Introducing model tax convention amendments into all existing bilateral tax treaties requires a bilateral negotiation and the process can take several years to complete. A quicker and more agile way to adopt changes would be through multilateral negotiations and a multilateral instrument.
A multilateral tax instrument is a tool included in both pillars of BEPS 2.0.
On July 11 2023, 138 members of the OECD/G20 Inclusive Framework on BEPS (IF) agreed on an outcome statement that reports the package of deliverables developed to complete the two‐pillar solution. Among others:
The package on Amount A of pillar one, which allows jurisdictions to reallocate and exercise a domestic taxing right over a portion of residual profits of defined multinational enterprises (MNEs) to market jurisdictions, includes the text of a multilateral convention (MLC); and
The Subject-to-Tax Rule (STTR), together with its implementation framework consisting of a multilateral instrument (MLI) and an explanatory statement, will enable developing countries to update their bilateral tax treaties to restore taxing rights on certain outbound intra-group income where such income is subject to low or nominal taxation in the other jurisdiction involved.
The MLC on Amount A of pillar one
As Amount A of pillar one is not consistent with existing bilateral tax treaties, it requires an MLC to come into effect.
Under the MLC of Amount A of pillar one, jurisdictions will be allowed to reallocate and exercise a domestic taxing right over a defined portion of the largest and most profitable MNEs’ residual profits that meet certain revenue and profitability thresholds and that have a special purpose nexus to the markets of the relevant jurisdictions. These taxing rights are allocated across jurisdictions based on the market shares of MNEs to overcome the issue of companies operating in jurisdictions without physical presence.
The agreed rules on Amount A are being translated into provisions for inclusion in an MLC. The MLC will establish the legal obligations of the parties involved to implement Amount A consistently.
In addition to the operative provisions of Amount A (for example, scope and the mechanisms for relieving double taxation), the MLC will contain provisions requiring the withdrawal of all existing digital service taxes (DSTs) and relevant similar measures with respect to all companies, including those not in the scope of Amount A. The MLC will also include a commitment not to enact DSTs or relevant similar measures.
The IF will publish the text of the MLC once it has been prepared for signature. The MLC will be opened in the second half of 2023 and a signing ceremony will be organised by year end. The aim is to enable the MLC to enter into force in 2025.
Only companies that are headquartered in a jurisdiction that signed the MLC can be covered. Therefore, to assess the consequences in terms of the revenue potential of Amount A, it is necessary to focus on who ratifies and effectively implements the reform: the MLC would require ratification by a significant number of jurisdictions to come into effect as it involves the participation of all countries in which MNEs declare significant income.
The MLI for the implementation of the STTR
The STTR, as part of pillar two, is a treaty-based rule that applies to intra-group payments (interest, royalties and other defined payments) from source states that are subject to low nominal tax rates in the residence state (less than 9%).
The document Tax Challenges Arising from the Digitalisation of the Economy – Subject to Tax Rule (Pillar Two): Inclusive Framework on BEPS was published on July 17 2023.
The MLI implementing the STTR is expected to be released and open for signature from October 2 2023. It will amend the bilateral tax treaties of lower-income countries with other countries.
The STTR is presented as a separate treaty article to make it easier to manage its interaction with other treaty provisions and it is consistent with the structure of, and terminology used in, the OECD Model Tax Convention on Income and on Capital.
The draft does not preclude the flexibility to make amendments in the context of a bilateral tax treaty as the MLI will provide one possible option for implementation of the STTR. Jurisdictions are free to include the provision in their tax treaties on a bilateral basis. The form of the provision included in the MLI will contain adaptations so that it is modified to existing treaties that might conform to the UN Model Double Taxation Convention between Developed and Developing Countries as there are divergences between the OECD and the UN model.
Background: the BEPS MLI
The OECD Multilateral Convention to Implement Tax Treaty Related Measures to Prevent BEPS (the BEPS MLI) is a mechanism to amend several bilateral tax treaties at one time. It was adopted to transpose BEPS 1.0-related changes into more than 2,000 existing bilateral tax treaties. It modifies bilateral tax treaties of pairs of countries and applies only where the two countries agree to apply it to a bilateral treaty and only to the extent that they agree.
The MLI was signed on June 7 2017 and entered into force on July 1 2018.
Based on OECD data, 100 jurisdictions have joined the MLI; out of which, 81 jurisdictions have ratified or approved the BEPS MLI, and it covers around 1,850 bilateral tax treaties. Around 650 additional treaties will be modified once the BEPS MLI has been ratified by all signatories. The BEPS MLI requires a complex matching process to identify which bilateral tax treaties will be amended.
In June 2023, an improved version of the database supporting the application of the MLI was released and it is a useful tool to verify the implementation and application of the MLI as it offers the ‘matching results’ under the MLI in respect of each covered tax treaty.
A few years after its adoption, the BEPS MLI has not yet had its full effect because a third of the bilateral tax treaties still need to be amended and among these, Italy is continuing to be delayed.
The path of Amount A of pillar one is still evolving and for it to be effective, it is necessary for the US to ratify the MLC (most of the MNEs in scope are American) and for the MLC to be ratified by a number of countries representing a significant percentage of covered MNE groups.
