In Brief

OECD, BEPS, and the Multilateral Instrument: Navigating International Tax Treaties

August 2, 2023
OECD, BEPS, and the Multilateral Instrument: Navigating International Tax Treaties

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Digital technology and the global economy have allowed more businesses to expand rapidly and in unprecedented ways – for example, selling to customers anywhere in the world without having a fixed place of business (also called a permanent establishment).

But some of these businesses have adopted accounting techniques that exploit gaps and mismatches in tax rules – managing their tax liability in a manner that weakens governments’ abilities to tax business income from foreign activities.

To protect their tax base and combat these base erosion and profit shifting (BEPS) activities, some countries have instituted measures such as digital services taxes. But these protective steps can prompt disputes about the amount of taxes owed and raise concerns about double taxation.

To help reduce disputes and standardize compliance requirements – and help counter the abuse of international tax treaties – the Organisation for Economic Co-operation and Development (OECD) has worked with governments, policy makers and citizens across the globe on international standard-setting. And it has offered solutions via the OECD/G20 Inclusive Framework on BEPS and its Pillar One and Pillar Two proposals.

OECD has implemented the Multilateral Convention to Implement Tax Treaty Related Measures to Prevent Base Erosion and Profit Shifting (also called the multilateral instrument or MLI) as Action 15.

How Pillar Two is reshaping the digital global economy

Tax Law Analyst Alexis Sharp breaks down the importance of GloBE Rules and the Subject to Tax Rule, which are key components of the OECD’s Pillar Two.

What is the multilateral instrument?

A group of more than 100 countries and jurisdictions, including all members of the OECD and G20, developed the multilateral instrument to address aggressive tax-reduction measures and structures. The MLI seeks to preserve the role of bilateral income tax treaties in eliminating double taxation worldwide while combating opportunities to use treaties to eliminate all taxation or to reduce tax rates to aggressively low levels.

The first formal signing ceremony took place on June 7, 2017 – with more than 70 jurisdictions participating – and the MLI entered into force on July 1, 2018, after five countries ratified the agreement.

Who will the MLI affect and why?

The multilateral agreement closes loopholes in thousands of tax treaties worldwide. It already covers 100 jurisdictions from all continents and all levels of development, including countries from Albania and Argentina to the United Kingdom and Vietnam. (See the OECD’s full list of signatories as of January, 1 2023.)

Although U.S.-based multinationals are not yet directly affected because the United States is not a signatory to the MLI, the OECD’s 2017 model and its reflection in the treaties changed by the MLI will influence both future U.S. tax treaty negotiations and how foreign tax authorities view the interpretation of some current treaties.

In addition, multinationals with operations and subsidiaries in MLI-adopting countries can expect to see more aggressive tax authorities in countries that are enforcing new, and possibly more challenging treaty rules.

These changes mean international tax professionals will need to familiarize themselves with how the MLI impacts their clients in each country.

[Learn more about the latest Pillar 2 developments in our on-demand Tax Leadership Forum.]

How does the MLI work?

The MLI implements “a series of tax treaty measures to update international tax rules and lessen the opportunity for tax avoidance by multinational enterprises,” the OECD confirms.

The MLI supplements and modifies existing income tax treaties (though it is not a self-standing income tax treaty or an amending protocol), and it modifies the application of thousands of tax treaties to eliminate double taxation. In this way, governments do not need to bilaterally negotiate separate treaties.

The MLI applies to “Covered Tax Agreements” (CTAs). First, each country designates which of its specific bilateral income tax agreements it wishes to be covered by the MLI (i.e., which should be designated as “CTAs”). Then, each country designates which provisions of the MLI it wishes to adopt. Some provisions, known as minimum standards, must be adopted, while others are optional. If both parties to a bilateral tax agreement designate it as such, it becomes a CTA. This means various articles of the treaty will be impacted, depending on the countries’ mutual acceptance of, or reservations against, specific MLI provisions.

In addition, countries can designate treaties and protocols that are signed but not yet in force with the expectation that they will become CTAs when they enter into force. Changes go into effect at an accelerated time period, not when a new bilateral treaty using the new model is implemented. As more countries ratify their signatures of the MLI, more changes will go into effect.

Because the MLI was designed to be flexible, its impact will vary significantly from treaty to treaty.

How does the MLI modify a covered tax agreement?

To modify a CTA, each participating country must provide a notification to the OECD about which of its treaties it wishes to be CTAs and which provisions of the MLI it adopts.

To determine impact on a particular CTA, one must match up the two countries’ various positions regarding those provisions. Each country’s notification either accepts each MLI provision as written or rejects it by “reserving” against it. The MLI provides various reservations to each article, and choosing one of the reservations changes how that article will apply to the country’s CTAs. Silence generally means acceptance when reading a particular signatory’s list of reservations and notifications, though certain articles, such as Part VI (Arbitration) require election of additional measures that both parties must affirmatively elect.

In addition, certain provisions are designated as “minimum standards” that must be accepted unless a CTA already contains such a provision. In fact, Articles 6, 7, and 16 of the MLI are considered BEPS “minimum standards,” and every signatory to the MLI must agree these measures will be incorporated into all of its CTAs. Otherwise, these minimum standards may be reserved against only by making a commitment to implement an alternative process that achieves the same result.

The MLI’s specific articles can affect a CTA in several possible ways, depending on the language of compatibility clauses (e.g., applying a provision “in place of” or “in the absence of” an existing provision). Countries can tailor the way the MLI affects their treaties by “opting out” of various provisions that are not designated as minimum standards.

Under the provisions of the Convention, each jurisdiction is required to provide a list of reservations and notifications (the “MLI Position”) at the time of signature. The MLI then can take effect alongside bilateral income tax treaties.

[Download our roadmap on the OECD’s Pillar Two plan and track developments that impact your business.]

Which countries are MLI signatories?

As of January 1, 2023, there are 100 signatories to the MLI.

Armenia Hungary Norway
Australia Iceland Oman
Austria India Pakistan
Bahrain Indonesia Panama
Barbados Ireland Papua New Guinea
Belgium Isle of Man Peru
Belize Israel Poland
Bosnia and Herzegovina Italy Portugal
Bulgaria Jamaica Qatar
Burkina Faso Japan Romania
Cameroon Jersey Russian Federation
Canada Jordan San Marino
Chile Kazakhstan Saudi Arabia
China (People’s Republic of) Kenya Senegal
Colombia Korea Serbia
Costa Rica Kuwait Seychelles
Côte d’Ivoire Latvia Singapore
Croatia Lesotho Slovak Republic
Curaçao Liechtenstein Slovenia
Cyprus Lithuania South Africa
Czech Republic Luxembourg Spain
Denmark Malaysia Sweden
Egypt Malta Switzerland
Estonia Mauritius Thailand
Fiji Mexico Tunisia
Finland Monaco Turkey
France Mongolia Ukraine
Gabon Morocco United Arab Emirates
Georgia Namibia United Kingdom
Germany Netherlands Uruguay
Vietnam

Currently, the MLI is open for additional signatories. And as of November 30, 2022, Algeria, Eswatini, and Lebanon “have expressed their intent to sign the Convention,” the OECD notes.

Bloomberg Tax subscribers can learn more about these jurisdictions, their timelines, and related OECD actions via our BEPS Tracker, OECD – Action 15: Multilateral Tax Instrument. Not a subscriber? Request a demo.

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