Interaction between PPT, tax treaty and domestic GAARs

This second blogpost will address the PPT as introduced in BEPS Action 6 and the interaction with GAARs (General Anti-Avoidance Rules) in tax treaty and domestic law.

  1. Background

As of June 2019, 129 jurisdictions/countries have committed to the implementation of the BEPS 4 Minimum Standards including the PPT. However, one question that remains to be dealt with is how countries see the interaction between the domestic GAARs, treaty GAARs and the PPT of Action 6?

Before the PPT was introduced, countries introduced GAARs in their domestic tax law system (e.g. substance over form, business purpose, sham doctrine) and in their tax treaties (e.g. beneficial ownership, the main purpose test and the limitation on benefits provisions).  These domestic and tax treaty GAARs have been used by countries (tax administrations and judges) to tackle tax avoidance and aggressive tax planning at domestic level and at cross-border (international) level. Some countries also introduced treaty provisions that make the application of domestic anti-avoidance rules possible when a tax treaty is being abused (e.g. art. 27 Panama-the Netherlands bilateral tax treaty). (See Mosquera et al, Tools Used by Countries to Counteract Aggressive Tax Planning in Light of Transparency, Intertax, 2018)

  1. Interaction between tax treaty GAARs and the PPT

In principle, since the PPT is regarded as an umbrella GAAR clause in tax treaties, it will apply even if the transaction has passed the LOB test, or any other test in the treaty. However, in the choices made by countries in the MLI, there are differences in the way that countries see the interaction between tax treaty GAARs and the PPT. In a 2018 article, this author addressed the concerns of developing countries regarding the implementation of the PPT since one size does not fit all. This is the case of developing countries with a limited tax treaty network, or sloppy drafting of a treaty provision, or poor treaty negotiation (Mosquera, Output Legitimacy Deficits and the Inclusive Framework of the OECD/G20 Base Erosion and Profit Shifting Initiative, Issue 3 Vol. 72 Bulletin, IBFD Publications 2018).

Unlike some of the developed countries (e.g. the Netherlands, Belgium, and the United Kingdom) who have an extensive treaty network, countries with a limited tax treaty network (e.g. Costa Rica, Burkina Faso, Peru, Cameroon) which have committed to the implementation of the BEPS 4 Minimum Standards including the PPT will require more than toolkits for tax treaty negotiation developed by the Platform for Collaboration on Tax  and on the job-training. These countries will need long-term investment in education for treaty negotiators by way of participation in international tax law programs to acquire knowledge of international tax law, tax treaties negotiation and tax treaties interpretation among others.

  1. Interaction between domestic GAARs and the PPT

In case of domestic anti-avoidance rules (GAARs) there is not clarity in the interaction between these GAARs and the PPT. The following paragraphs will highlight some of the issues identified by scholars.

One issue is the threshold for the application of the PPT.  In general, there are three approaches available to countries for the application of the GAARs, (i). intermediate: one of the main purposes (ii) narrow: exclusive/sole purpose and (iii) broad: one of the purposes. The 2018 IFA Report provides an overview of these approaches in 42 countries (International Fiscal Association (IFA) General Report: Anti-avoidance measures of general nature and scope GAAR and other rules Vol. 103b).

The PPT provides for an intermediate threshold test (if one of the main purposes). However, since other countries follow other approaches, the analysis of the introduction of an intermediate approach for countries who apply a narrow approach (e.g. Belgium, Brazil, France, Luxembourg, Spain and Turkey) or broad approach (e.g. India, New Zealand) will need to be taken into account by tax administrations, judges, law-makers, taxpayers.  Some questions that can be raised: (i) are these countries going to change their approach due to the PPT? and if not (ii) how will the interpretation by courts take place? Will the threshold test be addressed separately (i.e. an intermediate approach for the PPT and a narrow or broad approach for GAARs?

Another issue is that unlike domestic GAARs, the PPT does not have a ‘genuine economic’ or ‘artificial’ test. Some countries apply domestic GAARs taking into account the economic reality for the application and in case of genuine economic reality, the tax benefit will not be denied, but granted. Therefore, some tax scholars have plead for the application of the PPT only in cases of ‘wholly artificial arrangements’.

For instance, at EU level, following case law by the Court of Justice of the European Union (CJEU) originated by the Cadbury Schweppes case (C-196/04), GAARs can only be applied to ‘wholly artificial arrangements’ thus limiting the application of the GAAR in EU countries. Therefore, a domestic GAAR will only apply in the EU to “wholly artificial arrangements” which do not reflect an economic reality.

The differences in approach between PPT and GAARs have been also highlighted in the  EU report to the 2018 IFA Congress Report following  the EU Commission 2016 Recommendation. This Recommendation introduce the element of ‘genuine economic’ test in the wording of the PPT as follows:

‘Notwithstanding the other  provisions of this Convention, a benefit under this Convention shall not be granted in respect of an item of income or capital if it is reasonable to conclude, having regard to all relevant facts and circum­stances, that  obtaining that  benefit was  one  of  the  principal purposes  of  any  arrangement or  transaction that resulted directly or indirectly in that benefit, unless it is established that it  reflects a  genuine economic activity or that granting that  benefit in  these  circumstances would  be  in  accordance with  the  object and  purpose  of  the relevant provisions of this Convention.’ (section 2)

These differences are not only of importance for the tax treaty concluded by EU countries, but also for countries outside the EU, mainly due to the general application of the EU principle to prevent abuse that provides for interpretation of the CJEU and also of domestic courts of the PPT in light of the EU principle.

More recently in the Danish Beneficial Ownership cases ((C-115/16, C-118/16, C-119/16, C-299/16 and C-116/16 and C-117/16)  the CJEU stated that the general EU principle to prevent abuse including the element of ‘ genuine economic activity/artificiality’ is  still applicable to tackle tax treaty abuse.

The Danish ownership cases have raised the following questions:

  • how ‘genuine economic activity’ should be interpreted? And

  • who is analyzing the compatibility of the EU abuse principles with the EU countries domestic GAARs and treaty anti-abuse rules including PPT? Is it the CJEU? The EU country domestic court? And if it is the CJEU, can the CJEU recharacterize the transaction or will it be up to the EU domestic court to do that? There is a precedent in the interpretation of a tax treaty provision by the CJEU in the Austria-Germany case (C-648/15)  which even though it refers to tax treaty arbitration cases, can also open the door for other tax treaty interpretations by the CJEU. In this case such an interpretation could justified by the current application of the EU principle to prevent abuse by EU countries in light of CJEU case law.

To conclude the interaction between PPT and domestic GAARs should be studied in countries members of the Inclusive Framework and/or signatories of the MLI. Furthermore, more training will be needed for countries lacking tax treaty negotiation including not only tax administrations, but also judges and law-makers since the ratification of the MLI and the implementation of the PPT will raise questions that will require more knowledge of  the implementation and interpretation of tax treaty provisions. Finally, the current EU developments including the Danish Ownership cases should be also taken into account not only by EU countries but also by third (non-EU) countries. This is mainly due to the introduction of the EU Standard of Good Tax Governance that will be addressed in the following blogpost.


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