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Multilateral Instrument (MLI) – An Introduction

Multilateral Instrument- A Big Challenge for tax professionals

Multinational Entities (MNE) through aggressive international tax planning are shifting profit to the locations where they are paying no tax or very less tax. Being mindful of this fact, more than 100 tax jurisdictions came together to defeat the ill intentions of these MNEs under the OECD/G20 BEPS project. The key object of this project to address certain hybrid mismatch arrangements, prevent treaty abuse, address artificial avoidance of permanent establishment status, and improve dispute resolution. Understanding the urgency led to the birth of Multilateral Instrument, an innovative instrument, to modify more than 3000 bilateral/multilateral agreements. Here are some of the key concepts of “Multilateral Instrument (MLI) – An Introduction” in Q & A form:

Q-1: What is Multilateral Instrument (MLI)?

A: Multilateral Instrument(MLI) is single agreement/instrument that enable to modify multiple bilateral tax treaty in a synchronised efficient manner to implement tax treaty related BEPS measures recommend by BEPS Action Plan-2 (Neutralising the effect of hybrid mismatch arrangements), Action Plan-6 (prevention of treaty abuse), Action Plan-7 (prevention of artificial avoidance of PE status), and Action Plan-14 (making DRP mechanism more effective).

MLI will not replace the existing tax treaties, instead will apply alongside the existing treaties and either supplement, complement, super side or modify their application unlike protocol to a single existing treaty, which would directly amend the text of the treaty.

Q-2: What is CTA?

A: CTA-Covered tax agreement- an existing bilateral tax treaty which is to be modified by the provisions of MLI is called as CTA. To qualify CTA all the 3 conditions must be satisfied simultaneously;

i) both the contracting jurisdiction have sign the MLI; and

ii) both the contracting jurisdiction have ratified the MLI as per their domestic procedure; and

iii) both the contracting jurisdiction have deposited the rectified MLI document with registry at OECD.

Q-3: What are key dates for MLI?

A: MLI provides two important dates for implementation of CTA are:

(1)      Entry into force MLI Article-34: Initially MLI to be in force when at least 5 jurisdictions have deposited ratified MLI documents with OECD i.e. 1.7.2018 (as on this date initial condition satisfied. the fixed date) and after that date Entry into force shall be 1st day of the month following the expiry of 3 months from the date of deposit of ratified copy of MLI with OECD. Example-1: India has deposed the ratified MLI documents with OECD on 25.6.2019 therefor for India Entry into force of MLI is 1.10.2019 for all CTAs. (As Entry into force is qua Country not qua each CTA)

(2)      Entry into Effect MLI Article-35: Entry into force is effective for the determination of Entry into Effect to be as under:

(i)  Once the Entry into force date is determined for both jurisdictions the latter Entry into force MLI date will be “cut-off date” used in determining Entry into force MLI date.

                  (ii)  Entry into Effect date to be determined separately w.r.t. A) Withholding taxes and B) Other taxes

 (A)     For withholding taxes, on or after 1st day of calendar year or taxable years if the Country so choose, India choose Taxable year that begins on or after the cut-off date as above.

Example-2: The Cut-off date for India is 1.10.2019 as in example-1 above, Entry into Effect date for withholding taxes is 1.4.2020.

(B)      For other taxes the MLI Entry into Effect for the taxable period beginning on or after the expiration of six calendar months (or shorter period, if so notified by all parties to CTA) from the “cut-off date” as above.

Example-3: The Cut-off date for India is 1.10.2019 as in example-1 above, Entry into Effect date for other taxes is also 1.4.2020.

(3)      So for the CTA between India and such Contracting Jurisdiction that have ratified and deposited MLI with OECD till 30.6.2019, the Entry into Effect date for both withholding taxes and other purpose shall be same i.e. FY 2020-2021. It seems India chooses the date of ratification accordingly.

Q-4: What are Minimum standards under MLI?

A: There are bare some minimum recommendations of OECD and G20 BEPS project which have been agreed to be adopted and implemented by the signatories to MLI on non-negotiable basis (marginal exceptions) like a country can choose to opt out of minimum standard provisions of MLI, only in limited circumstances where existing CTA already have adequate provisions similar to minimum standard or it is willing to negotiate a comparable provision with treaty partner.

These minimum standards are:

  1. MLI Article-6: Purpose of CTA-Introduction of title and Preamble to every CTA.
  2. MLI Article-7: Prevention of treaty abuse- PPT (Principal Purpose Test)
  3. MLI Article-16: Mutual Agreement Procedure (MAP) and
  4. MLI Article-17: Corresponding adjustments

Q-5: What are Reservations under MLI?

 A: The MLI offers various flexibilities to the Contracting Jurisdictions through the mechanism of reservations. Some of the key points to understand reservation under MLI are as under:

  1. MLI documents provides a list of explicit reservations w.r.t. each Article of MLI and if Any Contracting Jurisdiction wants to opt out of a given MLI provisions, the Contracting Jurisdiction can do so by making reservation and submitting the list of identified reservations with the depository.
  2. Every Contracting Jurisdiction has to provide provisional list of all its reservations at the time of signing of MLI and Final list of Reservations is required to be filled with depository at the time of filing ratified copy of MLI.
  3. Any Contracting Jurisdiction which has made a reservation, may at any time withdraw it or replace it with a more limited reservation (so CJ cannot add new reservation or replace the existing reservation with more comprehensive reservation) by way of notification with the depository.
  4. A Contracting Jurisdiction can choose to opt out the entire article of MLI or some provision of that article of MLI in case of non-minimum standards. But in case of minimum standards, opt out is possible to a limited extent only if the existing treaties do have similar provision or more comprehensive provision similar to MLI. Any such opt out whether entire article or some provision of an article of MLI will operate qua all the tax treaties notified by CJ under the list of its CTAs.
  5. Once a Contracting Jurisdiction has expressed a reservation on an MLI article or some of the provisions within the given MLI article, such MLI provision shall not apply irrespective of the position adopted by the other Contracting Jurisdictions to the CTA and therefore existing treaty provision will apply.

Q-6: What is Compatibility under MLI?

A: Compatibility is again a mechanism to align the various provisions of CTA with the relevant article of MLI based upon the reservations and options of the contracting jurisdictions notified to the depository. To achieve Compatibility some terms are used in MLI, here is the terms and its impact on CTA:

  1. “in place of” or “applies to” or “modifies” when used in MLI means the provision is already present in existing CTA after incorporation relevant MLI article, the impact shall be either to replace existing CTA provision or modify it without replacement according to MLI provision.
  2. “in the absence of” when used in MLI means the provision is already absent in existing CTA therefore added MLI provision in CTA.
  3. “in place of” or “in the absence of” when used in MLI means the provision is already present/absent in existing CTA therefore replaced/added with MLI provision in CTA.

Q-7: What is MLI Synthesized Text?

A: Post MLI the reading of tax treaties would requires altogether a different approach. As MLI does not amend treaties like an amending protocol. Instead, the MLI modifies the treaties by sitting alongside the treaties. In the absence of amended text of CTA, it may be challenge for both taxpayers and tax authorities. Therefore, an efforts has been made by contracting jurisdictions along with OECD to make available a MLI synthesized text of CTAs for facilitating the uses with a disclaimer of transferring risk on user.

Way ahead

The beauty MLI as an instrument not only to ensure achieving its defined objective but also to safeguard the sovereignty of every Contracting Jurisdiction.  Amending more than 3000 bilateral tax treaties in a single stroke through Multilateral Instruments- A Big Challenge for tax professionals in the times to come while advising the clients.

(Disclaimer: This content is meant for our clients or professional friends only for stimulating discussion on the subject matter not to frame any commercial opinion. All efforts are made to compile correctly with no guarantee of extreme accuracy)

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