Tax planning strategies are not meant to exploit gaps in tax rules to artificially shift profits to low or no tax jurisdictions where there is little or no economic activity. Action 6 of the BEPS Action Plan discusses the matter of Treaty Abuse and summarises the provisions as they relate to the Principle Purpose Test (“PPT”).

Article 7 of the Multilateral Convention to Implement Tax Treaty Related Measures to Prevent Base Erosion and Profit Shifting (“the MLI”) states that: “a benefit under a Covered Agreement (i.e.: a tax treaty to which the ML applies) shall not be granted in respect of an item of income or capital if:

  • it is reasonable to conclude that obtaining the 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 granting that benefit in these circumstances would be in accordance with the object and purpose of the relevant provisions of the Covered Tax Agreement.”

The Competent Authority may still grant treaty benefits if it determines that such benefits would have been granted to that person in the absence of the transaction or arrangement. Further, the benefits of the treaty are denied where the principal purpose or one of the principal purposes of any arrangement or transaction, or of any person concerned with an arrangement or transaction, was to obtain those benefits.

The Action 6 Report includes three alternative rules to address situations of treaty abuse. The first of these alternatives is a general anti-abuse rule based on the principal purpose of transactions or arrangements. In addition to this PPT, the Action 6 Report provides two versions (a simplified and detailed version) of a specific anti-abuse rule, the limitation on benefits (“LOB”) provision, which limits the availability of treaty benefits to persons that meet certain conditions.

It is stated that countries, at a minimum, should implement: (i) a PPT only; (ii) a PPT and either a simplified or detailed LOB provision; or (iii) a detailed LOB provision, supplemented by a mechanism that would deal with conduit arrangements not already dealt with in tax treaties.

Because a PPT is the only approach that can satisfy the minimum standard on its own, it is presented as the default option. Parties are then permitted pursuant to paragraph 6 to supplement the PPT by choosing to apply a simplified LOB provision. Given that the detailed LOB provision requires substantial bilateral customisation, which would be challenging in the context of a multilateral instrument, the Convention does not include a detailed LOB provision.

Instead, Parties that prefer to address treaty abuse by adopting a detailed LOB provision are permitted to opt out of the PPT and agree instead to endeavour to reach a bilateral agreement that satisfies the minimum standard. Also, given that Parties preferring a detailed LOB provision may accept the PPT in paragraph 1 as an interim measure, such Parties are permitted to express such intent in a notification. 

Barbados has traditionally sought to enter into Double Tax Treaties as opposed to Tax Information Exchange Agreements. In addition, the provisions of many Barbados Double Tax Treaties already contain LOB clauses.

Further, Barbados has continually recommended that entities incorporated as Barbados holding companies have a geographic and economic purpose for establishment, enabling the pooling of funds for global investment purposes. The strategic purpose, substance of surrounding transactions, and role played by a company’s directors, have always been relevant to establishing Barbados tax residency as is required in order to claim treaty benefits. Whilst we seek to determine the extent of amendments required to be made to existing LOB clauses, the Barbados authorities continue to engage in the treaty negotiation process and to progress arrangements to facilitate the signing of the MLI within the timeframe identified.

About the Author

Louisa Lewis-Ward
Louisa Lewis-Ward - Partner, Tax, KPMG

Providing tax advice on both direct and indirect tax matters are Louisa’s focus, in addition to managing a diverse portfolio of tax clients. Louisa brings to the firm a wealth of experience having worked within the audit and assurance, and tax departments of PwC and another big four firm.