7 June 2017 witnessed an historical turning point in the area of international taxation with the signature of the Multilateral Convention to Implement Tax Treaty Related Measures to Prevent Base Erosion and Profit Shifting (MLI). The signing ceremony brought together 68 jurisdictions (including Switzerland) which agreed to introduce the tax treaty measures of the OECD/G20 Base Erosion and Profit Shifting initiative (BEPS) into their international tax policy.
The present contribution looks first of all at the nature, functioning and effect of the MLI which is designed to apply alongside existing bilateral tax treaties. We then focus on treaty abuse and more specifically on the Principal Purpose Test (PPT rule) which the instrument aims at introducing as a minimum standard pursuant to BEPS Action 6.
We conclude that states may not give to the PPT rule an interpretation that exceeds its proposed commentaries which represent binding context under the Vienna Convention on the Law of Treaties. Accordingly, the PPT rule should in essence be construed as a business reality test which applies to both abusive restructurings and conduit situations. We show that when the PPT rule is applicable a jurisdiction is not prevented from granting treaty benefits on the basis of a re-characterized fact pattern (i.e. for example treaty benefits available before a restructuring) even if such jurisdiction has not opted for the discretionary relief mechanism provided by art. 7 (4) MLI. Further, we find that despite the language «Notwithstanding any provisions of a Covered Tax Agreement », the PPT rule may only come into play to the extent that the relevant factual situation is not covered by a specific treaty anti-avoidance rule (SAAR). Finally, it is remarkable that BEPS Action 6 addresses conduit structures exclusively on the basis of the PPT rule (or an anti- conduit mechanism producing similar results) and makes no reference to the beneficial ownership concept in art. 10 – 12 OECD MC. In our opinion, this is yet another confirmation that beneficial ownership is not an appropriate test to deal with conduit situations and should be construed restrictively pursuant to the 2014 OECD Commentary. For this reason, we argue that the broad and substance oriented interpretation favored by the Swiss Federal Tribunal since the famous Total Return Swap Case decided in 2015 should be revisited and fully aligned with the 2014 OECD Commentary and possible conduit situations assessed pursuant to the PPT rule. The Swiss case law, which does not take into consideration the intention of the taxpayer and focuses primarily on the criterion of economic interdependence, does not fully coincide with the analysis under the PPT rule. The PPT rule will indeed not simply apply because there is some sort of interdependence but rather because the purpose of the transaction is abusive. Hence, for example, the PPT rule will not apply, where despite the existence of an interdependence, the transaction is conforming to the standard commercial organization and behavior of the group.
This being said, from a policy perspective, it is unfortunate that the PPT rule is drafted in broad terms as its meaning becomes potentially very far reaching as soon as it is detached from its proposed commentaries. This may indeed lead to uncertainties and increased tax treaty disputes around the globe. Therefore, multinational enterprises will be well advised to ensure in advance and especially in the initial implementation phase that the scope that will be given to the PPT rule by the jurisdictions in which they operate coincides indeed with the OECD interpretation.