Revised discussion draft on Action 6 (Preventing Treaty Abuse)

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1 Marlies de Ruiter Head Tax Treaties, Transfer Pricing and Financial Transactions Division OECD / CTPA By taxtreaties@oecd.org Our Ref 12 June 2015 GT / OL Dear Ms de Ruiter Revised discussion draft on Action 6 (Preventing Treaty Abuse) We welcome the opportunity to comment on the revised discussion draft issued under BEPS Action 6 issued on 22 May 2015 (the Revised Discussion Draft ). Matheson is an Irish law firm and our primary focus is on serving the Irish legal and tax needs of Irish and international companies and financial institutions doing business in Ireland. Our clients include over half of the Fortune 100 companies. We also advise seven of the top ten global technology companies and over half of the world s 50 largest banks. We are headquartered in Dublin and also have offices in London, New York and Palo Alto. More than 650 people work across our four offices, including 75 partners and tax principals and over 400 legal and tax professionals. In this letter, the Report refers to the report issued under BEPS Action 6 in September 2014 report. The 2010 Report refers to the OECD Report The Granting of Treaty Benefits with Respect to the Income of Collective Investment Vehicles. LOB refers to the limitation of benefits clause proposed in the Report. PPT refers to the principal purposes test proposed in the Report. CIV refers to collective investment vehicles that are widely-held, hold a diversified portfolio of securities and are subject to investor-protection regulation in the country in which they are established. Comments in this letter are made solely on our own behalf. 1 The simplified LOB CIVs should be included as a separate category of qualified person in paragraph 2 of the simplified LOB. Failure to do so will undermine the conclusions reached under the 2010 Report and the agreed position reached in respect of CIVs under Action 6.

2 Non-CIV funds (including securitisation companies) should be included as a separate category of qualified person in paragraph 2 of the simplified LOB. This would reflect the acceptance that non-civ funds play an important role in the broader economy. A simplified LOB must be accompanied by a PPT, this should be sufficient to address any concerns about non-civ funds and securitisation companies being used for treaty abuse. 2 Non-CIV funds As a general rule, non-civ funds should be entitled to claim treaty benefits. We welcome the recognition of the economic importance of non-civ funds and the acceptance that non-civ funds should be entitled to avail of treaty benefit where appropriate. In our opinion, the basic principle should be that non-civ funds should always be eligible to claim treaty benefit, save in clear cases involving treaty abuse. The LOB is a wholly inappropriate test for securitisation companies. Securitisation is a fundamental part of the capital markets. Financial regulators are currently seeking to improve and develop the securitisation market. We remain very concerned that insufficient recognition has been given to the economic importance of the securitisation market in Action 6. Securitisation companies should be wholly distinguished from other non-civ funds such as private equity or REITs. In particular, securitisation companies issue debt securities into clearing systems and accordingly will not be in a position to verify who owns those securities. As a result, securitisation companies cannot confirm if the derivative benefits test or the local ownership provision is satisfied. Accordingly, special provision for such entities must be made in the LOB rule (and Action 6 as a whole) to ensure that the global securitisation market is not undermined by rules designed to address other concerns. The derivative benefits provision must be amended. As currently drafted the derivative benefits provision is likely to be of limited assistance to non-civ funds because of the seven or fewer test. The requirement that the interests in the entity seeking treaty relief are held by seven or fewer investors will not be satisfied by the vast majority of non-civ funds. This arbitrary limitation, which seems to have no policy basis, must be removed. 3 Issues related to the LOB rule 3.1 The derivative benefits provision The derivative benefits provision is unnecessarily restrictive. As noted in our previous submissions on the various Action 6 papers, the limitation in the draft derivative benefits provision to entities that are owned by seven or fewer investors is arbitrary and should be removed. There is no policy rationale that justifies limiting the provision in this way. It should not matter if an entity is owned by five or 100 investors if all of those investors are equivalent beneficiaries. We again strongly urge that this limitation is removed. 2

3 3.2 Special tax regimes provision Stakeholders should be provided a fair opportunity to comment on this new provision. It is surprising to see two entirely new concepts introduced to the Action 6 proposals at this late stage (the special tax regimes provision and the future changes provision). No guidance or draft commentary has been provided with the draft provisions. Stakeholders have been requested to keep comments on the Revised Discussion Draft short. However, stakeholders must be given an adequate opportunity to review the draft provisions along with detailed commentary on how it is intended they will operate before considered comments and suggestions can be provided. It will damage the credibility of the consultation process if the new draft provisions are included in the report due to be issued in September. We strongly urge that no final decision on the inclusion of either provision should made until 2016 after full consultation on the proposals. The new provisions go much further than their stated aim. Both new provisions are designed to deal with concerns some countries had in respect of the derivative benefits provision. It is not clear what those objections are. In any event, the new provisions appear to deny treaty benefit to a much broader range of taxpayers than only those who rely on the derivative benefits provision. If adopted, the special tax regimes provision should be limited to payments between related parties. We note that the special tax regime provision is very similar to the provision that has been proposed for inclusion in the US Model Tax Treaty. However, the draft US provision only applies to payments between related parties. That reflects a more practical approach as it does not require the payer to obtain detailed information about the recipient s tax status (which in a third party context, it is unlikely to get). At the very least, any provision proposed for inclusion in the OECD Model Convention should be limited in the same way. Many of the concepts included in the special tax regimes provision are unclear and subjective. Here are some examples: it is not clear how the effective rate of taxation should be calculated. Is it a comparison of the cash tax paid by a company in a particular year against accounting profits recognised in that year?; it is not at all clear when an effective rate of taxation would be considered preferential or, what it would be compared to in determining whether it is preferential; arguably, there is nothing to prevent taxpayers that take standard tax deductions for payments made on an arm s length basis from being treated as benefitting from a special tax regime; arguably, there is nothing to prevent taxpayers that rely on standard tax reliefs (for example tax depreciation, tax losses) in the usual way from being treated as benefitting from a special tax regime (eg, if the tax depreciation differs from accounting depreciation which would often be the case); 3

4 treaty relief would only be denied if the taxpayer is subject to a special tax regime with respect to interest, royalties or other income. It is not at all clear when a regime would be considered to apply with respect to any particular item of income; it is not clear when a tax regime would be considered to disproportionately benefit interest, royalties or other income or any combination thereof ; it is not clear when a substantial activity requirement would be considered to be satisfied; it is unclear what, if anything, contracting states would be permitted to carve out of the special tax regimes provision under paragraph (viii) if only regimes that do not result in a low effective rate of taxation may be carved out. Definitions would be required for each of the new concepts introduced along with detailed commentary. Indeed, it is difficult to understand or comment on the draft provision in the absence of draft commentary. The subjective nature of the special tax regimes provision will weigh heavily against taxpayers. The absence of a clear definition of special tax regime and the subjective nature of the terminology used throughout the provision will permit tax authorities to deny treaty benefits to taxpayers at will. It is unclear how a taxpayer can successfully appeal against a decision made under an inherently subjective and unclear provision. Inclusion of such a provision in double tax treaties will significantly shift the balance of rights away from taxpayers and in favour of tax authorities. The process of claiming treaty relief will be entirely devoid of certainty for taxpayers seeking to rely on double tax treaties that include such a provision. This lack of clarity will undermine the rule of law. As an aside, we note that these comments equally apply to the PPT. Countries should be permitted to determine for themselves what, if any, of their tax rules or administrative practices amount to special tax regimes. We note that the US technical explanation accompanying the similar draft US provision states that no US legislation, regulations or administrative practices that apply with respect to interest, royalty and other income would satisfy the definition of special tax regime. Is it intended that other countries that include a special tax regime provision in their treaties should similarly be permitted to determine whether or not any of their domestic provisions or administrative practices amount to special tax regimes? The provision will have broad-ranging unintended consequences. It could be used to deny treaty relief to taxpayers that claim deductions for expenses incurred in the usual course of business, including deductions for tax depreciation in respect of investment in fixed assets and expenditure on research and development. It could be used to deny treaty relief to taxpayers who utilise tax losses to shelter taxable profit. Any of these outcomes will negatively affect real business. Is this provision intended to have negative consequences for treasury company activities? Is it intended to have negative consequences for leasing activities? 4

5 Non-CIV funds and securitisation companies should be specifically carved out from the special tax regimes provision. The absence of a carve-out would undermine their treatment under the LOB. A time limit should be included in paragraph 3 of the future changes provision. Countries who deny treaty benefits under the future changes provision should be required to conclude amendments to the treaty to restore the balance of benefits provided within a specified timeframe. 4 Issues related to the PPT 4.1 The anti-conduit rule The anti-conduit rule should not be applied to CIVs or non-civ funds. Any attempt to apply an anti-conduit rule to CIVs or non-civ funds would undermine the conclusions reached under the 2010 Report and the positions agreed to date in respect of CIVs and non-civ funds under Action 6. The commentary on the anticonduit rule should be amended to include an explicit statement that it is not designed to apply to CIVs or non-civ funds. 4.2 Examples for commentary on PPT Additional examples of the application of the PPT to CIV and non-civ funds should be included in the commentary. We have provided examples in Schedule 1. 5 Application of the new tie-breaker rule The conclusions reached on the tie-breaker rule underestimate the difficulties inherent in the approach for tax payers. Amending the default tiebreaker rule so that residence is determined by mutual agreement ignores how mutual agreement procedures ( MAP ) usually operate in practice. Comprehensive comments were provided by stakeholders under BEPS Action 14 on the inadequacies in practice of MAP. It is unwise to amend the default tiebreaker rule to one based on MAP until it is demonstrated that MAP operates effectively and efficiently. If MAP is retained as the default tie-breaker, time limits for reaching agreement must be included. The statement included in the revised draft commentary (that competent authorities should deal with it expeditiously and should communicate their response to the taxpayer as soon as possible ) is not sufficient. Should you wish to discuss any of the comments raised, please let us know. Yours faithfully Sent by MATHESON 5

6 Schedule 1 1 Securitisation company 2 CIV RCo, a securitisation company resident in State R, was established by a bank which sold to RCo a portfolio of loans and other receivables owed by debtors located in a number of jurisdictions. RCo is fully debt-funded. RCo has issued a single one dollar share which is held on trust and has no economic value. RCo s debt finance was raised through a note issuance. The notes are widely held by investors and are held in a clearing system and are listed on a recognised stock exchange. To comply with regulatory requirements, the bank also retained debt securities issued by RCo. RCo currently holds 60% of its portfolio in receivables of SMEs resident in State S, in respect of which it receives regular interest payments. Under the tax convention between State R and State S, the withholding tax rate on interest is reduced from 30% to 10%. In establishing RCo, the bank took into account a large number of issues, including a robust securitisation framework, securitisation legislation, skilled and experienced personnel and support services in State R and the existence of tax benefits provided under State R s extensive tax convention network. It is likely that a majority of investors in RCo would be financial institutions and pension funds located in OECD member states. Investors decisions to invest in RCo are not driven by any particular investment made by RCo and RCo s investment strategy is not driven by the tax position of the investors. RCo is taxed in State R on income earned and is entitled to a full deduction for interest payments made to investors. In making its decision to sell receivables owed by companies resident in State S, the bank and RCo considered the existence of a benefit under the State R / State S tax convention with respect to interest, but this alone would not be sufficient to trigger the application of paragraph 7. The intent of tax treaties is to provide benefits to encourage cross-border investment and, therefore, to determine whether or not paragraph 7 applies to an investment, it is necessary to consider the context in which the investment was made. In this example, unless RCo s investment is part of an arrangement or relates to another transaction undertaken for a principal purpose of obtaining the benefit of the Convention, it would not be reasonable to deny the benefit of the State R / State S tax convention to RCo. RCo, a collective investment vehicle resident in State R, manages a diversified portfolio of assets. The interests in RCo are widely-held. RCo currently holds 60% of its portfolio in shares of companies resident in State S, in respect of which it receives annual dividends. Under the tax convention between State R and State S, the withholding tax rate on dividends is reduced from 30% to 10%. RCo s investment decisions take into account the existence of tax benefits provided under State R s extensive tax convention network. A majority of investors in RCo are residents of OECD member states or countries with which State S has a tax convention. Investors decisions to invest in RCo are not driven by any particular investment made by RCo and RCo s investment strategy is not driven by the tax position of the investors. RCo is subject to investor protection regulation in State R and is not taxed in State R on income or gains. 6

7 In making its decision to invest in shares of companies resident in State S, RCo considered the existence of a benefit under the State R / State S tax convention with respect to dividends, but this alone would not be sufficient to trigger the application of paragraph 7. The intent of tax treaties is to provide benefits to encourage cross-border investment and, therefore, to determine whether or not paragraph 7 applies to an investment, it is necessary to consider the context in which the investment was made. In this example, unless RCo s investment is part of an arrangement or relates to another transaction undertaken for a principal purpose of obtaining the benefit of the Convention, it would not be reasonable to deny the benefit of the State R / State S tax convention to RCo. 7