On July 1, 2018, the MLI (Multilateral Instrument to Modify Bilateral Tax Treaties), which is a revolutionary tool to fight tax avoidance at the international level, entered into force. MLI allows the implementation of international tax law measures, developed by OECD, to the currently binding treaties for the avoidance of double taxation (DTT) without the necessity to conduct additional negotiations between the states. The MLI convention shall impact the tax consequences starting from 2019.
The regulations elaborated by OECD, which are undoubtedly the result of international tax scandals (Luxemburg Leaks or Panama Papers), aim to prevent the practice of tax base erosion and profit shifting to the more appealing tax jurisdictions. The MLI convention is another tool implementing the BEPS project and it’s a new solution introduced in order to seal the tax systems of countries.
Covering DTT with the provisions of the MLI convention requires notification by both states being parties to a given DTT. On the other hand, non-notified or unilaterally notified agreements will not be covered by the convention and will apply in their current wording.
Poland has currently declared its willingness to apply the scope of the convention to 78 DTTs, however not including the DTT with Germany. MLI's provisions will not apply to a treaty with the United States which have not signed the convention yet.
However, the discussed tax revolution will be carried out gradually. Transitional deadlines will apply in the subsequent months. All countries which have signed the Convention are obliged to introduce only the so-called minimum standard, which in particular includes the anti-avoidance clause.
Article 7 of MLI provides for a mechanism to prevent the abuse of DTT in the form of anti-tax avoidance clause – Principal Purpose Test (PPT). According to the clause, if one of the main purposes or the main purpose of concluding an arrangement (including an agreement or creating a structure) or carrying out a transaction is to obtain a tax benefit in relation to income or capital, such a benefit cannot be granted.
It should be noted that using the phrase "one of the main purposes" in the Convention may lead to the application of the PPT clause even in cases where a given activity or transaction seems to be economically justified (e.g. availability of labour force in another country or other market conditions). In addition, in contrast to the Polish regulations, for the application of the PPT clause, the method of operation does not have to be considered artificial.
In view of the fact that the PPT clause was covered by the so-called minimum standard, its incorporation is obligatory for the MLI signatories, whereas states may adopt the PPT clause in accordance with its basic wording specified in the convention or implement it along with the limitations of granting contractual benefits (LOB). The adoption of LOB may be both simplified and detailed. Poland chose to use the PPT clause explicitly, at the same time reserving the possibility of using detailed LOBs in individual double taxation treaties. In this case, it will be necessary to conclude an arrangement with the other state being a party of the DTT.
The structure of the PPT clause is similar to the general anti-avoidance clause existing in the Polish legal order, but it will only cover DTTs submitted by Poland for coverage within the MLI scope. Importantly, the scope of the clause will be limited to cross-border structures or transactions that use DTTs to obtain specific tax benefits. However, the clause will not apply to structures using regulations other than the provisions of the DTTs. Polish taxpayers must, however, bear in mind that in such a case the general anti-avoidance clause provided for by the Tax Ordinance may apply.
The provisions of MLI in the scope of PPT may replace the clauses existing so far on the basis of particular DTTs. Their replacement by PPT will be possible only if the signatories of a given DTT make an appropriate notification. In the absence of it, PPT will be applied in the same way as the existing clauses and will take precedence in case of non-compliance of a given DTT with MLI. Additionally, in the case of DTTs, in which no similar clause has been included, it will be incorporated entirely.
Considering the current state of progress in the work on the ratification of MLI by individual states and a small amount of states that have made notification so far, it can be concluded that the majority of clauses existing on the ground of particular DTTs will not be replaced by MLI. Currently, PPT may in the future replace the clauses existing inter alia under the DTTs concluded between Poland and Canada, Malta, Singapore and the United Kingdom.
Considering the fact that not many states ratified the MLI so far, further observation of the ratification process is necessary - including reservations submitted by states, in order to determine the impact of MLI on the application of particular DTTs. It is also unknown whether the PPT clause introduced by MLI is only to deter and discourage to conclude the favourable tax agreements and transactions or rather will become a powerful tool, which is meticulously used by the tax authorities of a given state. In the context of an increasing number of tools sealing the taxation system both at the domestic and international level (including MLI), we would recommend verification of the existing international structures in the context of identifying possible risks as well as analysis of possible remedies.
Renata Kupczyńska, Assistant Manager in the Tax Advisory Department, the office in Gdansk
Marcin Wawrzynowicz, Consultant in the Tax Advisory Department, the office in Gdansk
Fabian Bujak, Expert in the Tax Advisory Department, the office in Gdansk