More BEPS. More Tax Uncertainty. More Cost
Tax history was made with the strokes of almost 70 pens in Paris this month. Sacre bleu! A giant tax treaty (the Multilateral Instrument (MLI)) was signed by almost 70 OECD member countries with Minister Noonan signing for us. The MLI is part of the OECD’s Base Erosion and Profit Shifting (BEPS) initiative which seeks to deal with, according to the OECD, the avoidance of up to €240 billion in tax annually between those countries.
Without this giant treaty almost 1,100 double tax treaties between those countries would have had to be renegotiated and amended individually which could have taken decades. But this is 2017. Paraphrasing the 1970’s “Six Million Dollar Man” TV series (I watched repeats!): We have the technology. We have the capability to make the world’s first multilateral tax treaty. The MLI will be that treaty. Better than tax treaties were before. Better, stronger, faster to agree. This giant treaty amends all signatory treaties in one go and seeks to reduce that €240 billion hole mentioned earlier
A double tax treaty recognises that a taxpayer operating in a foreign country can have its profits taxed at home and in that foreign country. The treaty reduces that double tax risk by saying which country can tax those profits or by allowing the foreign taxation while granting a credit for the foreign tax against the taxpayer’s tax bill back home. In certain instances a reduced withholding tax rate may also apply.
Granted the MLI is designed to deal with anti-avoidance but it applies to taxpayers in the signatory countries. Those taxpayers will have to satisfy themselves that they were not engaged in tax avoidance and that requires additional work on their part. Avoidance is a legal concept and the rule of law applies.
The MLI allows countries various options to deal with the issues outlined in the MLI with different countries taking differing measures. For example, Ireland is not adopting the MLI provisions dealing with the taxation of certain agents. However it is abiding by the provision designed to prevent corporate groups from breaking up their operating business into several smaller operations to avoid taxable presences abroad and all the tax that would go with it.
Overall the MLI increases the possibility of a taxpayer having a taxable presence in another country. Good for the country concerned but potentially costly for the taxpayer. A taxpayer’s business profits will generally be taxed at home but a tax treaty allows a foreign country to tax those profits where the taxpayer has a taxable presence (the legalese being ‘permanent establishment’) in that country.
That means that a taxpayer will then be taxable in two countries but with a credit for the foreign tax back home. Brilliant! However, our standard corporate tax rate is 12.5% and as we know, much to the chagrin of other countries, they have a higher tax rate than ours. If a company’s profits are taxed in a foreign treaty country with the higher tax rate then the maximum credit allowed here will be the Irish tax payable on those profits. The foreign tax over and above that credit is an additional cost to the Irish company.
Ireland, in somewhat silver lining mode, has certain relieving provisions for that excess tax (T’s and C’s apply) but nonetheless this brings about additional compliance work for the taxpayer company concerned.
The MLI also addresses concerns that double tax treaties could be used to allow treaty benefits in unintended circumstances. This is dealt with by bringing about a “principal purpose test” (PPT) or combining it with a form of “limitation on benefits” provision. Most countries have gone with the PPT option. That effectively says if you enter into an arrangement with a principal purpose of benefitting from the treaty then those benefits aren’t available.
We have a similar provision within our domestic law known as the “General Anti-Avoidance Rule”. It removes a tax advantage where it is reasonable to consider that a tax benefit was a primary purpose of the transaction. Its application was once explained by a former Revenue Commissioner who likened it to a cross eyed javelin thrower competing at the Olympics; he may not win but he will keep everyone on the edge of their seats. I’ve always thought that very apt in demonstrating the uncertainty that such a provision brings about and now we will have a similar provision within our tax treaties.
Adam Smith wrote that
“the certainty of what each individual ought to pay is, in taxation, a matter of so great importance that a very considerable degree of inequality…is not so great an evil as a very small degree of uncertainty”.
That’s as true now as it was in the eighteenth century when he wrote his “Wealth of Nations”. Bottom line: uncertainty brings about additional compliance costs.
A double tax treaty will only be amended by the MLI if the parties agree between them on the various optional provisions to deal with double tax issues. The OECD has published provisional lists of treaties, options and reservations for each MLI signatory on its website.
Businesses currently benefitting from double tax treaties between the initial signatories can now analyse the potential impact of the changes published. This requires careful scrutiny as the information available is long and complex with Ireland’s position alone amounting to 49 pages! The MLI remains open to interested parties and the OECD hopes that up to 90 jurisdictions will have signed up by the end of this year.
The United States did not participate in the MLI’s signing ceremony but it does have complex limitation on benefits provisions in existing treaties. The Ireland-US treaty is currently the subject of a renegotiation process. The limitation on benefits provision in the model used in that process goes far beyond that recommended by the BEPS Report and could deny treaty benefits to many Irish listed companies and certain funds which have their primary listing in certain countries. It would therefore be preferable to maintain the wording adopted in the current treaty rather than the more onerous version suggested by the model used in the renegotiation process given that the MLI is not yet on the cards for the US.
The next step in the MLI process is for the signatories to complete their home country ratification which will determine when the changes have effect for each tax treaty.
Someone once said “plus ca change plus c’est la meme chose”. He obviously didn’t work in tax!
Tom Maguire is a Tax Partner in Deloitte and his monthly columns on tax matters appear in the Sunday Independent. The above article was first published on 18 June 2017