i
SHOULD ETHIOPIA SIGN THE MLI?
Prospects and Challenges with a spotlight on treaty abuse and PE
Advanced LL.M Thesis
University of Amsterdam-IBFD
Advanced LL.M International Tax Law
Submitted By: Birhanu Tadesse Daba Supervisors: Dr. Joanna C. Wheeler Dr. Bruno Da Silva
27 July 2018 Amsterdam, the Netherlands
ii Table of Content pages Abstract……….
Acknowledgment……… ……. List of abbreviations………. CHAPTER ONE: INTRODUCTION……… 1.1. Background………. 1.2. Ethiopia’s tax treaty network………. 1.3. MLI………. 1.4. Objectives, questions, scope, methodology and structure of the study………. 1.4.1. Objectives of the study………. 1.4.2. Research questions……… 1.4.3. Scope and delimitation of the study………. 1.4.4. Research methodology……….. 1.4.5. Structure of the study……… CHAPTER TWO: ANALYSIS ON PREVENTION OF TREATY ABUSE
AND AVOIDANCE OF PE STATUS ... 2.1. Prevention of Treaty Abuse………... 2.1.1. LOB Rule………. 2.1.1.1. LOB rule under the FITP………. 2.1.1.2. LOB rule under the MLI………. 2.1.2. GAAR and PPT Rule……… 2.1.2.1.GAAR under the FITP………. 2.1.2.2.PPT rule under the MLI……… 2.1.3 Interplay between LOB and PPT rules………. 2.2. Avoidance of PE Status ……… 2.2.1. PE provisions under the FITP and FITR……….. 2.2.1.1. Service PE……… 2.2.1.2. Construction PE………... 2.2.1.3.Agency PE and Stock PE………. 2.2.2. PE provisions under Part IV of the MLI……….. 2.2.2.1.Artificial avoidance of PE status through commissionaire arrangement and
iv v vi 1 1 2 4 5 5 5 6 6 7 8 8 9 9 15 19 19 21 22 22 23 23 24 24 25
iii similar strategies……….
2.2.2.2.Artificial avoidance of PE status through the specific activity exemptions……….. 2.2.2.3.Splitting of contracts ………. 2.3. Treaty Abuse and PE provisions in light of Ethiopia’s investment policy……….. CHAPTER THREE: PROCEDURAL AND PRACTICAL CONSIDERATIONS OF
THE UNDERLYING MLI PROVISIONS AND THE MLI POSITIONS OF ETHIOPIA’S TREATY PARTNERS………. 3.1. Compatibility and related clauses under the MLI……… 3.1.1. Compatibility clause……….. 3.1.2. Reservations clause……… 3.1.3. Optional Provisions……… 3.1.4. Notifications clause……… 3.2. Compatibility and related clauses under Article 7 of the MLI………. 3.3. Compatibility and related clauses under Articles 12 to 14 of the MLI……… 3.4. The MLI positions of Ethiopia’s treaty partners and their implications……….. 3.4.1. Article 7: LOB and PPT rules………... 3.4.2. Article 12: PE through commissionaire arrangement and similar strategies……… 3.4.3. Article 13: PE through Specific Activity Exemptions ……… 3.4.4. Article 14: PE through splitting up of Contracts……….
CHAPTER FOUR: PROSPECTS AND CHALLENGES OF SIGNING THE MLI ...
4.1. Prospects in signing the MLI……….. 4.2. Challenges in signing, and of signing the MLI………
CHAPTER FIVE: CONCLUSION AND RECOMMENDATIONS .………..
5.1. Conclusion………... 5.2. Recommendations………...
Bibliography ………..
Appendices ………... Appendix A: Articles 4, 48, 78, 79 and 80 of the FITP………... Appendix B: Article 4 of the FITR………. Appendix C: Article 60 of the VATP ……… Appendix D: Articles 7, 12, 13, 14 and 15 of the MLI ……….
25 27 28 29 32 32 32 33 34 34 34 36 37 37 39 39 40 42 42 43 51 51 52 54 68 68 72 72 73
iv Abstract
The MLI is one of the building blocks of the BEPS project aimed at translating multilateral measures through a quick way modification to tax treaties without the need for renegotiations. The usefulness of the MLI however should not only be measured in light of its purpose as a package rather it has to be gauged in terms of its substantive and procedural provisions as well as practical considerations based on each treaty partner’s preferences to fulfill its purpose. This research has examined whether the MLI is useful for Ethiopia with spotlight on the treaty abuse and PE provisions of the MLI and in consideration of Ethiopia’s new income tax legislations, investment policy, its tax treaties and its six treaty partners’ positions to the MLI following the aforementioned suggested pattern. Accordingly the substantive provisions of the LOB rules in treaty abuse and the PE Articles of the MLI found to be potentially promising to investment inflow into, and broaden the tax base of, Ethiopia, respectively, as compare and/or complementarily to the corresponding provisions of its domestic laws. However, the substantive provision of the PPT rule and the procedural provisions entrenched in compatibility clauses of the MLI, and practical considerations in signing and of signing the MLI at this point in time do not encourage moving for the MLI. The mere fact that the PE Articles could lower impliedly the threshold and the treaty abuse deny treaty benefits would not help pragmatically source states since it is the source state that bears the ultimate burden of administrative responsibilities. Furthermore, there are some uncertainties hovering around, and complexities embedded in, the MLI.
Therefore it is reasonable for Ethiopia, at this particular moment, to procrastinate in joining the club in order to take some time and gather more information whilst pondering over the prospects and challenges in signing and of signing the MLI rather than jumping into such a labyrinthine network of tax treaties with multifarious consequences and get entangled.
v
Acknowledgement
First of all, glory to the Almighty God for His invaluable and indescribable deeds in my life. This journey would not have been possible without the financial support of IBFD-CSAT hence I am very grateful to them for sponsoring my study.
I would like to express my deep gratitude to my thesis supervisors, Dr. Joanna C.Wheeler and Dr. Bruno Da Silva, for their useful advices and comments.
I take pride to thank Prof. Dr. Fisseha-Tsion Mengistu, who encouraged me to pursue this program, for his kind and unwavering support and inspiring me to follow my dreams. My gratitude goes to Kennedy Munyandi (IBFD) for his kind cooperation in the sponsorship and internship since the very beginning and to Anna Bardadin (IBFD) for her very generous support and helpful suggestions to make me settle swiftly.
I would also like to express my gratitude to Bochu Sintayehu (MoFEC), Firehiywot Handamo (MoFEC), Serkalem Eniyew (MoFEC) and Mesay Woldesemayat (EIC), who have been so helpful and cooperative in giving their support to achieve my goal. I must also thank IBFD library staff for their cooperation in the course of the study.
I have a great pleasure to thank the 2017/2018 UvA comrades of advanced LL.M in International Tax Law, for sharing with them good times and for giving me the opportunity to grasp the true color and beauty of diversity which is already part of my recollections.
Finally, I am enormously grateful to my parents and siblings for their endless love and support in every inch of my journey, my friends and work colleagues at MoFEC, especially Geni, for their thoughts, well wishes and encouragement throughout this study. I dedicate this thesis to my beloved mother, Sorse Kudama, for her unconditional love, indescribable support and for unselfishly upbringing and nurturing me to be where I am today.
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Lists of abbreviations
ATAF African Tax Administration Forum BEPS
CSAT
Base Erosion and Profit Shifting Center for Studies in African Taxation CTA Covered Tax Agreement
DTA Double Taxation Avoidance Agreement EAC East African Community
EIC Ethiopian Investment Commission
EU European Union
FDI Foreign Direct Investment
FDRE Federal Democratic Republic of Ethiopia FITP Federal Income Tax Proclamation FITR Federal Income Tax Regulation
FTAP Federal Tax Administration Proclamation
G20 Group of Twenty/An International Forum for the Government and Central Bank Governors
GAAR General Anti-Avoidance Rule
GIZ Deutsche Gesellschaft fur Internationale Zusammenarbeit IBFD International Bureau for Fiscal Documentation
IMF International Monetary Fund ITP Income Tax Proclamation LOB Limitation on benefit
MLI Multilateral Convention to Implement Tax Treaty Related Measures to prevent Base Erosion and Profit Shifting
MNE Multinational Enterprise
MoFEC Ministry of Finance and Economic Cooperation
OECD Organization for Economic Co-operation and Development OECD MC OECD Model Tax Convention on Income and on Capital PE Permanent Establishment
vii UAE United Arab Emirates
UK United Kingdom and North Ireland UN United Nations
UN MC United Nations Model Double Taxation Convention between Developed and Developing Countries
VATP Value Added Tax Proclamation
1 CHAPTER I: INTRODUCTION
1.1. Background
The world is in turmoil and international taxation is exactly in the storm. Taxation has taken the centre stage in the ongoing political and economic crisis where states are struggling to make ends meet.
Cees Peters1
The pace of integration of national economies and market has increased substantially, having boosted trade and foreign direct investment in many countries.2 In this respect, international tax
law has a paramount importance in facilitating cross border trade and investment in particular and in supporting the global economy in general. Although taxation is at core of countries’ sovereignty, the interaction of independent sets of rules enforced by sovereign countries and the tax treaty rules governing taxation of cross-border income has been alleged to creating “gaps and frictions including potential double taxation and double non taxation, particularly for corporations operating in several countries.”3
Consequently the international tax landscape has changed dramatically in recent years4 and “international tax issues have never been as high on the political agenda as they are today.”5
Different initiatives have been proposed6 to alleviate the gaps and frictions occurring in the international tax arena in order to enable countries protect their revenue bases. Particularly in the aftermath of the 2008 economic crisis, “international corporate tax issues are prominent in public debate, notably with the OECD/G20 project addressing Base Erosion and Profit Shifting (‘BEPS’).”7
1 Cees Peter, On the legitimacy of international tax law (IBFD, Amsterdam 2014) p1
2 OECD, ‘Action Plan on Base Erosion and Profit Shifting’ (OECD Publishing, Paris 2013) p7 3 id p 9
4 OECD, ‘Background Brief: Inclusive Framework on BEPS’(OECD: January 2017) p7;Accessed <https://www.oe cd.org/ctp/background-brief-inclusive-framework-for-beps-implementation.pdf>
5 OECD, ‘Developing a Multilateral Instrument to Modify Bilateral Tax Treaties’ Action 15-2015 Final Report’
OECD/G20 BEPS Project( OECD Publishing: Paris 2015) p3
6 See for instance, OECD, ‘Harmful Tax Competition: an Emerging Global Issue ( OECD Publishing, Paris 1998);
OECD, Model Tax Convention on Income and On Capital –Volume I and II (Updated 22 July 2010) (OECD Publishing, Paris 2010)
7 Ernesto Crivelli, Ruud De Moooij and Mickael Keen, ‘Base Erosion, Profit Shifting and Developing
Countries’(IMF working paper WP/15/118;2015) p2 Accessed <https://www.imf.org/external/pubs/ft/wp/2015/wp 15118.pdf >
2 Hence it has been heralded and broadly advocated that the fundamental leitmotif of the BEPS project is curbing tax planning strategies, which exploit gaps and mismatches between and- among different tax jurisdictions, by strengthening tax system of, and by creating strong affiliation among, sovereign jurisdictions. Indeed, “the factors that influence BEPS differ from country to country and from region to region, depending on economic structures and the character of economies.”8 Accordingly the BEPS project has brought kaleidoscopic range of issues in 15 actions. The 15 actions of the BEPS project have pinpointed unilateral measures to be taken by jurisdictions individually and multilateral measures requiring amendment of bilateral (and multilateral) tax treaties. The Multilateral Convention to Implement Tax Treaty Related Measures to Prevent BEPS (MLI) signed on 7th July 2017 is therefore one of the outcomes of the
OECD/G20 project to tackle BEPS and aimed at translating multilateral measures through modification of tax treaties.9
Ethiopia is one of fast-growing economies in Africa. It has not however signed the MLI and had not participated in any of the BEPS and MLI conferences organized in international and regional levels. Ethiopia is not also a member of the Global Forum as well as BEPS Inclusive Framework. It has also hardly participated in regional tax platforms. It is a member neither to African Tax Administration Forum (ATAF) nor to the East African Community (EAC), which are rigorously working on tax issues in the region. Nonetheless Ethiopia has been extending its tax treaty networking in recent years.
1.2. Ethiopia’s tax treaty network
Ethiopia embarked on negotiating comprehensive double taxation avoidance agreement (DTA) by the end of 1980s in its first ever effort with the then Yugoslavia. However, it concluded the first specific transport tax treaty with India in 197610 and the first comprehensive double tax treaty with Kuwait in 1996. In the last two decades however the number of tax treaties has been growing steadily, and continues to grow at the same pace which includes treaties with Western
8 Amanda Anthanasiou, ‘Developing Countries seek more from Platform on Tax Collaboration’ Tax notes (February
16 2018) IBFD
9 OECD, ‘Explanatory Statement to the Multilateral Convention to Implement Tax Treaty Related Measures to
Prevent Base Erosion and Profit Shifting’ OECD/G20 BEPS Project( OECD Publishing, Paris 2016)
3 Europe, emerging economies and other developing countries in Europe, Asia and Africa. Hitherto 32 treaties have been ratified, 23 treaties entered into force, 2 treaties signed but not ratified, 3 treaties are initialed but not signed, and 7 treaties are under negotiations. There is also a pre-negotiation engagements including exchange of draft treaty texts with 22 countries, totally Ethiopia have had 66 countries in its treaty network. Many countries have been requesting for bilateral tax treaties negotiations in the last few years and 4 countries have requested for renegotiations in 2017/18.
Ethiopia has its own treaty model and its tax treaties are signalized and inspired by the leverage of the UN and OECD MCs and Commentaries thereon as well as EAC model provisions, treaty partners’ proposals with new and very specific provisions and other features in terms of economic and political orientations already in place. Having concluded different tax treaties with developed and developing countries (in Europe, Asia and Africa), Ethiopia has adopted various approaches (such as Limitations on benefits(LOB), Capital Gains, and permanent establishment (PE) provisions) and reserved certain provisions (such as a minimum rate for passive incomes, tax sparing clause for active income). The dynamic nature of international tax issues and proliferation of new concepts and principles have also influenced Ethiopia to have borrowed and incorporated various principles, guidelines and concepts into its treaty model and have embedded them in treaty negotiations and practice such as LOB, insurance PE, Exchange of Information, among others.
One of the priorities of Ethiopia’s tax treaty is affiliated with attracting foreign investment. Accordingly tax sparing clause,11 in the light of its lucrative investment incentives, among others, in the form of tax holiday, is a lynchpin provision in its tax treaties. The lucrative tax
11 Tax sparing clause is a tax treaty provision mostly proposed by developing countries in order to safeguard their
tax incentives, given through their domestic law notably to attract foreign (direct) investment, from being taxed or nullified by other states. See for further discussion, Celine Azemar and Dhammkika Dharmapala,‘ Tax Sparing Agreements, Territorial Tax Reforms, and Foreign Direct Investment’(2016) Oxford University Center for Business Taxation (WP15/22) ;Accessed<https://www.sbs.ox.ac.uk/faculty-research/tax/publications/working -papers-0/tax-sparing-agreements-territorial-tax-reforms-and-foreign-direct-investment>; James R.Hines, ‘Tax Sparing and Direct Investment in Developing Countries’: in James R.Hines (ed) International Taxation and Multinational Activity (University of Chicago Press:2000);Vanessa Arruda Ferreira and Anapaula Trindade Marinho, ‘Tax Sparing and Matching Credit: From an Unclear concept to an Uncertain Regime’(August 2013) 67 Bulletin For International Taxation 8 ;Sergio Andre Rocha, ‘Brazil’s International tax Policy’(June 1 2017) Editora Lumen Juris; Accessed <https://ssrn.com/abstract=3048899> Pp 73-351
4 incentives are assumed to be, domestically, providing multilateral enterprises (MNEs) with the tax benefits however “the effectiveness of those tax incentives depends crucially on the MNEs’ residence country tax regime, especially where the residence country imposes worldwide taxation on foreign income.”12 Therefore the tax sparing clauses in tax treaties help prevent
Ethiopia’s tax incentives from being nullified by residence country tax system.13
According to a study on sub Saharan African tax treaties “analyzing the processes that led to the treaties in force today reveals that in many cases they do not fulfill the original role that may have been envisioned by developing countries who signed them.”14Hence, bearing in mind the
initial desire of Ethiopia’s tax treaty, it is crucial to examining implications of the underlying provisions of the MLI in light of Ethiopia’s investment policy. Out of 24 MLI signatory countries of Ethiopia’s treaty partners, 16 countries have included her under their lists of Covered Tax Agreements (CTA). Furthermore it is pertinent to look into practical considerations of the MLI provisions in light of its treaty partners’ positions in the MLI.
1.3. MLI
The MLI provides a quick way to modify (amend) bilateral (and multilateral) tax treaties without the need to renegotiate with each individual country.15 Basically each party sets out what aspects
of BEPS it is prepared to accept within its tax treaties and then this is matched up with other signatories.16 Accordingly “the main aim is to make it harder for business to use tax treaties to circumvent taxable income through jurisdictions with limited substance hence the changes will limit treaty benefits and potentially affect where and how enterprises conduct businesses”17
12 Celine Azemar and Dhammkika Dharmapala, Ibid p 1 13 ibid
14 Martin Hearson, ‘Tax Treaties in sub –Saharan Africa: a critical review’ ( Tax Justice Network-Africa: Kenya
2015) London School of Economic(LSE) Research Online p 8; Accessed <http://eprints.lse.ac.uk/67903/ >
15 Grant Thornton, ‘BEPS multilateral instrument- A turning point or just more uncertainty?’ p 2; Accessed
< https://www.grantthornton.nl/globalassets/1.-member-firms/global/insights/article-pdfs/2017/beps-multilateral-instrument.pdf>
16 ibid 17 id pp2-3
5 The MLI is not therefore “a turnkey treaty with specified near future termination procedure or date” 18 instead it provides for addition of contents through amendment which could even go beyond the scope of BEPS project.19 So far it has been signed by 82 and ratified by 9 countries. Accordingly it entered into force on 1st July 2018. It is also the first comprehensive multilateral
tax treaty in cross continental context.20
1.4. Objectives, questions, scope, methodology and structure of the research 1.4.1. Objectives of the Research
The main objective of this study is to understand and assess foreseeable implications of signing the MLI in Ethiopian context and proffer a sound prognostication thereto. In this respect, the study has the following objectives: briefly discussing the foundation of Ethiopia’s new income tax legislations and tax treaties, examining the underlying provisions of the MLI in light of Ethiopia’s investment policy, assessing selected Ethiopia’s treaty partners’ positions in the MLI from the underlying provisions context, analyzing the possible implications of signing the MLI in Ethiopian context, and finally drawing some conclusions and recommendations on the way forward.
1.4.2. Research Questions
It is imperative to elucidate the prospects and challenges resulting from signing the MLI. Hence the main research question this research seeks to answer is: Is the MLI useful for Ethiopia?: what are the prospects and challenges in signing and of signing the MLI? The sub-questions are:
What are the implications of the substantive provisions, along with compatibility and related clauses therein, of treaty abuse and PE Articles of the MLI?
To what extent do those provisions comply with the new income tax legislations and investment policy of Ethiopia?
What are the practical considerations of Ethiopia’s treaty partner’s positions to the MLI?
18 Yariv Brauner, ‘McBEPS: The MLI-The First Multilateral Tax Treaty that Has Never Been’ (2017) 46
INTERTAX , p7
19 MLI, Article 33; see also Brauner, ibid
20 There were efforts for multilateral international tax rules and there are multilateral tax treaties in regional level,
such as Nordic Tax Convention ; see Dirk M. Broekhuijsen, ‘A Multilateral Tax Treaty: Designing an Instrument to Modernize International Tax Law’( PhD Dissertation; Leiden University, 2017)
6
1.4.3. Scope and Delimitation of the Research
Undertaking research on the prospects and challenges of signing the MLI at this very time and level is, as a prickly and contemporary subject, a complex task as it requires sufficient time and data sources to deciphering the gist of the instrument. Hence these constraints have potentially forced the researcher to conduct the study at a country level, i.e. Ethiopia. Consequently the study has been confined mainly with, and accentuated on, two parts of the MLI i.e. treaty abuse provisions of Part III (particularly Article 7) and the whole Articles of Part IV on artificial avoidance of PE status ; because the treaty abuse provisions particularly ‘prevention of treaty abuse’ under Article 7 of the MLI is one of the minimum standards hence it is mandatory; whilst the PE provisions of the MLI are alleged to be in favor of source/developing countries as they impliedly broaden the tax base of source states by lowering the PE threshold. Furthermore it included six Ethiopia’s treaty partners’ positions in the MLI in the light of the selected MLI provisions for illustration purposes. Although the study has been confined with Ethiopia’s context, the results of this research could be used to reflect on the other developing countries who are intending to sign the MLI (or have signed it already for further reconsideration before ratification).
This study, therefore, specifically focused on identifying the underlying factors which are pivotal to determine whether Ethiopia should sign the MLI or not.
1.4.4. Research Methodology
This research is essentially a library based one. Thus a survey of pertinent literatures was conducted. OECD official documents and the MLI legal text along with the Explanatory Statement, relevant bilateral tax treaties, as well as Ethiopian legislations were explored as primary sources of the study. Relevant books, scholarly articles, working papers and trustworthy newspapers were also examined as secondary sources in the light of the rapid progress emerging around the MLI.
7 1.4.5. Structure of the research
Chapter two analyses the substantive provisions on treaty abuse and avoidance of PE status of the MLI (Articles 7, 12, 13, 14, and 15); it also addresses the corresponding provisions in Ethiopia’s income tax law in the light of the underlying provisions of the MLI and with respect to Ethiopia’s investment policy. Chapter three elucidates the procedural provisions, i.e. compatibility and related clauses, of the MLI pertaining to the articles covered in chapter two. It also goes through the practical considerations and their implication by analyzing six Ethiopia’s treaty partners’ positions in the MLI in light of the articles addressed in chapter two and the provisions of respective tax treaties. Chapter four answers the research questions by stipulating the prospects of signing the MLI and the challenges in signing and of signing the MLI in the light of the discussions made in the preceding chapters. This chapter submits essential considerations and prognosis as to why Ethiopia should or should not sign the MLI. And finally, chapter five draws a conclusion and propounds recommendations.
8 CHAPTER TWO: ANALYSIS ON PREVENTION OF TREATY ABUSE AND
AVOIDANCE OF PE STATUS
2.1.Prevention of Treaty Abuse
The MLI, as an implementation catalyst of the BEPS Actions which have incorporated various methods devoted to curbing treaty abuse, encompasses general and specific treaty anti-abuse alternatives under Part III “Treaty Abuse” with 6 Articles (from Article 6 to 11). These Articles21
combine broader anti-abuse provisions in Articles 6, 7, and 11 and relatively specific item- oriented anti abuse-rules in Articles 8, 9 and 10.
The BEPS Action 6 final report corresponding to Article 7 of the MLI has proposed three alternative rules to combat treaty abuse situations. These are two versions of specific anti abuse rules of limitation on benefits “LOB” rules; namely, simplified limitation on benefits or “ simplified LOB rule” and detailed limitation on benefits or “detailed LOB rule” which are intended to limit the availability of tax treaty benefits for residents who could meet certain conditions22 set forth to filter treaty shoppers. The main distinction between the two versions of the LOB rule lies on the depth and technicalities of the alternatives. The detailed LOB rule, as the name per se indicates, accentuates on detailed and more complex version of the rule whilst the simplified LOB rule propounds the basics of such rule.23 The third alternative is a more general anti abuse rule based on the principal purposes of transactions or arrangements namely “the principal purposes test or PPT rule”. Consequently the PPT rule is intended to address any
21 Article 6 (Purpose of a Covered Tax Agreement), Article 7 (Prevention of Treaty Abuse), Article 8( Dividend
Transfer Transactions), Article 9(Capital Gains from Alienation of Shares or Interests of Entities Deriving their value Principally from Immovable Property), Article 10 (Anti-abuse Rule for Permanent Establishment Situated in Third Jurisdictions, and Article 11 (Application of Tax Agreements to Restrict a Party’s Right to Tax its Own Residents).
22 The main function of the residence concept in tax treaties is to limit the application of treaty provisions to persons
who have connection with contracting states and meet other requirements set forth as income attribution or as anti avoidance rule; such as beneficial ownership test. See, Joanna Wheeler, The Missing Keystone of Income Tax Treaties, (Amsterdam: IBFD 2012); Joanna Wheeler, ‘Persons Qualifying for treaty Benefits’: In Alexander Trepelkov, Harry Tonino and Dominika Halka(eds), United Nations Handbook on Selected Issues in Administration of Double Tax Treaties for Developing Countries (New York: United Nations 2013)
23 The Commentary under BEPS Action 6 report overwhelmingly focused on the detailed LOB provisions (see
pages 21-55) whilst the 2017 OECD MC Commentary on Article 29 “Entitlement to benefits” elucidated on both versions of the rule. However, the MLI provided with the simplified LOB provisions in paragraphs 8-11 of Article 7 and left the detailed LOB provisions for parties opting out of the PPT and agree to endeavor to reach a bilateral agreement that satisfies the minimum standard.
9 other treaty abuse situations including treaty shopping situations that would not be covered by the LOB rule.24
The sub-subsections of this subsection however deal with the LOB and GAAR rules in the new Ethiopia’s domestic tax law and only two alternatives of the MLI, i.e. the Principal Purpose Test (“PPT”) rule and the simplified limitation on benefits (“LOB”) rule, as stipulated under Article 7 of the MLI. Article 7, in similar manner with other Articles of the MLI, consists of substantive provisions and compatibility and related clauses. Accordingly the sub-subsections on LOB and PPT rules of the MLI will accentuate on, and deal with, the substantive provisions of Article 7 as stipulated under paragraphs 1, 4, 8, 9, 10, 11 and 12 therein; hence the remaining provisions on compatibility and related clauses will be discussed under chapter three of this study.
2.1.1. LOB Rule
2.1.1.1. LOB rule under the FITP
The 2016 Federal Income Tax Proclamation No. 979/2016 (FITP) has overhauled the income tax system of the country and introduced anti treaty shopping rules i.e. limitation on benefit (LOB) provisions under Article 48. Article 48 of the FITP with the heading “Tax Treaties” contains four paragraphs that deal with the eligible authority to sign treaties25, the status of tax treaties, insinuated treaty override in light of treaty abuse and simplified LOB rule.26
Article 48(2) of the FITP provides for a priority rule applicable when the provisions of a tax treaty are inconsistent with the provisions of the FITP. Accordingly, in principle, the provisions of the tax treaty prevail over the provisions of the FITP. However, this paragraph also provides that the priority rule does not override the anti-treaty shopping or LOB rules in paragraphs (3) (and 4) Article 48 and the general anti avoidance rules in part eight27 of the FITP.
24 OECD, ‘Preventing the Granting of Treaty Benefits in Inappropriate Circumstances, Action 6-2015’ Final Report
(OECD/G20 Base Erosion and Profit Shifting Project) (OECD Publishing Paris, 2015) p9
25 Article 48(1) of the FITP indicates that the Minister of Finance and Economic Cooperation is empowered to be
the competent authority in negotiating bilateral or multilateral tax treaties on behalf of Ethiopia. See Appendix A
26 See Appendix A
27 Part eight of this Proclamation deals with“ Anti Tax Avoidance “, and it contains three Articles i.e. Article 78 “
Income Splitting”, Article 79 “Transfer Pricing”, and Article 80 “Tax Avoidance Schemes”; These articles have, having been drafted during the time of the OECD/G20 BEPS Project has been developed, reflected just cameo of the base erosion and profit shifting issues along with other provisions of the Proclamation such as Thin Capitalization rule with lower debt to equity ratio from 4:1 to 2:1.
10 According to the 1995 Constitution of Ethiopia28, which is the supreme law of the land, international agreement including bilateral tax treaty has equal status with primary domestic legislations without hierarchy. Indeed there is a seamless debate on the interplay between tax treaty provisions and domestic anti-abuse provisions. Treaty models,29 some international
instruments,30 and some scholars31 advocate that tax treaty should prevail over domestic tax
legislation in case of conflict. In contrast, other scholars32 as well as some countries, as their view is reflected in the OECD MC,33 propound that tax treaties should not always get priority over domestic tax legislations, particularly where the domestic anti abuse rules apply. The latter view emphasize on what is not the object and purpose of tax treaties; i.e. tax treaties should not be available where the main purpose of a transaction by residents is to secure a more favorable tax position or treaty benefits which is abusive.34Avi-Yonah, for instance argues that “…tax
treaties are too cumbersome to renegotiate every time taxpayers find a new way to abuse the treaty so that treaty override should be allowed…”35otherwise it would encourage abuse. Indeed,
“the relationship between tax treaties and domestic tax law cannot be summarized in a broad statement such as ‘tax treaties prevail over domestic law’ because the interplay between the two is considerably more complex.”36
28 Article 9(4) of the Constitution of the Federal Democratic Republic of Ethiopia (known as FDRE Constitution)
stipulated that “ all international agreements ratified by Ethiopia are an integral part of the law of the land”
29 UN MCs of 2011 and 2017, paragraph 14; OECD MC 2014, paragraph 70 of commentary on Article 1; UN and
OECD MCs Article 3(2).
30 Articles 26 and 27 of Vienna Convention on the Law of Treaties(VCLT)
31 Klaus Vogel, ‘The Domestic Law Perspective’: in Guglielmo Maisto (ed) Tax Treaties and Domestic Law ( IBFD,
Amsterdam 2006) pp3-11;Vogel argues from domestic law perspective that “…a tax treaty is instrument of international law… and its main purpose is to avoid double taxation of income, capital and estates by modifying the domestic law of the Contracting state…being restricted to cross border taxation of residents of the two contracting states…it is a special legislation…hence making a legislation that contradicts an existing tax treaty is a violation of International Law.” Jan Wouters and Maarten Vidal, ‘The International Perspective’: in Guglielmo Maisto (ed) Tax Treaties and Domestic Law (IBFD, Amsterdam 2006) pp13-35; Wouters and Vidal also argue from international law perspective that “…the principle of good faith is a cornerstone principle of international law and dictates both states should not engage in setting up changes in their domestic law in order to take advantages of the ambulatory interpretation of tax treaties, and that states respect their international obligations and consequently, do not enact or enforce legislation that violates their treaty obligations.”
32 Reuven S. Avi-Yonah, ‘Tax Treaty Overrides: A Qualified Defense of U.S. Practice’ : in Guglielmo Maisto (ed)
Tax Treaties and Domestic Law (IBFD, Amsterdam 2006) pp65-79; Avi-Yonah argues that “…treaty override should be allowed only when consistent with the underlying dual purpose of tax treaties i.e. to prevent double taxation and double non taxation…tax treaties are too cumbersome ”
33 OECD MC 2014, paragraphs 9-26 of Commentary on Article 1 34 OECD MC 2017, paragraph 61 of Introduction
35 Avi-yonah, supra note 32, p79
36 Jacques Sasseville,’ A Tax Treaty Perspective: Special Issues’ :in Guglielmo Maisto (ed) Tax Treaties and
11 However, the FITP is aligned with the second view and underpins that tax treaties have no role to play in determining tax liability under domestic law other than allocating or limiting taxing rights between contracting states so that the domestic tax law applies to curb abusive practices.37 Furthermore, Ethiopia has anti treaty abuse provisions in its tax treaties with the Netherlands (Art 21A)38, India (Article 28), Egypt (Article 27), Poland (Article 28), Korea Republic (Article
28), Portugal (Article 1 of the Protocol), Slovak (Article 27), Czech Republic (Article 27), and Mozambique (Article 29). Accordingly it also satisfy the first view with these treaty Articles.
Article 48(3) and (4) of the FITP comprise three parameters to dispel that a status of resident of a contracting state is not through treaty shopping arrangement in seeking for treaty benefits or to partly trigger the overriding provisions in Article 48(2) (i.e. to apply the LOB rule). The three parameters are based on ownership, list on stock exchange and active conduct of business.
i. Ownership
This is the main principle of the LOB rule in Article 48(3) which intends to prevent the abuse of Ethiopia’s tax treaties through treaty shopping practices. Paragraph (3) provides that the benefit of the exemption, exclusion, or reduction is not available to any-body who, for the purposes of the tax treaty, is a resident of the other contracting state when fifty percent or more of the underlying ownership (i.e. beneficial ownership) of that body is held by an individual or individuals who are not residents of that other contracting state for the purposes of the tax treaty with an exception for the two parameters i.e. companies listed on a stock exchange and company carrying on active business. The reference to a ‘resident body’ in Article 48(3) of the FITP implies that the LOB rule does not apply to individuals who are residents of the other contracting states and the contracting states per se since they are not covered by the definition of the term ‘body’.39
37For instance, the OECD MC (2014) Commentary on Article 1 paragraphs 56-109, which articulate different views
of states regarding correlation between treaties and domestic anti avoidance rules in case of abuse.
38 Unlike the anti treaty provisions in other treaties, this Article is an LOB provision is similar to the simplified LOB
provisions in Article 7(8-13) of the MLI.
39 The term “body” is defined under Article 2(5) of the Federal Tax Administration Proclamation (FATP) as “a
company, partnership, public enterprise or public finance agency, or other body of persons whether formed in Ethiopia or elsewhere.”
12 The following fact pattern40 illustrates the threat posed to the Ethiopian income tax base through treaty shopping practices and what Article 48(3) intends to overcome. Under the FITP, a non resident body providing technical services41 to a resident of Ethiopia other than through an Ethiopian permanent establishment of the non-resident body is subject to a non resident tax at the rate of 15% of the gross amount of the technical fee derived for the services.42 Where the
non-resident body providing the technical services is a resident of a country that has a tax treaty with Ethiopia, the business profit article of the tax treaty (conventionally Article 7) provides that Ethiopia can tax the technical fees only43 when the fee is attributable to a permanent
establishment of the non-resident body in Ethiopia; by contrast there is no Ethiopian tax if there is no permanent establishment. Accordingly, if the non-resident body is a resident of third country that does not have a tax treaty with Ethiopia; the tax rate is 15% of the gross amount of the technical fee; however, where the non-resident body is resident of a country with which Ethiopia has a tax treaty, the rate will be zero percent. This encourages non- resident bodies providing technical services to establish bodies in a country that has tax treaty with Ethiopia to exclude Ethiopian tax on technical fees.
Accordingly the provision of Article 48(3) prevents such arrangements by limiting the benefits of a tax treaty to genuine residents of treaty partners. It also applies when a tax treaty made under the Article provides that Ethiopian source income is exempt or excluded from tax or the application of the tax treaty results in a reduction in the business income tax payable under the FITP. However, this ownership requirement could not still prevent the benefits of tax treaty to a resident of third country where such resident holds less than fifty percent of the body, provided that the requirements under Article 48(3) are met.
40 This fact pattern was based on an example used during the drafting process of the FITP in order to illustrate how
Ethiopia could be affected by treaty shopping.
41 Technical services was not defined in the FITP or in the FTAP’; However, Article 2(23) of the FITP defines
“technical fee” as “ a fee for technical, professional, or consultancy services, including a fee for the provisions of services of technical or other personnel”. This gives an implied and open ended definitional scope of technical services.
42 FITP, Article 51(2)(c)
43 Where there is no a separate provision dealing with technical fees either stand alone or with the royalties Article;
For instance Ethiopia’s tax treaties with India-Article 12, Portugal-Article 13,Seychelles-Article 13, and Sudan Article 13, dealt with technical fees hence permanent establishment is not a condition to levy tax on such fees.
13
ii. Company listed on a stock exchange
Article 48(3) has referred to paragraph (4) as an exception for the ownership requirement set therein. Accordingly Article 48(4)(a) provides that where the resident body of the other contracting State is a company and such company is listed on the stock exchange in the other contacting State, the ownership requirement, stated under Article 48(3) will not apply. Neither the FITP nor the Federal Income Tax Regulation No. 410/2017(FITR), issued for proper implementation of the FITP, set any requirement for, or further indication on, the stock exchange listing. Countries with stock or security exchange system set various listing requirements which companies must fulfill to be permitted being listed on the stock exchange, such as list of shareholders and trading on a recognized stock exchange.44 Hitherto Ethiopia does not have
stock exchange hence there is no any indication whether a company listed in more than one country stock exchange is eligible for treaty benefits. For instance, the tax treaty with the Netherlands has a very broad scope in this respect by including, among others, stock exchanges in all members of the European Union.45 The dark side of the truth is that an Ethiopian resident company doing business in the other Contracting State might not get treaty benefit in the context of this paragraph.
However, the minimum requirement under Article 48(4)(b) is that for a company to get treaty benefit it has to be listed on stock exchange of the contracting state that does have a tax treaty with Ethiopia. This implies that it is difficult to look through to the individuals who ultimately own the company as ownership of interest in the company could widely be diversified.
44 The three major markets in the U.S., the NASDAQ National Market, the NEW York Stock Exchange and the
American Stock Exchange set general listing requirement which companies must meet to have their shares being bought and sold in these markets, such as net tangible assets, minimum number of shareholders and market capitalization, <https://smallbusiness.findlaw.com/business-finances/markets-and-listing-requirements.html>. The Uganda Security exchange listing rule of 2003, for instance, sets around 25 requirements; see Requirements for listing on the USE- <https://www.use.or.ug/content/requirements-listing-use>;
45 Article 21A(6) of the 2014 Ethiopian-Netherlands Tax Treaty states that “ for the purpose of the provisions of
paragraph, the term “ recognized stock exchange” means (a) any of the stock exchanges in the member states of the European Union(EU), (b) any of the stock exchanges of the African Securities Exchange Association; (c) any other stock exchange agreed upon by the competent authorities of the Contracting States, provided that the purchase or sale of shares on the stock exchange is not implicitly or explicitly restricted to a limited group of investors.”
14
iii. Carrying on active conduct of business
The second exception to the ownership requirement under Article 48(3), and the third parameter for LOB rule is related to carrying on active conduct of a business. According to Article 48(4)(b) of the FITP, where a resident of the other contracting state is a company, it must satisfy two conditions in order to be eligible for treaty benefits and curb the application of Article 48(3): first it has to carry on in active conduct of business in the other contracting state; second the Ethiopian source income derived by the company should be attributable to such active business. Therefore the income of Ethiopian source must be derived in connection with, or be incidental to the business. Article 48(5) of the FITP defines “active business” in negation stating that “active business does not include the business of holding, or managing shares, securities, or other investments unless the company is a financial institution or insurance company.”
The FITP lays down the main provisions of the income tax, including the specific and general anti avoidance rules, such as LOB, among other, as stipulated in Article 48, with envision that the regulation and directives to be issued there under will elucidate of the details. However, the FITR of 2017 did not illustrate the provisions of Article 48 of the FITP.
The provisions of Article 48 of the FITP are in line with the spirit of the LOB rule of OECD BEPS Action 6 /Article 7 of the MLI on treaty shopping. This implies that Ethiopia, becoming hub of foreign investment and destination of MNEs, cannot ignore the need to entrench relevant international tax rules in its domestic tax law in order to address tax avoidance practices, literally base erosion and profit shifting. “Allowing persons who are not directly entitled to treaty benefits (such as the reduction or elimination of withholding taxes on dividends, interest, or royalties) to obtain these benefits indirectly through treaty shopping would frustrate the bilateral and reciprocal nature of tax treaties.”46 Consequently this article restricts the general scope of Article
1 of tax treaties i.e. “personal scope” or “persons covered” and seeks to deny treaty benefits in the case of structures that could result in granting of treaty benefits indirectly to persons that are not directly entitled to these benefits.47
46 OECD, Action 6 Supranote 24, p 22 47 Id p23
15 Despite the fact that tax treaties can be restrictive to domestic taxing rights, particularly on passive incomes (such as dividend, interest and royalty), they can encourage and facilitate capital inflows from other countries.48 However, in the absence of measures to prevent tax avoidance, tax treaties could be abused in effect resulting in base erosion and profit shifting.49 Accordingly
Article 48 has unequivocally focused on both specific and general anti avoidance rules exceptionally permitting the domestic tax law to prevail over tax treaties in treaty abuse circumstances.
2.1.1.2. LOB rules under the MLI
Article 7(8)-13) of the MLI addresses the substantive provisions of the LOB rules and Article 7(8) set the main principle of the LOB rule.50
Accordingly, except as otherwise provided in paragraphs (9) to (13) of Article 7, a resident shall not be entitled to a treaty benefit that would otherwise be accorded by the CTA unless such resident is a “qualified person” at the time the benefit would be accorded. This paragraph, in essence, restricts the scope of Article 1 of the OECD (and UN) MC.
It may be useful to divide paragraph 8 of Article 7 of the MLI into three subpart: a resident with ‘qualified person’ status who is automatically exonerated from the LOB rule; a resident not a ‘qualified person’ but exceptionally exempt from the LOB rule, and a resident person irrespective of the status of ‘qualified’ or ‘not qualified’ person being provided with a ring fenced access to the CTA ( i.e. in Articles 4(3) dual residency, Article 9(2) corresponding adjustment, and Article 25 for Mutual Agreement Procedure). Accordingly the following sub-subsections will discuss about the first two parts of Article 7(8) i.e. a resident who is a ‘qualified persons’ and a resident who is not a ‘qualified person’ but treated exceptionally in Article 7(10) to 7(12) through:- active conduct business, derivative benefit test and discretionary relief .
48 V. Thuroyni, Tax Law Design and Drafting, (IMF, 1998) Vol 2; cited in Annet Wanyana Oguttu, ‘OECD’s Action
Plan on Base Erosion and Profit Shifting : Part 1 What should be Africa’s response’ Bulletin for International Taxation (November 2015) p659
49 Annet Wanyana Oguttu, ‘OECD’s Action Plan on Base Erosion and Profit Shifting : Part 1 What should be
Africa’s response’ Bulletin for International Taxation (November 2015) p659
16
i. Qualified person
Article 7(9) in subparagraphs (a) to (e) stipulates five categories of a resident who should be considered as a ‘qualified person’ for the purpose of the MLI. These are (a) an individual; (b) a Contracting Jurisdiction or its affiliates51; (c) “a company or other entity if the principal class of its shares is regularly traded on one or more recognized stock exchanges”52; (d) a person, other than an individual, that (i) is a non-profit organization53, or (ii) is an entity or arrangement established in the Contracting Jurisdiction that is treated as a separate person under the taxation laws thereof 54;
and (e) a person other than an individual, if, on at least half the days of a twelve-month period that includes the time when the benefit would otherwise be accorded, persons who are residents of that Contracting Jurisdiction and that are entitled to benefits of the Covered Tax Agreements under subparagraphs (a) to (d) own, directly or indirectly, at least fifty percent of the shares of the person.55
The provisions of Article 7(9)(c) on ‘principal class of shares56 traded one recognized stock exchange’ and Article 7(9)(e) about ‘ownership’ have some similarities with the provisions of Article 48(3) and (4) of the FITP. The main differences are that; under Article 7(9)(c), instead of being listed on stock exchanges, a company or other entity must satisfy that its principal class of shares is regularly traded on one or more recognized stock exchange situated in the Contracting Jurisdiction of which the company or the other entity is a resident. Similar to the LOB provision under the Ethiopian-Netherlands DTA (discussed above under sub-subsection 2.1.1.1.(ii)), however some countries consider that “the fact that shares of a company or other entity in a Contracting Jurisdiction are regularly traded on recognized stock exchanges situated in other jurisdictions constitutes a sufficient safeguard against the use of that company or entity for treaty shopping purposes.”57
51 MLI, Article 7(9)(b), including a political subdivision or local authority thereof, or an agency or instrumentality of
any such Contracting Jurisdiction, political subdivision or local authority. See Appendix D
52 MLI, Article 7(9)(c) 53 MLI, Article 7(9)(d)(i), 54 MLI, Article 7(9)(d)(ii) 55 MLI, Article 7(9)
56 The terms “principal purpose of shares” and “share” per see are defined in Article 7(13)(b) and 7(13)(d); See
Appendix D
57 Action 6, commentary on Article X, paragraph 16; it illustrates that this approach is sound in a state that is part of
17 On the other hand the provision of Article 7(9)(e) of the MLI is partly similar with the parameter set under Article 48(4) of the FITP in terms of the holding for the ownership and the nexus between the business activity in the residence state and the income derived from the source state. However, this paragraph is more wider than the provisions in the FITP due to the following reasons: first the ownership test in Article 48(3) of the FITP is confined with individuals of the residence state whereas the ownership test under Article 7(9)(e) of the MLI covers any person who is entitled for treaty benefits such as individuals, Contracting jurisdiction and their agencies, companies and other entities, pension funds, among others; second Article 7(9)(e) of the MLI has a holding threshold at least for half the days of the person’s taxable period which is not the case in the FITP.
Therefore the provisions of Article 7(9)(c) and (e) of the MLI entails broader scope while applying time threshold in subparagraph(e) hence the FITP provisions are restrictive without a minimum holding time test.
ii. Active Conduct of a Business
Article 7(10)(a) of the MLI provides that a resident of a Contracting Jurisdiction will be entitled to treaty benefits with respect to an item of income derived from the other Contracting Jurisdiction, regardless of whether the resident is a qualified person, if the resident is engaged in the active conduct of a business58 in the first mentioned Contracting Jurisdiction, and the income derived from the other Contracting Jurisdiction emanates from, or is incidental to, that business.
In addition, Article 7(10)(b) of the MLI proposes another alternative, which is referred to as ‘substantiality test’, to the ‘active conduct of a business’ test.
The provisions of both Article 7(10)(a) and 7(10)(b) set forth alternative tests under which a resident of a Contracting Jurisdiction may receive treaty benefits with respect to certain items of
securities trading. This satisfies EU member states obligation on non discrimination between residents, see the European Commission case on Netherland-Japan LOB clause,< http://europa.eu/rapid/press-release_MEMO-15-6006_en.htm>.
58 Article 7(10)(a) of the MLI defines “Active conduct of a business” by negation stating that it shall not include the
following activities or combination thereof “ (i) operating as a holding company; (ii) providing overall supervision or administration of a group of companies; (iii) providing group financing (including cash pooling); or (iv) making or managing investments, unless these activities are carried on by a bank, insurance company or registered securities dealer in the ordinary course of its business as such.”
18 income where such income is connected to an active business conducted in its resident state; or where a resident of a Contracting Jurisdiction actively carries on business activities in the residence state including activities conducted by connected persons, and derives income from the source state in connection with, or incidental to, such business activities. In both alternatives set forth in Article 7(10) the source state bears the responsibility to prove or dispel the correlation between the item of income derived there from and the active conduct of a business in the residence state taking into account the facts and circumstances of the persons and their business activities.59
iii. Equivalent beneficiary or Derivative benefit
Article 7(11) of the MLI sets forth a derivative benefits or equivalent beneficiary test60 that entitles a resident of a Contracting Jurisdiction to treaty benefits that would otherwise be accorded by the CTA if, on at least half of the days of twelve month period that includes the time that the benefit is accorded, persons who are equivalent beneficiaries61 own, directly or
indirectly, at least 75 percent of the beneficial interests of the resident.
This gives alternative way of clearance, for residents of contracting states, from strict LOB rules as well with a safe harbor for the source state. In effect, as compare to the LOB provisions under the FITP, it will not affect capital inflow into the source state rather facilitates therefore with certainty. However, it still needs to prove or disprove whether the taxpayer satisfies the equivalent beneficiary test where a resident of a Contracting state is not a qualified person as per Article 7(9).
iv. Discretionary relief
In a patter different from the objective tests stipulated in paragraphs (9) to (11) of Article 7, Article 7(12) provides that if a resident of a Contracting Jurisdiction is neither a qualified person
59 Article 7(10)(b) last sentence states that “whether a business activity is substantial for the purposes of this
subparagraph shall be determined based on the facts and circumstances”. This clause also should apply to the ‘active conduct of a business test’ where it needs to be determined whether the income derived from the source state forms part of, or is complementary to, i.e. ‘in connection with, or incidental to’, the business activity in the residence state; see Action 6 Final Report, commentary on the detailed version of the LOB in Paragraphs 44-57.
60 Christopher Bergedahl, ‘Anti-Abuse Measures in Tax Treaties following the OECD Multilateral Instrument-Part
1’ (January 2018) 72 Bulletin For International Taxation 1- IBFD; p 26
19 nor entitled to treaty benefits in the preceding provisions of Article 7(8-11), the competent authority of the other Contracting Jurisdiction/source state may, nevertheless, grant treaty benefits or the benefits with respect to a specific item of income, if such resident demonstrates to the satisfaction of such competent authority that neither its establishment, acquisition or maintenance, nor the conduct of its operations, had as one of its principal purposes the obtaining of benefits under the Covered Tax Agreement.62 However, prior to making a decision on such request the competent authority of the source state must first consult with the competent authority of the residence state.63
This alternative is almost similar to the PPT provisions (discussed in the following subsection) as it grants discretionary power to the competent authority to determine whether or not a resident of a Contracting Jurisdiction should be accorded treaty benefits in the light of the object and purpose of the treaty vis-à-vis the principal purpose of the taxpayer’s circumstance.
2.1.2. GAAR and PPT Rule 2.1.2.1. GAAR under FITP
The 2016 FITP has introduced (a general) anti tax avoidance rule (GAAR) under part eight of the proclamation with the heading “Anti Tax Avoidance”. It has three Articles: Article 78 ‘income splitting’, Article 79 ‘transfer pricing’, and Article 80 “tax avoidance schemes” therein. As it has been discussed under subsection 2.1.1.(LOB rule), the priority rule of tax treaty provisions do not apply to the provisions of Articles 78, 79, and 80 of the FITP; in effect Article 48(2) of the FITP permits a treaty override in treaty abuse situations.
Article 78 of the FITP “Income Splitting” provides rules to counter income splitting practices and it applies when a person attempts to split income, by transferring income, the right to income or assets, directly or indirectly, with a related person64; hence it obliges the tax authority to adjust
the income, deductions and the tax credit of both persons so as to prevent any overall reduction
62 MLI, Article 7(12)
63 MLI, Article 7(12)
64According to Article 4 (1) of the FTAP two persons are related persons “when the relationship between the two
persons is such that one person may reasonably be expected to act in accordance with the directions, requests, suggestions, or wishes of the other person, or both persons may reasonably be expected to act in accordance with the directions, requests, suggestions, or wishes of a third person.”
20 in tax payable as a result of the splitting of income.65 It therefore in such a manner addresses the threats of base erosion and profit shifting. In contrast to the PPT rule, this Article does not give discretion to the tax authority, it rather impose an obligation thereon to make an adjustment. However, it obliges the Tax Authority to consider any consideration given for the transfer in determining whether a person is attempting to split income or the transaction is not for that intent.66
Article 79 ‘Transfer pricing’ generally provides for transfer pricing rules, with the effect that pricing in transactions must be based on arm’s length principles.
Article 80 “Tax Avoidance Schemes” provides for a general anti avoidance rule applicable to taxes imposed under the FITP. Initially this rule was adopted by the Value Added Tax Proclamation No. 285/2002 (VATP) in Article 60 with heading “Schemes for obtaining tax benefits”67 and transplanted into the FITP without any substantial change or nuance. According
to this Article when the tax authority is satisfied that (a) a scheme68 has been entered into or carried out; or (b) a person has obtained a tax benefit in connection with the scheme; and (c) having regard to the substance of the scheme, it would be concluded that a person, or one of the persons, who entered into or carried out the scheme did so for the sole or dominant purpose of enabling the person to obtain the tax benefit referred to in (b); the authority may determine the tax liability of the person who obtained the tax benefit and of any other person related to the scheme.69In determining the tax liability of such persons, the authority considers as if the scheme had not been entered into or carried out or in such manner as in the circumstances the authority considers appropriate for the prevention or reduction of the tax benefits.70
Both Articles 78 and 80 apply to all taxable persons and categories of income whether in domestic or tax treaty contexts, as being devised to counter tax avoidance arrangements.
65 FITP, Article 78(1) and (2) 66 FITP, Article 78(3)
67 Article 60 of the VAT Proclamation, See Appendix C
68 Article 80(4)(a) of the FITP defines the term ‘scheme’ which identical to the definition in the VATP; See
Appendix A and C
69 FITP, Article 80(10) and (2) 70 FITP, Article 80(2)
21 Furthermore, the reference to ‘for the sole or dominant purpose’ in Article 80 is similar to the notion of the ‘principal purpose’ that lays the foundation for the PPT rule.
2.1.2.2. PPT rule under the MLI
Article 7(1) of the MLI set forth the PPT rule whereby treaty benefits provided in CTA would be denied if it is reasonably concluded that one of the principal purposes of entering into any arrangement was to obtain a tax treaty benefit. Article 7(1) of the MLI71 encompasses very
crucial terms and phrases which set the foundation of the PPT rule; such as; benefits (resulted directly or indirectly), arrangement or transaction, one of the principal purposes, and the object and purpose of relevant provisions. In the absence of benefits it is not needed to discuss about the PPT rule. There has to also be an arrangement that targets a treaty benefit where the benefit should be one of the principal purposes of such an arrangement. Consequently the result of the arrangement with the aforementioned intent has to be contrary to the object and purpose of a relevant provision of the CTA for the PPT rule to apply.
However, an alternative provision in Article 7(4) grants a broader discretion to the competent authority of a Contracting Jurisdiction to determine that a person who is denied of a benefit or benefits under Article 7(1) to be entitled for such benefit or benefits, upon request in consideration of relevant facts and circumstances.
In Comparison with the GAAR under part eight of the FITP, the scope of the PPT rule of the MLI is broader. Because the PPT rule applies when one of the main purposes of the transaction or arrangement is to obtain a tax benefit; whereas the GAAR could only be triggered where the sole or dominant purpose of such transaction or arrangement, referred to as scheme, is to obtain tax benefits. Therefore in PPT rule the threshold is low for abuse to exist and it would raise issue from practical perspectives.72
71 See Appendix D
22 2.1.3. Interplay between LOB and PPT rules
Being fathomable from the above discussions the striking differences between the LOB and the PPT rules are conspicuous that they represent different norms, and focuses and they are likely to produce different outcomes.73 LOB rules primarily focus on the legal nature, ownership in, and general activity of, resident of a Contracting State; so that the rules do not imply that a transaction or arrangement entered into by such a resident cannot constitute an improper use of a treaty provision.74 According to the BEPS Action 6 report, the PPT provisions must read in the
context of the LOB provisions and the rest of the CTA, including the preamble “which is particularly important for the purpose of determining the object and purpose of the relevant provisions of the CTA.”75The PPT rule, in this context, supplements and does not restrict in any
way the scope or application of the LOB rule in the MLI. It also implies that a benefit that is denied in accordance with the LOB rules is not a benefit under CTA that PPT provision would also deny.76
It is hardly unequivocal about the correlation between the specific anti avoidance rules and the general anti avoidance rules in the FITP. However, Article 80(2) of the FITP under the ‘Tax Avoidance Schemes’ begins with the wording ‘despite anything in this Proclamation…’ which implies restriction, unlike the interlink between LOB rule and PPT rule in the MLI, on specific anti avoidance rules in contrast to supplementation.
2.2. Avoidance of PE Status
The concept of permanent establishment (PE) plays a very crucial role in determining economical nexus between business profits and contribution of countries involved in the profit making process and in allocating taxing rights thereon. Tax treaties generally provide that the business profits of a foreign enterprise are taxable in the source state only when two conditions
73 Yariv Brauner, ‘International Approaches to BEPS: What is BEPS? In Billur Yalti (ed) Base Erosion and Profit
Shifting (BEPS) in Taxation :International Tax Law Conference series 5 (BETA: Istanbul 2018) p 53
74 OECD, Action 6 supra note 24, pp 55-56 75 id p 56
