China: Analysis Of Opt-In Provisions In The MLI With Reference To Article 7 (The Prevention Of Treaty Abuse Article)

Opt-in Provisions of Article 7 in the MLI

There are three classes of options in the MLI: opt-out provisions (reservations), opt-in provisions and alternative provisions. This paper examines i) the design of the options with respect to Article 7 (titled "Prevention of Treaty Abuse"), and ii) how contracting jurisdictions apply the opt-in provisions in Article 7 to the CTAs, subject to the reservations made under different circumstances.

Opt-in provisions supplement the application of a primary operative clause. One example is Article 7(4) that provides for the granting of a discretionary tax benefit by the tax authority. Article 7(3) provides that a Party that has not made the reservation for Article 7(1), - that is, the party has not opted out of the principal purpose test (PPT) - may choose to apply paragraph 4 of Article 7 to supplement its application of paragraph 1 to its CTAs. To meet the minimum standard requirement, a party to the MLI can adopt the PPT in article 7(1) alone if it does not opt-in for article 7(4). If a party opts in for article 7(4), Article 7(1), as modified by article 7(4), shall apply in circumstances that a person that has failed the PPT would still be granted the tax benefits on a specific item of income or capital provided that the competent authority of the contracting jurisdiction to which a request has been made by a resident of the other contracting jurisdiction shall consult with the competent authority of that other contracting jurisdiction before rejecting the request. Article 7(1) and Article 7(4) provide, as below:

1. Notwithstanding any provisions of a Covered Tax Agreement, a benefit under the Covered Tax Agreement 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 granting that benefit in these circumstances would be in accordance with the object and purpose of the relevant provisions of the Covered Tax Agreement.

4. Where a benefit under a Covered Tax Agreement is denied to a person under provisions of the Covered Tax Agreement (as it may be modified by this Convention) that deny all or part of the benefits that would otherwise be provided under the Covered Tax Agreement 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 competent authority of the Contracting Jurisdiction that would otherwise have granted this benefit shall nevertheless treat that person as being entitled to this benefit, or to different benefits with respect to a specific item of income or capital, if such competent authority, upon request from that person and after consideration of the relevant facts and circumstances, determines that such benefits would have been granted to that person in the absence of the transaction or arrangement.

The second and third examples of opt-in provisions are Article 7(6) and Article 7(7). Where a contracting jurisdiction chooses to adopt the simplified limitation of benefit provision in addition to the PPT article, it may opt-in for articles 7(6) or 7(7), whose texts are given below:

"6. A Party may also choose to apply the provisions contained in paragraphs 8 through 13 (hereinafter referred to as the "Simplified Limitation on Benefits Provision") to its Covered Tax Agreements by making the notification described in subparagraph c) of paragraph 17 (Article 7(17)(c)). The Simplified Limitation on Benefits Provision shall apply with respect to a Covered Tax Agreement only where all Contracting Jurisdictions have chosen to apply it." [Emphasis added.]

"7. In cases where some but not all of the Contracting Jurisdictions to a Covered Tax Agreement choose to apply the Simplified Limitation on Benefits Provision pursuant to paragraph 6, then, notwithstanding the provisions of that paragraph, the Simplified Limitation on Benefits Provision shall apply with respect to the granting of benefits under the Covered Tax Agreement:

Object and Purposes of Article 7

As paragraphs 88 and 89 of the Explanatory Statement to the MLI explain, 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 principal purpose test (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 one or more categorized tests listed in paragraphs 9 to 13 of Article 7. The Action 6 Report states that countries, at a minimum, should implement:

• a PPT only;
• a PPT and either a simplified or detailed LOB provision; or
• a detailed LOB provision, supplemented by a mechanism either that would deal with conduit arrangements not already dealt with in tax treaties or a PPT.

The Explanatory Statement further provides that, as the default option, the PPT in Article 7(1) is the only approach that can satisfy the minimum standard on its own. Parties are then permitted pursuant to Article 7(6) to supplement the PPT by choosing to apply a simplified LOB provision (the SLOB). The MLI does not provide the detailed LOB, but the contracting jurisdictions that adopt the detailed LOB should endeavor to reach a mutually satisfactory solution that meets the minimum standard.

Notifications

Notifications are required if a contracting jurisdiction makes a reservation for an article, or a provision of an article, of the MLI not to apply to the relevant provision of the CTA, or that the CTA already has a provision that addresses the same issue as the provision of the MLI. That is, the existing provision is a provision compatible to the corresponding MLI provision.

Notifications are also required to give legal effect to the opt-in provision that a contracting jurisdiction has chosen. Table A below shows the notifications, as denoted by the letter "Y", given in respect of Article 7 under Article 7(17) by some selected contracting jurisdictions as required under Article 29 – Notifications, as of 9 April 2019, using information from the MLI database's matrix of options and reservations, which is provided by the contracting jurisdictions to the OECD Depositary.

Table A: Notification given for opt-in provisions under Article 7(17)(b),(c), and (d)

P = provisional list pending deposit of Instrument of Ratification; SLOB = simplified limitation of benefit

Note that if Article 7(4) is chosen, it will modify Article 7(1). Article 7(17)(b) of the MLI provides that each Party that chooses to apply paragraph 4, which modifies paragraph 1, shall notify the Depositary of its choice. Paragraph 4 shall apply to a Covered Tax Agreement only where all Contracting Jurisdictions have made such a notification. [emphasis added.] If notification is not given by all the parties, the choice shall not apply with respect to the CTAs. Articles 7(17)(c) and (d) also impose such a condition that provides that only where all contracting jurisdictions have given notifications, the provision of the MLI shall apply to the CTAs. The term "all contracting jurisdictions" covers both parties of a bilateral tax treaty and multiple parties of a multilateral tax treaty respectively.

An example of a multilateral tax treaty is the Convention between the Nordic Countries for the Avoidance of Double Taxation with respect to Taxes on Income and Capital (23 Sept 1996), as concluded by six signatory states: Denmark, the Faroe Islands, Finland, Iceland, Norway, and Sweden. Denmark and Norway, which are two of the contracting jurisdictions listed in Table A, have made a matched notification, but the opt-in provision under Article 7(4) shall not apply as it does not satisfy the approval requirement of "all contracting jurisdictions" in Article 7(17)(b) with respect to the Nordic Multilateral Double Taxation Convention.

Table B - Notifications by some of the selected parties choosing Article 7(4) in Table A

It is observed that except for India, 4 other contracting parties have chosen to opt-in for Article 7(4). Therefore, Article 7(4) shall apply to the New Zealand-Singapore CTA, the New Zealand-UK CTA, and the Singapore-UK CTA because each of the bilateral (or paired) CTAs contains a matched notification with respect to the application of Article 7(4). With regard to the CTAs concluded by Mauritius provisionally, they have no legal force until after Mauritius has deposited the Instrument of Ratification to the OECD Depositary, pursuant to Article 34(2).

Notification under Article 7(4) of the MLI

The information in Table A shows that Ireland, New Zealand, Singapore, and the United Kingdom have adopted the option in Article 7(4) that supplements the PPT option in Article 7(1). Japan and Slovak, both of which have confirmed their MLI position definitively, have not chosen to adopt the supplementary option in Article 7(4).

From the U. K. perspective, Article 7(4) shall apply to the CTAs with Ireland, New Zealand and Singapore because the 4 jurisdictions have chosen to apply Article 7(4) and the notifications have been matched with respect to the preceding bilateral tax treaties. However, Article 7(4) shall not apply to the CTAs with Japan and the CTA with Slovak Republic because both Japan and Slovak Republic have not chosen or opt-in to apply Article 7(4) to their respective CTAs. This is shown in the following table: -

Table C – Selected Parties that adopt Article 7(4) to supplement Article 7(1)

Notification under Articles 7(6)

Article 7(17)(c) of the MLI provides that each Party that chooses to apply the Simplified Limitation on Benefits Provision, pursuant to paragraph 6, shall notify the Depositary of its choice. Both India and Slovak Republic have opted in for the SLOB under Article 7(6). However, Article 7(6) shall not apply with respect to the India-Slovak CTA as India has not confirmed its position and given notice to the Depositary with respect to Article 7(6).

Notification under Article 7(7)

Due to tax policy preferences, some of the contracting jurisdictions may not adopt the simplified limitation of benefit (SLOB) provision because choosing the PPT alone is sufficient to meet the minimum standard. The asymmetry in choice of options, if Article 7(6) is chosen, will be at odds with the principle of reciprocity and thus result in the entire Article 7 not being applied to the CTAs for those contracting jurisdictions.

Article 7(7) addresses the situations that provided that only some of the parties adopt the simplified limitation of benefit (SLOB) provision in Article 7(6), all the parties not adopting the SLOB, with respect to the granting of benefits under the CTA, may agree to adopt Article 7(7)(a), under which the SLOB shall apply to all parties symmetrically, or Article 7(7)(b) under which the SLOB shall apply asymmetrically to the parties that have chosen the SLOB only.

In the absence of any agreement reached pursuant to Article 7(7)(a) or 7(7)(b), a Party that chooses to adopt the SLOB only can opt out of the entire Article 7. In that case, the parties shall endeavor to reach a mutually satisfactory solution which meets the minimum standard as mentioned above, pursuant to Article 7(16).

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.