Theory of Probabilities of the MLI Convention
Author: Olexandr Bondarchuk, Managing Partner of LA “Absolute”
On July 23, 2018 Ukraine signed the multilateral MLI convention, which is one of the tools for the implementation of the BEPS plan, i.e. programs to counteract the erosion of the tax/tax base and the withdrawal of income/profits from taxation. The ideological leader of this process was the Organization for Economic Cooperation and Development (OECD), in cooperation with the G20 countries.
Sources of tax relations
The official start of the regulation of interstate tax relations is widely considered to be the distant year 1843, when a document was signed on mutual administrative assistance and the exchange of tax information between France and Belgium.
So, in the 1920s, international cooperation on eliminating double taxation and combating evasion was intensified. In 1920, Brussels hosted the first international forum devoted to these issues.
Nevertheless, states and international organizations continued to struggle, and enterprising deviators – in every possible way shirk.
The struggle of the PEEN
In 1954, the Organization for European Economic Cooperation (OEEC) became the central international body on tax issues. Since 1958, the PEEN has been engaged in the development and standardization of agreements on the avoidance of double taxation (SOIDS) for the member countries of this organization.
In 1961, the Organization for European Economic Cooperation of the PEEN was renamed the Organization for Economic Cooperation and Development (OECD), which developed and implements the BEPS plan.
As we see, during the 64 years of the struggle, the final victory of the OECD, for the joy of thrifty entrepreneurs, never took place. While the OECD was struggling, enterprising lawyers, accountants and consultants found loopholes in a variety of agreements to avoid double taxation, built quaint corporate structures, and without shame took advantage of the benefits spelled out in the agreements, minimizing the tax burden.
According to the most conservative estimates of the OECD, diluting the base of taxable profits and deriving profits from taxation, including through benefits from the use of SOIDS, companies annually manage to save from 100 to 200 billion dollars!
Based on today’s data, there are about 3000 interstate tax treaties in the world, which complicates the BEPS action plan. each individual SOI is being worked out, coordinated internally at the interstate level with the signatory country, signed, ratified.
In practice, from the beginning of the development of changes to the ratification of one interstate SOAP, many months, or even years, can take place.
In order to exclude red tape and speed up the process, the OECD, together with the G20, developed a multilateral MLI convention, which, in its essence, is designed to simplify the process of making changes to SOIDS by signing only one document.
It would seem that everything is perfect – the member countries signed the convention, the changes took effect, tax holes were eliminated, companies pay taxes in full.
However, not all so simple. The convention automatically introduces only a minimal package of changes aimed at preventing misuse of the provisions of the SOIP and improving the procedures for resolving the disputes of the BEPS plan, by which Ukraine has not limited itself.
One of the most vexing changes requested by the Ukraine, it is the use of the test core activities Principal Purpose Test, which is discussed below.
In order for the amendments to take effect, the member states must mutually declare their desire to amend the existing SOI between them through a multilateral convention.
Thus, Ukraine has included in the Convention a list of 77 countries with which it wants to make changes to the SOIDS. Accordingly, in order for this action to cover 77 interstate SOIDS, 77 countries from the list of the Ukrainian version of the convention should also make Ukraine their version of the MLI multilateral convention.
The country-signatory of the convention independently chooses a variant of the provision from several proposed variants of the provisions that it wishes to change in the SOI with another country participant. And, even if a couple of countries have coincided, but each of them has chosen different versions of the provisions that they would like to change in their SOIDS, the changes will not take effect.
Based on the results of all these probabilities, the changes will take effect only after they have been ratified by both sides, the participating countries.
The effect of the MLI convention
There was so much hype around the signing of the MLI convention, and the output was completely unpredictable.
The effectiveness of the MLI convention and the recommendations of the OECD are far from ideal. Sometimes it seems that the shortcomings only stimulate the business to look for new gaps in SOIDS, or to continue using existing, not eliminated, for the purpose of further saving on taxes.
It is noteworthy that such pleasant and popular countries actively used to build corporate structures with preferential taxation conditions, like Malta, the Netherlands and Switzerland for some reason did not express a desire to make changes in the SOIDS with Ukraine. Consequently, the old version of the interstate SOI remains in force.
It turns out that a part of the business, which will continue to work as before, has been eliminated at random. The amendments made by the convention will not affect. More precisely, until they touch. The consequences of signing the MLI convention cannot be called critical, but it is possible that the remaining gaps will be eliminated by some other, more stringent method and in the shortest possible time.
We live in an era of dynamic change. Therefore, in order to continue to use legitimate ways to minimize tax deductions, businesses need to also dynamically restructure their work.
First of all, it is worth analyzing the structure of the business, and how the provisions of the MLI convention are reflected or reflected in its future functioning (this applies even to entities registered in countries for which the provisions of the convention have not spread).
Unfortunately, no one will offer a reliable mechanism for the long term. In some cases, you can play in advance – you can use jurisdictions in the new structuring, which changes have already touched, but the benefits from working with them will be an equivalent option compared to the current scheme, which is no longer relevant in connection with the signing of the MLI convention.
Principal Purpose Test A
Сomplex and difficult obstacle for many classical schemes will be the passing of the Principal Purpose Test (PPT), since a very large amount of investment in Ukraine came through controlled company-pads that did not carry out real activities, but were used only for aggressive tax planning and minimization of tax deductions. A striking example is Cyprus, through which only in 2017, 27% of investments were received in Ukraine.
This test has already been applied by Ukraine, because was previously included in some SOIDS. The essence of this test is to prove to the relevant state authorities that the tax privilege received from a single legal entity on the transaction from another legal entity is not the main objective of this transaction.
The difficulty is that business can become a hostage of circumstances, and will feel the manipulation of the controlling bodies. In the pursuit of obtaining tax deductions, the real sector of the economy may also suffer, which, in turn, will make Ukraine economically unattractive for foreign investors.
Criteria in the PPT test are many. The credentials of directors of foreign companies in terms of independence in making decisions on the management of the company, disposing of income, confirming the conduct of activities in the country of registration (presence of an office, qualified personnel, business expenses of the company), the presence of business risks, activities of the group of companies as a whole .P.
Please note that similar requirements have appeared in banking institutions – confirmation of the presence of an office in the country of incorporation of the company or the so-called Substance. Moreover, the criteria for this requirement on the part of banks become more stringent and similar to the PPT criteria, and the absence of Substance entails a refusal to cooperate with respected banking institutions.
Therefore, the situation on both sides inevitably requires analysis, preparation, and development of a business strategy to confirm the activity and reality of the office of a non-resident company.
A competently implemented strategy will be a solution both for the country’s supervisory authorities granting a privilege, and for banking institutions servicing the corporate account of a non-resident company.
Consequently, the business has to be patient, competent lawyers and free funds, because the above described processes involve an increase in labor costs, and will also cause a significant rise in the cost of the transformation and content of the international structure.