures, significance of the United States not signing the MLI, and timeline for the MLI’s ratification.
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Manal Corwin (MC): Hello, my name is Manal Corwin. I lead in KPMG's International Tax practice. I'm joined here today by my colleague, Jesse Eggert, a principal in Washington National Tax. Jesse just joined us from the OECD, where he was a senior advisor to the BEPS project. We're here to talk about this week's latest development, which is the signing of the multilateral instrument.
Action 15 of the BEPS action plan called for the development of a multilateral instrument to implement the treaty-related provisions of the BEPS action plan. A hundred jurisdictions participated in the development of that multilateral instrument, and it was first opened for signing at the end of the year in 2016. Since that time, the big question has been which countries would sign up and to which provisions.
Well, this week we got the answers to some of those questions. On June 7 in a signing ceremony in Paris, 67 jurisdictions signed up to the multilateral instrument covering 68, because China signed on behalf of Hong Kong. Those jurisdictions listed over 2,300 treaties to be included in the MLI, and if ratified over 1,100 treaties would be impacted—so a fairly significant development.
So Jesse, obviously you were in the middle of the action with the MLI at the OECD and were central to the development. What are your thoughts about the implications of this week's signing and what are the key takeaways?
Jesse Eggert (JE): The first is this was a pretty tremendous achievement by the OECD to pull this all together in only two years. A lot of countries showed up to sign this instrument and have made a big different. They listed 2,300 treaties and have covered 1,100. That represents 85% of the treaties that those countries had with each other. So it's a big deal.
A lot of the countries signed up for a relatively small number of total provisions of the multilateral instrument. So it's not that everyone signed up to every provision of the treaty, but they did sign up to quite a lot. And we'll talk a little bit more about which provisions they signed up for.
Part of the issue here is the OECD released a pretty tremendous amount of information on Wednesday. It will take a little while to go through that information to fully understand the impact that this thing will have. There is no doubt it will be a substantial impact, because what we're seeing early on is that a lot of countries signed up for a whole lot of provisions. But fully understanding the matching process will take some time, and that's added to by the fact that countries can both sign later and can change their mind about some of the provisions they chose to opt into and opt out of. So we'll have to keep an eye on that as time goes by.
MC: So Jesse, among the key areas that the multilateral instrument was focused on was implementing the minimum standard to address treaty abuse. And, of course, the instrument offered three choices for countries to meet that minimum standard. The first was a principle purpose test and that was, of course, the default rule. The second was a principle purpose test plus a limited limitation on benefits provision, and then the third was to opt to do bilaterally a more detailed limitation on benefits.
What was the outcome? How many countries signed up for the minimum standard, and what did they tend to choose?
JE: So this is one of the big successes, I think, of the multilateral instrument. Every country that signed up chose to sign up to the principle purpose test. There were a lot of pressures that the instrument itself created for countries. The principle purpose test was the only provision they could sign up to that satisfied the minimum standard on its own. With that said, having everyone join it and no one opt out is a bit surprising and impressive.
A couple of things to note there. Twelve countries signed up for the simplified limitation on benefits provision with just a few more agreeing to let the other country in a bilateral relationship apply that simplified limitation on benefits provision, so only a handful of countries total.
MC: And, of course, that's in addition to the principle purpose test.
MC: Not instead of.
JE: Always a supplement. And the other thing to note is that about seven countries chose to make a statement when they signed up to the principle purpose test, saying they'd prefer to also or alone apply a detailed limitation on benefits provision, and that they wanted to pursue the negotiation of that provision.
So all in all, it looks like there will be changes to all of those treaties to incorporate a principle purpose test, and that's kind of a big deal. You know, some countries have some amount of experience applying a principle purpose test, so there may not be a ton of change, although this provision is broader than traditional principle purpose tests have been. But for some countries, this will be their first time, and it may take us a while to know exactly how broadly they intend to apply that provision.
MC: And, of course, that's an important point. Both the breadth of the provision and the number of countries who have adopted it is a source of some concern for companies because of the uncertainty as to how it will be applied on a going-forward basis.
MC: So another area, while not a minimum standard, is the changes to the permanent establishment standard under Action 7 of the BEPS action plan. Again, while not a minimum standard, it certainly caught the attention of both governments and business.
MC: And a number of choices there, including the ability to opt out completely, what did we see in terms of adherence to or signing up for the PE changes?
JE: We saw a lot of variety. No one signed up—well, a few countries signed up for everything there. In general, none of the provisions got a majority, with the exception of an anti-fragmentation provision that is meant to deal with a situation in which a company operates in multiple different locations, and none of those locations rises to the level of a permanent establishment. That one saw a lot of uptake.
The provision that I think generated the most concern for people when it was released as part of the work on the BEPS project was the provision on dependent agent permanent establishments that was intended to address commissionaire arrangements and similar arrangements for the distribution of products and services across border.
And there we saw only about a third of countries adopting that. And there were some significant names there. The Netherlands, France, Spain all chose to adopt that provision, but most countries chose to opt out.
MC: Another area that was carefully watched was the MAP. Now MAP, the improvements to the Mutual Agreement Procedure, or MAP, were part of the minimum standard. But the addition of arbitration to MAP was optional. A lot of companies were certainly feeling that it would be wonderful to have more countries adopt arbitration, particularly final offer or baseball arbitration. And so they were eager to see how many countries signed up. I think we ended up with more than we thought, but still a small number.
JE: Relatively small numbers signed up. So 25 overall signed up. Of those, 18 chose baseball arbitration. Seven chose reasoned opinion arbitration or sort of conventional arbitration.
Twenty-five is a pretty good number in the grand scheme of things, given how few countries had signed up for arbitration before. There had been a lot of resistance among governments to the idea of giving up, you know, control over their tax disputes to a third-party arbitrator. So this represents progress.
A couple of reasons to be less excited, unfortunately. The first is that many of the countries that signed up chose to carve out some categories of cases from what is subject to arbitration. The arbitration provision was a little unique. It let countries decide the scope of cases that would be subject to arbitration, and a lot of countries took advantage of that ability and chose to carve out a number of cases.
And some of the categories of carve outs are quite broad. They were, in fact, so broad that Japan when they signed up raised a formal objection to some of the reservations that other countries made from the scope of cases covered. And what that means is that Japan was so troubled by those choices that it was willing to forgo arbitration with the countries that made them, rather than have arbitration be subject to those carve outs. And so that's an indication of how strongly Japan must have felt about that.
So that's something to watch going forward. How effective does this end up actually being?
MC: And, of course, Japan negotiated or agreed to arbitration in its treaty with the United States, which hasn't yet been ratified, but has been signed.
MC: So Jesse, the U.S. chose not to sign the multilateral instrument, and a lot have wondered about the significance or implications of that. What are your thoughts?
JE: Yeah. So quite a bit has been made of that. I'm not sure it's a very big deal in the grand scheme of things for a couple of reasons. The first is that countries sign up for the MLI because they think there is something that they need to do there. So a lot of countries signed up because they wanted to satisfy the minimum standards. The U.S. already satisfied those minimum standards throughout its treaty network. So there might not have been very much there for the U.S. that they were interested in.
I suspect they were interest in arbitration, and it is a bit unfortunate that they weren't able to sign up to get that. But they have a couple of constraints on them. They have a very challenging ratification process at the moment for a bilateral tax treaty. One imagines that will be more difficult for a multilateral tax treaty, and so they may have just felt it's easier to bilaterally pursue those provisions than it is to try to get through their State department and Congress and get that done.
MC: So last question—obviously, we are one step closer to the multilateral instrument, which on its own wasn't binding on any jurisdictions becoming binding law. The signing is significant, but now the instrument actually has to get ratified to be put into effect domestically. What is the timing you think before we actually see some of these provisions springing to life and being effective, and then how many more countries do you think are going to sign up?
JE: Both hard questions to answer. The ratification process in countries can be quite quick, or it can drag on for a year or two years, or in the case of the U.S., much, much longer.
The OECD has been quite optimistic about when the instrument will enter into force. And it thinks it can get the instrument to enter into force during the course of this year. And what that just means is that at least five countries would ratify by the end of September or so, which would mean that for some countries, the withholding provisions would take effect by the beginning of 2018. I would expect that will be the minority of situations, and the ratification process will take long enough that we're talking more about 2019, or in some cases 2020 for the provisions to take effect.
In terms of who will join, the OECD has suggested that as many as 20 or 30 additional countries will join by the end of the year. And I don't know whether that number includes the eight or so that committed to join at the time of signing. But I think they're expecting a total of somewhere in the neighborhood of 90 to begin by the end of the year, which would be huge.
MC: So clearly a significant development. We're expecting maybe as soon as 2018 to see tangible impact from the signing on many, many treaties—ultimately over 1,000 potentially by 2019. So it's absolutely clear that businesses are going to need to pay attention to those developments, determine to what extent the multilateral instrument and the signatories and treaties affected will actually impact their operations, and make decisions about how to plan for the future. And we'll certainly keep watching it.
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