This is unless the taxpayer can show that granting that benefit in the circumstances “would be in accordance with the object and purpose” of the relevant provisions of the treaty.
The key issue here is that the PPT introduces an additional element of subjectivity.
Further, a provision such as the PPT is likely to be interpreted differently by different tax authorities, increasing uncertainty in the use of, and consequently financial institutions’ ability to rely on, tax treaties.
The OECD has published guidance as to its interpretation of the PPT in an investment fund context by means of certain examples, but the specificity of the examples means it is difficult to extract many principles on which to place more general reliance and so the guidance, at least in its current form, is of limited value.
- Fund managers’ use of tax treaties when dealing with dividends is coming under greater scrutiny
- Institutions are making greater use of tax treaties, just as Brexit is reining in their usage
- A principal purpose test which examines the use of tax treaties will be interpreted differently by different tax authorities
What can nevertheless be taken from the examples is that they display a number of non-tax attributes, evidencing robust commercial motivation for locating the fund in the jurisdiction concerned, not merely that jurisdiction’s network of tax treaties.
These include a link between the fund’s location and that of the underlying investments, and the availability of directors familiar with local requirements.
The existence of a favourable tax treaty network is considered an acceptable factor, provided, however, it is not the only one.
Limitation on benefits provision
By way of alternative approach to the PPT, the OECD has proposed a so-called “limitation on benefits” provision (these are commonly present in treaties to which the US is party).
This limits the benefits of a treaty to persons the shares of which are held by, or the investors in which are, “qualifying” persons, for example entities owned at least 50 per cent by persons themselves entitled to treaty benefits: so a fund may wish to separate investors with differing tax attributes into different fund vehicles, such that an SPV below at least one such fund vehicle (containing qualifying investors) continues to access treaty benefits.
It is, consequently, becoming common for funds to amend the ‘alternative investment vehicle’ language in their fund documentation to ensure that this permits reorganisations of the fund structure to respond toBEPS-related developments, including grouping investors having ‘good’ tax attributes separately from those which do not.
What are the consequences?
A consequence of these developments, particularly where the PPT approach is adopted, is an increased risk of challenge by the tax authorities of the jurisdiction in which the investment is located, if they consider that the tax relief sought is a “main purpose” of having established the SPV in its jurisdiction of residence.
The take away for funds and asset managers is that a greater amount of forethought now needs to be given to the non-tax related reasoning behind the choice of location of the SPV, as opposed merely to its appeal from a treaty perspective.