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Tax treaties, voluntary agreements and tax incentives

The Addis Agenda commits States to make sure that all companies, including multinationals, pay taxes to the governments of countries where economic activity occurs and value is created.

Anti-abuse clauses

Bilateral treaties are generally based on either the UN model convention or the OECD model convention. Both of these model conventions are under revision, and will adopt new preambles that will expand the aim of the conventions. In addition to eliminating double taxation with respect to taxes on income and on capital, double tax treaties are hence forth meant to do so without creating opportunities for non-taxation or reduced taxation through tax avoidance or evasion (including through treaty-shopping).  The revisions will not automatically change the existing base of more than 3,000 treaties, but it will provide a new standard for negotiation and revision of tax treaties going forward. Some countries  adopt the ambulatory approach for interpretation of tax treaties, which allows treaties to accommodate changes in domestic law without the need to renegotiate the treaty, or allowing countries to interpret the terms of the treaty according to the most recent amendment/interpretation conveyed by the intergovernmental institutions (UN or OECD).

There is no consolidated information regarding the adoption and inclusion of anti-abuse clauses in tax treaties. The widest research on tax treaties, was conducted in 2014 by the International Bureau of Fiscal Documentation (IBFD), covering the Tax Treaty Model Practice between 1997 and 2013. The article analysed how popular UN Model clauses were in the tax treaties concluded under that period. Since the research was conducted prior to the BEPS movement, there are no concerted figures concerning the inclusion of anti-abuse clauses (such as Limitation on Benefits or Principled Purpose Tests) in the tax treaties.

Under BEPS Action 6, the Members of the Inclusive Framework have committed to ensure a minimum level of protection against treaty abuse. The minimum standard on Action 6 is made of two components.

  1. Jurisdictions are required to include in their tax treaties an express statement that their common intention is to eliminate double taxation without creating opportunities for non-taxation or reduced taxation through tax evasion or avoidance, including through treaty shopping arrangements. This is achieved by including in tax treaties the preamble text of the OECD Model Tax Convention as produced in paragraph 72 (page 92) of the Action 6 Report.
  2. Jurisdictions are also required to address treaty abuse through the implementation of provisions that address situations of treaty shopping. To satisfy the minimum standard on treaty abuse, jurisdictions, at a minimum, should implement:
    • a PPT rule only;
    • a PPT rule and a simplified or detailed LOB provision; or
    • a detailed LOB provision, supplemented by a mechanism that would deal with conduit arrangements not already dealt with in tax treaties.

The implementation of these measures developed on the course of Action 6 requires jurisdictions to modify their tax treaties. The Multilateral Instrument (referred to here) allows parties to introduce a PPT or a PPT combined with a simplified LOB provision.  The Multilateral Instrument will open for signature in June 2017, but there is, as of yet, no formal indication of which countries will sign up to the Instrument. Under the rules of the Multilateral Instrument, countries are allowed to choose the provisions of the Instrument they agree with, and reject the ones that they would not like to pursue as a matter of policy, by opting in or out for optional provisions, or by making a reservation to the non-mandatory provisions.

Before the advent of the Multilateral Instrument, there were more countries including principled purpose tests into their tax treaties, then Limitation on Benefits clauses. Therefore, a similar pattern might arise following the ratification of the Multilateral Instrument.

The 2017 revision of the UN Model is also expected to bring about a new Article 29 denominated the entitlement to benefits clause. The new Article 29 will cover 3 options, aimed to restrict the entitlement to treaty benefits and prevent the abusive use of tax treaties: (i) a LOB clause; (iii) a simple principled purpose test (PPT); or (iii) a robust LOB with a PPT. If the country considers itself not to be comfortable with the PPT, it could have the option of adopting a robust LOB with an anti-abuse rule for conduit arrangements.

The EU has been actively engaged in the fight against tax avoidance. In June 2016, the EU approved the Anti- Tax Avoidance Directive, which lays down rules against tax avoidance practices that directly affect the functioning of the internal market. It is one of the constituent parts of the Commission's Anti- Tax Avoidance Package, which addresses a number of important new developments and political priorities in corporate taxation that require quick reaction at the level of the EU. The schemes targeted by the Directive involve situations where taxpayers act against the actual purpose of the law, taking advantage of disparities between national tax systems, to reduce their tax bill. Having the aim of combating tax avoidance practices which directly affect the functioning of the internal market, the Directive lays down anti- tax avoidance rules in six specific fields: deductibility of interest; exit taxation; a switch-over clause; a general anti-abuse rule (GAAR); controlled foreign company (CFC) rules; and a framework to tackle hybrid mismatches. The member states will have until 31 December 2018 to transpose it into their national laws and regulations, except for the exit taxation rules, for which they will have until 31 December 2019.

Tax incentives

The Addis Agenda recognizes that tax incentives can be an appropriate policy tool, but it also notes that States should be careful of excessive incentives which reduce the tax base.

The figure shows that developed countries tend to grant more targeted tax incentives, towards areas of greater economic interest, where the incentive provides a stimulus for increased economic activity and investment in the country (i.e., research & development, investment allowances). LDCs tend to grant more generic tax incentives which might not always translate into an economic or social benefit, because they might end up costing more, or being more long-lasting then originally forecasted. Most low- and middle-income countries grant tax holidays, exemptions and tax rate reductions.

Tax incentives should not be overly complex, and countries should make sure that the aggregate benefits generated by incentives outweigh the costs of granting them, while also being mindful of the potential distributional implications and the impact on inequality. In addition, tax incentives should be weighed against other uses of the funds, such as for improved infrastructure and strengthened institutions, which would stimulate both domestic economic activity and FDI. In addition, the Addis Agenda notes that countries can also “engage in voluntary discussions on tax incentives in regional and international forums” to determine optimal size and scope of incentives in a coordinated manner, to avoid countries competing on lowering tax rates and diminishing the tax base. A 2015 joint report by the IMF, OECD, United Nations and World Bank describes strategies for ensuring that incentives serve useful social purposes, meaning that the social benefits generated exceed the associated social costs.

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Good governance is critical for the effective and efficient administration of tax incentives. Transparency is necessary to facilitate accountability and reduce opportunities for rent seeking and corruption. Tax incentives should therefore be subject to the legislative process, consolidated under the tax law, and their fiscal costs reviewed annually as part of a tax-expenditure review. Tax incentives should not be granted through the use of discretionary power – it should be based on rules, rather than discretion.

According to a joint UN, IMF, OECD, World Bank publication, in most low-income countries the effectiveness and efficiency of tax incentives cannot be assessed due to lack of data and the absence of analytical tools and skills. Member States should work to make sure they have the internal processes in place to evaluate, consolidate and review the validity of tax incentives, on a periodic basis.