The Multilateral Instrument – 2 – Structure and Implementation

The Multilateral Instrument – 2 – Structure and Implementation

Structure and Implementation of the MLI

The Organization for Economic Cooperation and Development (‘OECD’) together with the G20, a block of 20 Developed and Developing countries, jointly undertook a project to tackle tax leakages due to Base Erosion and Profit Shifting (‘BEPs’). As discussed in an earlier article, the outcome of the BEPs Project was 15 identified Action Plans to be put into effect by countries in their domestic tax laws and Double Tax Avoidance Agreements (DTAAs).

Action Plan 15 called for a Multilateral Instrument (‘MLI’) that would be used to enable countries to streamline the implementation of the BEPS treaty measures. Following Action Plans required changes to the more than 3,000 bilateral DTAAs in force, and the consent of the nations that are party to these DTAAs:

  • Action Plan 2 – on Hybrid Mismatch
  • Action Plan 6 – on Prevention of treaty Misuse
  • Action Plan 7 – on Avoidance of Permanent Establishment status
  • Action Plan 14 – on Making Dispute Resolution more effective

Changing each of the more than 3,000 DTAAs in force would be time-consuming and subject to renegotiations. The MLI is a convention that seeks to modify all the DTAAs of signatory countries in one go. It acts as a modifying instrument that supersedes the DTAAs to the extent of a conflict of provisions in the DTAA and the MLI. The DTAAs must now be read along with the MLI.

Structure of the MLI

To draft the MLI, the OECD and G20 countries formed a group of experts in 2015. Participation was opened to members and non-members of the OECD/G20 countries for wider participation and implementation. The text of the MLI and its Explanatory Statement were completed in November 2016, and the documents were open for signature from 31 December 2016. A formal signing ceremony was held in June 2017 in which 70 countries signed the instrument on a single day.

The MLI comprises of VII Parts and 39 Articles, as follows:

Part I – Scope and Interpretation of terms

  • Article 1: Scope of the Convention
  • Article 2: Interpretation of terms

Part II – Hybrid Mismatches

  • Article 3: Transparent Entities
  • Article 4: Dual Resident Entities
  • Article 5: Application of Methods for Elimination of Double Taxation

Part III – Treaty Abuse

  • 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 in entities deriving their value principally from Immoveable Property
  • Article 10: Anti-Abuse Rule for Permanent Establishments situated in Third Jurisdictions
  • Article 11: Application of Tax Agreements to restrict a Party’s right to tax its own residents

Part IV – Avoidance of Permanent Establishment Status

  • Article 12: Artificial Avoidance of Permanent Establishment Status through Commissionaire Arrangements and similar strategies
  • Article 13: Artificial avoidance of Permanent Establishment status through Specific Activity Exemptions
  • Article 14: Splitting-up of Contracts
  • Article 15: Definition of a Person Closely related to an Enterprise

Part V – Improving Dispute Resolution

  • Article 16: Mutual Agreement Procedure
  • Article 17: Corresponding Adjustments

Part VI – Arbitration

  • Article 18: Choice to apply Part VI
  • Article 19: Mandatory Binding Arbitration
  • Article 20: Appointment of Arbitrators
  • Article 21: Confidentiality of Arbitration Proceedings
  • Article 22: Resolution of a Case prior to the conclusion of the Arbitration
  • Article 23: Type of Arbitration process
  • Article 24: Agreement on a different Resolution
  • Article 25: Costs of Arbitration Proceedings
  • Article 26: Compatibility

Part VII – Final Provisions

  • Article 27: Signature and Ratification, Acceptance or Approval
  • Article 28: Reservations
  • Article 29: Notifications
  • Article 30: Subsequent modifications of Covered Tax Agreements
  • Article 31: Conference of Parties
  • Article 32: Interpretation and Implementation
  • Article 33: Amendment
  • Article 34: Entry into force
  • Article 35: Entry into Effect
  • Article 36: Entry into Effect of Part VI
  • Article 37: Withdrawal
  • Article 38: Relation with Protocols
  • Article 39: Depositary

Implementing the MLI

In order to implement the MLI in a particular jurisdiction, it must be signed, ratified, deposited with the Depository, and thereafter it enters into force. The MLI has specific provisions (Article 35) to determine when the MLI enters into effect with respect to “Covered Treaties”. Ratification is the process where the government of a country gets the approval of its legislative body to the terms of the treaty. The government thereby gives its consent to be bound by the treaty.

Jurisdictions then submit to the Depositary, their ratified instrument together with notifications and reservations on their positions on each Article of the treaty. The Depository in this case is the Secretary General of the Organization for Economic Co-operation and Development (OECD). Each party to the Convention can choose to apply the Convention to only some of the DTAAs, or make modifications to the Conventions in respect of all or only a few DTAAs. Article 29 of the Convention lists the matters on which notifications are required. These are the notifications that must be submitted at the time of signature of the Convention or at the time of deposit of the ratified instrument. Reservations are the positions on an Article(s) that the party chooses to interpret differently and reserves the right to make a change at a later date. Article 28 of the Convention lists the matters in which a reservation may be made; no other reservations are permitted under this convention. Depositing the ratified instrument with the Depository amounts to making an international announcement that the Jurisdictions is bound by the Convention according to its notifications and reservations.

The MLI then enters into force “on the first day of the month following the expiration of 3 calendar months from the date of deposit of the instrument” to the Depository.

A list of countries that have agreed to be bound by the MLI, together with the date of signing the Convention, date of deposit of the ratified instrument, and the date of entry into force can be found at OCED

To date, the United States of America has not signed the MLI. The main reason is that US has a treaty policy that is consistent with the BEPS MLI. This includes existing provisions on saving clauses, taxation of transparent entities and limitation of benefits clauses. There are also concerns regarding the arbitration provisions in the MLI. While the US principally agrees with these arbitration provisions, it finds them lacking in the MLI. The position of the USA is primarily disclosed in its Model US treaty, the most recent version of which was updated in 2017. Nevertheless, it is possible that the USA will sign and later ratify the document in the near future.

Entry into Effect

After the MLI enters into force for a jurisdiction, each of the DTAAs must enter into Effect for that Jurisdiction with the modifications as set out in the MLI. Article 35 of the Conventions determines the Entry into effect while Article 36 sets out the Entry into Effect for Part VI, namely Arbitration. According to the Convention, Entry into Effect has a different date for tax withheld at source and for other taxes. For tax withheld at source under a bilateral DTAA, the Entry into Effect is the first day of the calendar year following the latter date of entry into force of the MLI for the either of the parties to the DTAA. In other words, if the MLI for country A enters into force on 1 September 2020 while for country B it is 2 February 2021, the provisions of the MLI will enter into effect on 1 January 2022.

Parties may choose to substitute the “taxable period” for “Calendar year” and must inform the Depository of this change. In this case if the MLI for country enters into force on 1 September 2020 and country A opts for a taxable period, say the financial year starting 1 April every year, then the Entry into Effect occurs from 1 April 2021 in the context of India. This tends to create a mismatch since in the above example, in Country A the provisions of the MLI enter into effect on 1 April 2021 while for country B, the date would be 1 January 2022. Nevertheless, this mismatch is relevant only in the initial years of enforcing the MLI.

For all other taxes, the MLI will have effect for all taxable periods starting on or after six calendar months from the latest of the dates of Entry into force. In the above example, this would be tax periods after 2 August 2021.

Summing Up

With a large number of countries that have signed the MLI but not yet ratified it nor deposited it with the Depository, the applicability of the MLI provisions would continue to create confusion. Further, it is now necessary to read and interpret the provisions of a DTAA along with the notifications and reservations of each party to the DTAA as submitted to the Depository. This too could complicate the interpretation of the DTAA.