Changes in tax treaties on the horizon | In Principle

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Changes in tax treaties on the horizon

In 2013 an OECD forum began work on the BEPS project, comprising 15 actions for tightening the international system of tax treaties and preventing tax avoidance by taxpayers exploiting loopholes in tax treaties. These measures cover a broad spectrum of issues connected with taxation of international trade.

One of the main challenges during work on the BEPS (base erosion and profit shifting) project was to introduce an effective mechanism for implementing changes in existing treaties on avoidance of double taxation. It is estimated that the measures undertaken in BEPS affect about 3,000 treaties in force among about a hundred countries. Updating of this entire web of treaties under the traditional procedure (renegotiation of each bilateral treaty separately) would take years. The adopted instrument should not only be faster but should also reflect the differences in existing tax treaties, the treaty policies of specific countries, and differences in internal laws.

Multilateral convention

The response to this dilemma is the Multilateral Convention to Implement Tax Treaty Related Measures to Prevent Base Erosion and Profit Shifting—the fruits of the work under BEPS Action 15. It was adopted in November 2016 and opened for signature from the beginning of 2017. The purpose of the convention is to provide a legal framework enabling the existing network of tax treaties to be adjusted to achieve the aims identified in work on specific points of the BEPS Action Plan. The multilateral convention will also allow the parties plenty of flexibility in modifying their existing treaties to suit the standards laid down under the BEPS project.

The convention will introduce changes only in selected bilateral tax treaties. Each of the states will provide notice of the treaties that are to be revised. If both states that are the parties to a given treaty make such notification to OECD as the depositary of the convention, they will be applied in the treaty as indicated by the parties.

Some provisions of the convention offer alternative solutions. The parties will need to select the option that suits their needs. The convention thus will not alter existing treaties to fit a single template, but offers a set of solutions aimed at achieving the established goal, from which the parties can choose what is best for them.

The parties to the convention can reject certain solutions in some or all of their tax treaties. However, the parties undertake to maintain the minimum standard defined in relation to the specific actions identified in the BEPS project. This standard applies to all treaties notified to OECD. The parties can also expand the operation of the convention in areas identified by themselves. If the convention provides for more than one option for achieving the required standard, the choice of the solution to be implemented in each treaty is left to the states who are party to that treaty.

Significantly, a change to a treaty under the convention will not directly result in amendment of the text of the treaty. The changes will be binding on a parallel basis, and in order to determine the terms agreed between the parties to a treaty it will be necessary to refer to the treaty and to the scope of changes determined by the parties. But the convention does not exclude the possibility of agreeing bilaterally on establishment of a consolidated text of the treaty. It can be anticipated that at least during the initial period after the convention enters into force, determining the operative wording of the standards in force between the parties will present a difficult task.

A condition for entry into force of the convention is ratification by five countries. Specific tax treaties will undergo modification as the convention is ratified by the parties to each bilateral treaty.

What will change

The convention governs a number of areas identified as key during the BEPS project, in particular the following issues:

  • Taxation of hybrid structures—this section includes regulations concerning tax-transparent entities, entities with dual tax residence, and application of methods for avoiding double taxation
  • Clarification of rules eliminating abuse of treaty privileges
  • Changes in the definition of a permanent establishment and elimination of provisions enabling taxpayers to avoid this status
  • Changes in the Mutual Agreement Procedure between states who are parties to the convention—designed to avoid situations where application of the treaty instruments leads to double taxation
  • Introduction of an arbitration procedure between parties to a given tax treaty.

Approach of Poland’s Ministry of Finance

Poland took active part in the work on the BEPS project. Some of the BEPS Actions have already been implemented into the Polish tax system (e.g. new rules for documenting transfer pricing).

But at present very little is known about the attitude of the Ministry of Finance toward the changes to be introduced by the multilateral convention and the form to be taken by Polish tax treaties covered by the convention.

Considering that the list of states that are parties to the convention largely overlaps with the countries with which Poland has concluded tax treaties, significant changes in those treaties should be anticipated in the near future.

Jakub Macek, Tax practice, Wardyński & Partners