A presentation was made on behalf of the BEPS Monitoring Group by Professor Kerrie Sadiq, to the first meeting of the Enlarged Framework of the OECD Committee on Fiscal Affairs, in Kyoto (Japan) on 29 June 2016. The outline of this presentation is here.
The BMG has now made a submission to the consultation on Non-CIV Funds, under BEPS Action 6 on preventing the granting of treaty benefits in inappropriate circumstances. Although presented in technical terms the proposals raise wider policy issues, since they could result in granting tax treaty benefits to hedge funds and private equity funds even if formed in tax havens.
This consultation document concerns proposals put forward by interested parties and not the Committee on Fiscal Affairs, which is now asking for comments. We regret that the document did not explain the policy issues, to facilitate a wider public engagement. This is especially important since the proposals concern the BEPS Action 6 measures to prevent treaty abuse, which are a core commitment for the expanding group of countries participating in the BEPS process, and may become a global standard through tax treaties.
Non-CIVs typically include private equity funds, hedge funds, trusts or other investment vehicles that generally do not have the key characteristics of CIVs. In particular, they are usually both unregulated and narrowly held, since they are aimed at sophisticated investors. Governments are therefore right to be concerned that these non-CIVs could be used to allow access to treaty benefits, in particular reduced withholding taxes at source, for investors who would not otherwise be entitled to such benefits, and who may be able to evade being taxed on such income.
We believe that any rules created to deal with these non-CIVs should require a positive demonstration by any non-CIV desiring treaty benefits that it can verify the bona fides of all its investors. To ensure taxation of income flowing through a fund which itself is exempt from tax, measures should be in place to ensure that its investors comply with their obligations to pay tax on payments to them from the fund. Hence, we consider that, to be eligible for treaty benefits, investment funds must be subject to
- Regulation which includes know-your-customer requirements, and
- Obligations to participate in comprehensive, automatic exchange of information for tax purposes.
Where, a fund is not itself able to verify the identity of all its customers because it receives investments from other funds, it must verify that its investors are subject to the same obligations. This would provide an incentive to ensure that jurisdictions hosting financial centres comply with the appropriate global standards, not only for financial regulation, but more importantly in this context for preventing tax evasion.
In addition, it is critical that high threshold tests be set to ensure that eligible funds are in fact widely held and are genuinely channels for portfolio investment. In particular:
- No one investor or group of related investors should own above 1% of the fund,
- The fund should have a maximum of 10% of its assets in any one investment,
- It should not own more than 5% of any such investment, and
- A minimum of 95% of funds investing in such a fund should be entitled to the same or similar treaty benefits.
A key test of whether the BEPS project can be a success is whether it will result in the inclusion of effective anti-abuse provisions in all tax treaties, not only prospectively, by formulating suitable provisions in the model treaty, but also more directly and quickly, by inclusion of such provisions in the proposed Multilateral Convention (MC), which aims to amend existing treaties.
The RDD proposes a ‘simplified’ limitation of benefits (LoB) provision, and as a minimum standard either (i) a combination of a principal purpose test (PPT) and an LoB provision, or (ii) a PPT provision alone, or (iii) an LoB rule plus some mechanism for dealing with conduit arrangements which are not already covered by other treaty provisions. However, the LoB provision is stated as only a bare outline with a direction to include whatever wording each pair of negotiating states can agree, while the full detailed wording of an LoB article is only in the Commentary, for use by states which prefer not to include a PPT provision.
This approach has exacerbated the concerns we expressed on the previous draft, that it would make it harder for small developing countries to conclude suitable treaties, and result in a kaleidoscope of different provisions, very likely leaving a continued scope for treaty shopping and increasing complexity for tax authorities as well as tax payers.
Furthermore, the RDD does not discuss how such provisions might be included in the MC, and the proposed ‘flexible’ format would make such inclusion difficult if not impossible.
Our comments also include a number of specific technical suggestions.
Summary of the BMG Comments
Effective implementation is crucial especially to put pressure on key states with extensive treaty networks used for channeling investments (e.g. the Netherlands, Switzerland, United Arab Emirates, Qatar and Mauritius) to accept inclusion of anti-abuse provisions in their treaties. A political commitment should be sought through the G20 to issue a Declaration Against Harmful Tax Practices, which should include ending treaties which facilitate abuse.
Developing countries’ preferences should have priority, and technical assistance should be fully built into the BEPS project.
Limiting complexity should be a guiding principle.
Exchange of information is also key to effective implementation.
Discretionary relief must be limited to exceptional cases, and especially rare under the principal purpose test. Decisions should be published (redacted if necessary), like other tax rulings.