On February 6, 2020, the Parliament of Kazakhstan ratified the Multilateral Convention to Implement Tax Treaty-Related Measures to Prevent Base Erosion and Profit Shifting (“MLI”). Provided that the President of Kazakhstan signs the law on ratification in 2020, it is expected that the MLI’s provisions on withholding taxation will become effective from January 1, 2021.
MLI was developed by the OECD’s tax committee and is intended to modify the existing International Double Tax Treaties in order to tackle the aggressive tax avoidance strategies in international business.
The extreme globalization of the economy and the global financial crisis put the issue of aggressive tax avoidance to one of the main agendas of the business community. The loopholes in the international tax rules resulted in a shift of nearly 660 billion USD in 2012, which is equivalent 0,9 of world GDP. Because of abuse of inconsistencies in the international tax legislation, in October 2015 the final recommendations on fifteen Base Erosion and Profit Shifting (“BEPS”) were released by OECD. Even though Kazakhstan is not a member of OECD, Kazakhstan aims to reach the taxation standards of OECD in order to be recognized as a country with a favorable investment climate.
Currently, Kazakhstan has already adopted recommendations of OECD on BEPS Action 3 by including a new provision to the Tax Code on Controlled Foreign Company Rules. In addition, the recommendations on Action 13 about the transfer pricing documentation and country-by-country reporting was also incorporated to the Kazakh law on transfer pricing.
By ratifying MLI Kazakhstan is also going to adopt another two actions on BEPS: Action 6: Preventing the Granting of Treaty Benefits in Inappropriate Circumstances and Action 7: Preventing the artificial avoidance of permanent establishment status.
- Article 7 – Prevention of
Treaty Abuse, which includes:
- Limitation of Benefi ts (LOB);
- Principle Purpose Test (PPT).
- Article 8 – Dividend Transfer Transactions
- Article 12 – Artifi cial Avoidance of Permanent Establishment Status through Commissionaire Arrangements and Similar Strategies.
Meanwhile, according to MLI, the given amendments to the Double Tax Treaty must be applied only if both jurisdictions are agreed to implement these amendments to the existing Double Tax Treaties and only after notifying OECD as a depositary of such amendments.
Therefore, under each article of the law on ratifi cation, Kazakhstan directly indicates the list of Double Tax Treaties and the MLI provisions that must be applied to these treaties.
The following is a brief review of the most essential MLI provisions that will be adopted by Kazakhstan with a possible impact on the country's taxation of international business.
I. Prevention of Treaty Abuse
According to MLI, application of benefi ts under the Double Tax Treaty must be determined by analysis under either LOB or PPT, or by their combination. In order to apply LOB and PPT to the existing Double Tax Treaties, both jurisdictions must have an agreement to apply them.
Simple Limitation of Benefi ts
According to the current law on ratifi cation, all the existing Double Tax Treaties must be applied considering the provisions of Simple Limitation of Benefi ts (SLOB). However, application of SLOB by Kazakhstan does not mean that SLOB will automatically be applied to all the Double Tax Treaties concluded by Kazakhstan. This is determined by each jurisdiction that has agreed to apply SLOB to the Double Tax Treaty with Kazakhstan.
If both Kazakhstan and other corresponding jurisdictions agree to apply SLOB and have notifi ed the OECD, taxation of the residents of these states will be governed by the MLI provisions on SLOB.
Under SLOB, Double Tax Treaty benefi ts are provided only for "qualifi ed persons", who are defi ned as:
- State authorities;
- Companies whose shares are traded on a recognized stock exchange;
- Non-commercial organizations with status regulated on the international level;
- Pension funds.
Meanwhile, even if the taxpayer is not a qualified person, it is still possible to apply Double Tax Treaty benefits if the taxpayer can prove a main involvement in "active business activity". Active business activity is defined as activity not including activities of holding companies, administration of group of companies, group financing, or making and managing investments.
For instance, an LLP registered in Russia (RuCo) performs engineering services for a Kazakh LLP (KzCo). KzCo pays RuCo fees for services. RuCo does not have a permanent establishment in Kazakhstan. The services are performed in Russia.
According to Kazakhstan's Tax Code, the income from the engineering services is recognized as income derived from Kazakh sources even if performed outside of Kazakhstan. However, under Article 7 of the Double Tax Treaty between Kazakhstan and Russia, RuCo's income must be exempted from taxation in Kazakhstan. After enforcement of MLI, it will be necessary to analyze international taxation taking into account MLI, aside from the Double Tax Treaty and the Tax Code.
Both Russia and Kazakhstan have notified OECD that the Double Tax Treaty between Russia and Kazakhstan must be applied, taking into account the SLOB provisions of MLI. Taxation of RuCo's income must therefore be determined on the basis of SLOB.
Under SLOB, however, RuCo is obviously not a qualified person since it is not an individual, state authority or noncommercial organization. But SLOB still allows RuCo to apply the Double Tax Treaty exemption, provided that RuCo can prove its main activity involves "active business activity". This means RuCo must prove it is not involved in a holding company, managing a group of companies, group financing or investment activity.
It is not clear how the Kazakh tax authorities will determine foreign companies' main activity. Therefore, the country's tax authorities should improve their cooperation with foreign tax authorities to avoid incorrectly implementing MLI. The tax authorities should also study the BEPS Final Report on Action 6 to understand the purpose of adopting SLOB and to formulate a clear approach on applying MLI in Kazakhstan.
Principle Purpose Test (PPT)
Under PPT, the Double Tax Treaty exemptions cannot be applied if it is reasonable to conclude that one of the principal purposes of the transaction is to obtain Double Tax Treaty benefits. In other words, if the parties entered into a transaction with the main intention being to exempt the income from taxation or to apply a reduced tax rate under the Treaty, the exemption will be disallowed.
The Final BEPS Report on Action 6 envisages that PPT is a subjective test that must be applied on a case-by-case basis by analyzing each transaction. Therefore, in deciding the tax treatment of a given transaction, the tax authorities must pay close attention to the substance of the transaction and its economic purpose. If the transaction's purpose is not a bonafide exchange of goods and services, but to obtain Double Tax Treaty benefits, the benefits can be denied.
In the Final BEPS Report on Action 6, OECD provides 10 examples of applying PPT. However, the examples describe straightforward and simple transactions, in which it is easy to spot the PPT violations. Moreover, some of these examples are already governed by the Kazakh tax legislation.
One of the examples describes a case in which RCo, a tax resident of state R, wins a tender for construction of a powerplant in state S. Construction work is intended to take about 22 months, so RCo splits the project into two contracts for 11 months each. One contract is for RCo itself, and the other is for SUBCo, a new RCo subsidiary.
The OECD holds that the second contract is solely for the purpose of obtaining exemptions under Article 5 of the Double Tax Treaty, which envisages a term of 12 months for creation of a permanent establishment. The transaction does not pass the PPT test and the Double Tax Treaty benefit for a 12-month period required to create a permanent establishment cannot apply to RCo.
It is worth noting that Kazakhstan's Tax Code already prevents splitting contracts between related parties to avoid permanent establishment. The tax authorities are therefore generally able to tackle permanent establishment strategies without MLI involvement.
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