IFA Colombia

V CONGRESO COLOMBIANO DE
TRIBUTACIÓN INTERNACIONAL
16-17 November 2016
Kees van Raad
Professor of Law, University of Leiden
Chairman International Tax Center Leiden
Of counsel, Loyens & Loeff 15 05 01
Overview of issues discussed

Tax treaties (60 mins):

o Anti-hybrids TT rule (BEPS Action 2)
o LOB / PPT (BEPS Action 6)
o Artificial avoidance of the PE status (BEPS Action 7)
o New MAP and arbitration rules (BEPS Action 14)
o Multilateral Instrument (MLI – BEPS Action 15)

Transfer pricing (20 mins):

o Overview of outcomes of BEPS Actions 8 to 10.
o Effect of those outcomes on the attribution of profits to PEs.
o CbCR (BEPS Action 13)
o Overlap of BEPS Action 4 and Art 9 of the OECD MC.
Overview of issues discussed
BEPS Action 2 – hybrid entities

Proposed rule (new 2d para. of Art. 1):

– For the purposes of this Convention,
– income derived by or through an entity or arrangement that is
treated as wholly or partly fiscally transparent under the tax law
of either Contracting State
– shall be considered to be income of a resident of a Contracting
State
– but only to the extent that the income is treated, for purposes of
taxation by that State, as the income of a resident of that State’

> cf. OECD 1999 Partnership Rep. & Art. 1.6 US 2016 Model
> applies also to other hybrid entities than partnerships
> more detailed Commentary
BEPS Action 2 – hybrid entities
– For the purposes of this Convention,
– income derived by or through an entity or arrangement
that is treated as wholly or partly fiscally transparent under the tax law
of either Contracting State
– shall be considered to be income of a resident of a Contracting State
– but only to the extent that the income is treated, for purposes of taxation
by that State, as the income of a resident of that State’
BEPS Action 2 – hybrid entities
Trilateral -- Case (a)
[OECD Comm Art. 1, 6.5] If State E treats
its partnership as nontransparent
(and taxes the income to the
partnership) and State P treats the
partnership as transparent and
taxes the income to the partners,
then State S is restricted by both
the S-E treaty and the S-P treaty
[irrespective how State S itself views the partnership].
However, in E-P treaty States E and P may agree that treaty
benefits may be claimed only by the partnership (E) and not
by the partners (P)
BEPS Action 2 – hybrid entities
BEPS Action 6 – int’l tax avoidance

O BEPS Action 6 minimum standard: implement LOB

and/or PPT + changes to treaty title and preamble
O Two options of LOB clauses: simplified or full version.
O One option of PPT clause.
O To be implemented through the MLI.
O Key issues:
• Interaction of these clauses with domestic anti-abuse
provisions.
• Interaction of these clauses among themselves.
• Application of the LOB clause to holding and financing
companies.
• Differing choices made by two Contracting Parties in the
context of the MLI.
BEPS Action 6 – int’l tax avoidance
As a general rule, there is no conflict between
domestic anti-abuse rules and tax treaties
O This was conclusion in OECD Comm. 1, Sec. 22.1.
O Confirmed by Final Report on BEPS Action 6 and by proposed
changes to the OECD Comm. But two specific situations:
• In some cases, treaties may expressly allow the application of
domestic anti-abuse rules.
• In other cases, treaty application depends on application of domestic
law (>> thus: if application domestic law is controlled by the
domestic anti-abuse rules, application of treaty is also affected).
O In line with OECD and BEPS recommendations, some treaties
recently concluded by Colombia already include clauses that
expressly allow the application of domestic anti-abuse provisions
(see treaties with India, Portugal and Czech Republic).
O What about those that do not include any anti-abuse provision?
BEPS Action 6 – int’l tax avoidance
LOB clauses can have a very restrictive effect in the
case of structures using holding companies when the
shareholders of the holding company are located in third countries.
The usual structure of LOB clauses, including the one proposed by
the OECD, comprise 5 tests (`safe havens´) :
• Qualified persons test (individuals, governments and state-owned
entities, pension funds, etc.)
• Publicly traded test
• Ownership and base erosion test
• Active business test
• Derivative benefits test
Most of these tests cannot be passed by a pure holding entity whose
shareholders are more than 50% residents of another jurisdiction.
BEPS Action 6 – int’l tax avoidance

Application of the LOB test

to a holding structure:

Qualified persons test

Publicly traded test
Ownership & base erosion test
Active business test
Derivative benefits test
BEPS Action 6 – int’l tax avoidance

Application of the PPT test

to a holding structure:

– PPT test : not mechanical but requires

judgement
– no express exclusion for the activity of
making and managing investments
– examples (F, G and H) are provided in draft Commentary of
cases where use of HC is legitimate
– but HC must have higher degree of substance
BEPS Action 6 – int’l tax avoidance
Most of the treaties concluded by Colombia include
an anti-abuse provision
O With the exception of the treaties with Spain and Switzerland, all
Colombian treaties include a specific anti-abuse provision.
O The most common provisions are of two kinds:
– One is denominated ‘Limitation on Benefits’ but is similar, in
substance, to a PPT rule.
– The other type contains specific wording establishing an ownership
test, paired with a derivative benefits clause that is not similar to the
OECD LOB or PPT and intends to prevent granting benefits to entities
that are perceived as conduits (including holding companies).
O Which kind of anti-abuse provision will adopt Colombia in the MLI?
O Will the currently existing provisions be replaced by those in the
MLI or supplemented by them?
BEPS Action 6 – int’l tax avoidance
Choice of anti-abuse rule in Multilateral
Instrument (`MLI´)
O ‘Cafeteria approach’ of the MLI: allows two treaty partners to
select two different kinds of anti-abuse rule to comply with the
minimum standard.
Example: State X selects a PPT clause while State Y selects the
simplified LOB plus the application of domestic anti-abuse provisions.
O How to deal with this?
– Allow different choices by the two parties to the relevant treaty (similar
to what happens in the context of Art. 23, where each Contracting
State may have different mechanisms to eliminate double taxation).
– Engage in bilateral negotiations to solve differences (thereby
frustrating the objective of the MLI).
– Other options? OECD to publish final version of the MLI at the end of
November 2016.
BEPS Action 7 – `abuse´ of PE definition
Exceptions of para. 4 of Art.5 (PE definition)

O Does the E-tailer earn profits taxable in States R, B and C?

O If yes, how to determine the amount of these profits?
BEPS Action 7 – `abuse´ of PE definition
Example 1 of structures affected by
new PE definition
BEPS Action 7 – `abuse´ of PE definition
Example 2 of structures affected by
new PE definition
BEPS Action 14 dispute resolution

O the purpose of BEPS Action 14 measures is `to ensure certainty

and predictability for business’.
O minimum standard (= must be implemented by all BEPS states):
– peer monitoring to ensure implementation of the minimum standard
– promotion of implementation of best practices.
– some States (not all) will in addition implement mandatory binding
arbitration.
– all to be implemented through the MLI.
BEPS Action 14 dispute resolution
By adopting the minimum standard, all countries
taking part of the BEPS Project have committed to:
• Include para.s 1 to 3 of Art 25 (MAP) OECD Model in their tax treaties
• Provide access to MAP in transfer pricing cases.
• Timely solve MAP cases (average timeframe of 24 months).
• Implement the result of MAP cases.
• Enhance existing relationships between Competent Authorities so as to
increase the effectiveness of MAP and ensure that the officials in charge
of solving MAP cases actually have the authority to make decisions and
commit the State without requiring the authorization of other officials.
• Prepare rules, guidelines & procedures to access and use MAP.
• Set up the FTA MAP Forum and be subject to peer review in the context
of the Forum.
.
BEPS Action 14 dispute resolution
Some considerations on
mandatory binding arbitration

• Countries committing to it amount to 90% of all MAP cases.

• Final wording of the treaty provision to be published as part of the
work on the MLI.
• Effective resolution of MAP cases.
• Harmonization of interpretation and application of tax treaty rules
• Concerns about sovereignty and about the independence of
arbitrators.
• Parallel work outside the OECD: the TRIBUTE initiative.
BEPS Action 15 MLI

Challenges of the MLI:

– Achieve adequate level of standardization while allowing flexibility for

a wider spectrum of countries to take part.
– Use of compatibility clauses or application of the lex posteriori rule of
Art 30.2 of VCLT.
– Identification of treaty provisions to be replaced or supplemented
(differences in location, numbering, language, etc).
– Modification of treaties in languages other than English or French..
– Differences in treaty policies towards different treaty partners (treaty-
by-treaty reservations?)
– Coherence in the application of the treaty rules (legal status of final
reports, new commentary and other relevant materials).
BEPS Action 15 MLI

Other issues: application of the new rules in time

– When will the new tax treaties rules become effective?
– Will the new rules affect existing structures or only structures
implemented in the future?
– In particular:
• Will the new rules on treaty abuse turn into ‘abusive
arrangements’ certain structures that were not sanctioned as
abusive before BEPS?
• Will taxpayers have newly created PEs as a consequence of the
new rules, even though the structures and relevant circumstances
will remain the same?
– Can it be argued that applying the new rules to existing structures
is ‘retroactive’?
BEPS Action 15 MLI

Opportunities opened by the MLI:

– New way to update tax treaties?
– Potential implementation of future changes to the OECD/UN MC.
– Homogenization of tax treaty rules (beyond the use of a common,
non-binding model).

Other issues:
– Potential use of treaty provisions incorporating existing Commentary
as authorized interpretation by the competent authorities of the
Contracting States.
BEPS Action 8-10 – Aligning Transfer
Pricing Outcomes with Value Creation
O revamps the guidance on the interpretation of the arm’s length that
enterprises carrying on the value-generating economic activities
O guidance on the arm’s length principle shifts from a more legal
analysis based on contractual arrangements and legal ownership
towards a more substance approach, focusing on the value generated
by the activities performed by the associated enterprises
O on 23 May 2016, the OECD Council approved the inclusion of the
new guidance on the Transfer Pricing Guidelines
In addition to the Final Report, the OECD has also released on the 4
July 2016 a ‘Public Discussion Draft on Revised guidance on profit
splits’, and the ‘Document for Public Review on Conforming
amendments to Chapter IX of the Transfer Pricing Guidelines’.
BEPS Actions 8-10
The impact on profit attribution to PEs
Under Art. 7.2 OECD MC, profits should be attributed to PEs as if they were
a separate and independent
>> as a result of deeming the PE as a separate enterprise, the Transfer
Pricing Guidelines are applicable by analogy
>> Changes introduced by BEPS Actions 8-10 will therefore impact on) the
attribution of profits to PEs, despite no changes introduced to the AOA. The
new guidance on comparability analysis for purposes of Art. 9 OECD MC
therefore to be taken into consideration when determining the arm’s length
price of any internal ‘dealing’ entered into by the PE
>> ‘synergies’ (incidental positive/negative effects arising from the integration
in a multinational group) may now require adjustments to the extent that they
constitute ‘clearly identifiable structural advantage or disadvantage’
>> ‘locational advantages’ derived from the functions performed by the PE
that are not passed on to third party customers (and therefore lead to in-
creased profits) should now be shared between PE (as if it were a separate
enterprise) and other group members in accordance with local comparables
BEPS Actions 13 – country-by-country R
The purpose of BEPS Action 13 is to ensure that all countries where
multinational groups operate have access to information on the global
allocation of profits, level of physical and human presence (e.g.: number of
employees) and the amount of tax paid in each country. For these purposes,
MNEs will be required to submit:
– a local file in the jurisdiction in which they operate, providing details
regarding the controlled transactions entered into
– a ‘master file’ with information on the worldwide operations and transfer
pricing policies, which should be submitted to all the tax authorities of the
countries where the group operates
– a ‘country-by-country report’: a separate form (with template similar in all
jurisdictions) providing overview of group’s activities, including operations,
revenue, taxes paid, total number of employees and assets owned worldwide
Implementation of these reporting obligations should be effective for fiscal
years beginning on/after 1 January 2016. MNEs with an annual consolidated
turnover below € 750 million: exempt from filing the ‘country-by-country´ R
BEPS Actions 13 – country-by-country R
The country-by-country report must be submitted only in the country of the
parent company of the group (State P). The tax authorities of State P will
subsequently exchange information automatically with all the other countries
Should State P fail to exchange information with other countries, another
member of the group (e.g. Sub Co. 1 or Sub Co. 2) should file the documents
on behalf of the parent company.
Parent Co.
In case State P does not have
country-by-country report rules, P
reporting obligations must be
complied within the jurisdiction
where the most significant activities Sub Co. 1 Sub Co. 2
take place (e.g. State S-1 or S-2). S-1 S-2
PE S-3
PE
Sub Co. 3
BEPS Action 4 – overlap with Art. 9 OECD
BEPS also recommends a set of changes to domestic laws which, in some
circumstances, may overlap with treaty provisions. In a financing transaction,
there may be a clear overlap between BEPS Action 4 and Art. 9 OECD MC
concerning the tax treatment of the financial expense at level of the payor:
>> BEPS Action 4 recommends that the deductibility of net financial
expenses should be limited to the higher of the following: (i) a de minimis
monetary threshold or (ii) an amount equivalent to 10% to 30% of the
EBITDA.
>> Art. 9.1 OECD MC provides that countries may adjust the profits of an
enterprise if they are not arm’s length (primary adjustment). Art. 9.2 OECD
MC then requires a corresponding adjustment in the other treaty state at the
level of the other associated enterprise to avoid economic double taxation.
>> If upon a corresponding adjustment under Art. 9 OECD MC, an interest
expense is not deductible, there will be economic double taxation of the
same item of income. No OECD guidance how to deal with this issue.
BEPS Action 4 – overlap with Art. 9 OECD
Case study
L Co. enters into a financing agreement with an associated enterprise, B Co.
B Co. (the borrower) pays interest of 100 to L Co. (the lender). As the higher
threshold under the laws of State B is 100 (de minimis threshold), all interest
expenses would be deductible by B Co.
If State L adjusts the profits of L Co. under Art. 9.1
OECD by deeming that the arm’s length interest
would be 120, then State B would be required to
make a corresponding adjustment under Art. 9.2
OECD, i.e. to allow the deduction of 120.
However, since 120 exceeds both thresholds for
deduction of net financial expenses, the increased
interest expense (20) would not be deductible,
thus leading to economic double taxation.
Is there a way to avoid this outcome?
.
ITC Leiden

In 1998, the International

Tax Center Leiden was
set up to accommodate
the rapidly increasing
interest in studying and
researching international
tax law.

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Leiden University Adv LLM Program
in International Tax Law
Fall term (Sep – Dec) :
ƒ Fundamentals of International Tax Law 4 weeks
ƒ Tax Treaties 11 week
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Spring term (Jan – Jun) :

ƒ Transfer pricing 4 weeks
ƒ EU tax law (basic) 3 weeks
ƒ US dom. tax law or Advanced EU tax law 3 weeks
ƒ Customs duties and excise taxes 1 week
ƒ VAT or Advanced transfer pricing 4 weeks
ƒ US international tax law 3 weeks
ƒ Corporate international tax planning 2 weeks
ƒ Paper [30-50 pages] 7 weeks
>>
231 see further at www.itc-leiden.nl
If you want to learn more about international tax law, you should consider enrolling in the
Leiden Adv LLM Program in International Tax Law. If you cannot go for a full year, you
should think about taking only 1 or 2 of the Program’s courses. If you do not have the time
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of Summer Course in Leiden each year in July

>> Always feel free to contact me at: mail@vanraad.eu

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