Download - Cora Final Submission
An analysis of rules for developing
countries to prevent treaty abuse
Adv LLM paper
submitted by
Cora Cheung
in fulfilment of the requirements of the
'Master of Advanced Studies in International Tax Law'
degree at the International Tax Center Leiden
(Leiden University)
supervised by
Prof. dr. Kees van Raad and
Monica Sada Garibay
Cora Cheung version 13 08 2014 II
PERSONAL STATEMENT
Regarding the Adv LLM Paper submitted to satisfy the requirements of the 'Master of Advanced Studies in
International Tax Law' degree:
1. I hereby certify (a) that this is an original work that has been entirely prepared and written by myself
without any assistance, (b) that this paper does not contain any materials from other sources unless these
sources have been clearly identified in footnotes, and (c) that all quotations and paraphrases have been
properly marked as such while full attribution has been made to the authors thereof. I accept that any
violation of this certification will result in my expulsion from the Adv LLM Program or in a revocation of my
Adv LLM degree. I also accept that in case of such a violation professional organizations in my home
country and in countries where I may work as a tax professional, are informed of this violation.
2. I hereby authorize the International Tax Center Leiden to place my paper, of which I retain the copyright,
in its library or other repository for the use of visitors to and/or staff of said library or other repository. Access
shall include, but not be limited to, the hard copy of the paper and its digital format.
3. In articles that I may publish on the basis of my Adv LLM Paper, I will include the following statement in
a footnote to the article’s title or to the author’s name:
“This article is based on the Adv LLM paper the author submitted in fulfilment of the requirements of the
'Master of Advanced Studies in International Tax Law' degree at the International Tax Center Leiden (Leiden
University).”
4. I hereby certify that any material in this paper which has been accepted for a degree or diploma by any
other university or institution is identified in the text. I accept that any violation of this certification will result
in my expulsion from the Adv LLM Program or in a revocation of my Adv LLM degree.
Signature:
Name: Cora Cheung
Date: 13 August 2014
Cora Cheung version 13 08 2014 III
Table of Contents
Table of Contents ......................................................................................... III
List of Abbreviations used ......................................................................... VI
Executive Summary ................................................................................... VII
Overview of Main Findings ....................................................................... VIII
1. Introduction............................................................................................... 1
1.1. Scope, definitions and assumptions .................................................................. 1
1.1.1. Scope ............................................................................................................ 1 1.1.2. Definitions...................................................................................................... 1
1.1.2.1. Developing Vs. Developed Countries............................................................. 1 1.1.2.2. GAAR Vs. SAAR ............................................................................................ 1
1.1.3. Assumptions .................................................................................................. 2 1.2. Characteristics of Developing countries ............................................................ 2 1.3. Importance of AAR for Developing Countries ................................................... 2 1.4. The Two-Fold of Challenges for Developing Countries .................................... 3
1.4.1. Capacity Deficiency ....................................................................................... 3 1.4.2. Common types of Abuse ............................................................................... 4
1.4.2.1. A description of the issues ............................................................................. 4
1.4.2.2. Capital gains taxable only in the conduit company’s state
– loss of taxing right........................................................................................ 4
1.4.2.3. Reducing WHT through conduit arrangement
– lose taxing right; enable round tripping ....................................................... 4 1.4.2.4. Interest deductions – reduce taxable base .................................................... 4
1.4.2.5. Switching character of income to alter source and taxability
– reduce taxable base .................................................................................... 4
1.4.2.6. Permanent Establishment loophole................................................................ 5 1.5. Objective ................................................................................................................ 5
2. International AAR ..................................................................................... 5
2.1. UN & OECD on Anti Avoidance ........................................................................... 5
2.1.1. Model Convention and commentary ............................................................. 5 2.1.2. BEPS Action 6 suggests 3-pronged approach .............................................. 6
2.2. GAAR ...................................................................................................................... 6
2.2.1. Main Purpose Test ........................................................................................ 6 2.2.2. Extension of MPT in distributive provisions: ................................................. 8
2.2.3. The Savings Clause ...................................................................................... 8 2.3. SAAR ...................................................................................................................... 9
2.3.1. Two General Approaches to SAARs ............................................................. 9 2.3.2. Limitation On Benefits ................................................................................. 11 2.3.3. Denying Benefits to Conduit Entities ........................................................... 12
2.3.3.1. Look-through provision ................................................................................. 12 2.3.3.2. Beneficial Owner Concept ............................................................................ 13
2.3.3.3. Deemed Conduit clause ............................................................................... 14
2.3.4. Denying Benefits to Conduit Arrangements ................................................ 15 2.3.4.1. Remittance based taxation & Subject-to-tax provision :............................... 15 2.3.4.2. Channel Approach ........................................................................................ 16
3. Domestic ................................................................................................. 17
Cora Cheung version 13 08 2014 IV
3.1. Introduction ......................................................................................................... 17
3.1.1. OECD and UN clarification on domestic AARs: no conflict ........................ 17
3.1.2. Pros and Cons of Domestic AAR ................................................................ 17 3.2. GAAR .................................................................................................................... 18
3.2.1. Standard GAAR .......................................................................................... 18 3.2.2. Alternative Minimum Tax ............................................................................. 19 3.2.3. Black List ..................................................................................................... 19
3.3. Judicial Doctrines ............................................................................................... 20 3.4. SAAR .................................................................................................................... 21
3.4.1. Introduction.................................................................................................. 21 3.4.2. Deeming Income & Capital Gains ............................................................... 21
3.4.2.1. Benefits for this category of rules ................................................................. 21 3.4.2.2. Controlled Foreign Company ....................................................................... 21 3.4.2.3. Deemed Interest on Interest-Free Loans ..................................................... 22
3.4.2.4. Exit Tax ....................................................................................................... 22
3.4.2.5. Suggestions for this category of rules .......................................................... 23
3.4.3. Deduction restriction ................................................................................... 23 3.4.3.1. Benefits for this category of rules ................................................................. 23 3.4.3.2. Interest Restriction/Thin Capitalisation Rule ................................................ 23 3.4.3.3. Leasing Expense Restriction ........................................................................ 23
3.4.3.4. Suggestions for this category of rules .......................................................... 24
3.4.4. Income Recharacterising Rules .................................................................. 24 3.4.4.1. Benefits for this category of rules ................................................................. 24
3.4.4.2. Interest Recharacterising Rule ..................................................................... 24 3.4.4.3. Substance over form approach .................................................................... 24
3.4.4.4. Anti-Dividend Stripping Rule ........................................................................ 25 3.4.4.5. Risks for this category of rules ..................................................................... 25 3.4.4.6. Suggestions for this category of rules .......................................................... 25
3.5. Safe Harbour Rules ............................................................................................. 25
3.5.1. Introduction.................................................................................................. 25 3.5.2. Stock Exchange provision – Business Purpose.......................................... 26 3.5.3. Holding Period – Substance Requirement .................................................. 26 3.5.4. Proof of Approval/Acknowledgement from Other Contracting State
– Reciprocity ............................................................................................... 27
4. Case Studies: Myanmar and neighbouring countries ......................... 27
4.1. Economic status ................................................................................................. 27 4.2. Attracting Foreign Investments - Incentives .................................................... 28
4.2.1. Improve Effectiveness of Incentives ........................................................... 28
4.2.2. Learn from Bhutan’s Mistakes..................................................................... 29 4.2.3. Considering Alternatives to Tax Sparing Relief .......................................... 29
4.3. Treaty partners .................................................................................................... 30
4.3.1. Myanmar’s Existing Treaty Network ........................................................... 30
4.3.2. Understand Why Cambodia Said No to Treaties ........................................ 31 4.3.3. Recognise the Reason for Mongolia’s Termination of Treaties with the
Netherlands, Luxembourg, Kuwait and UAE .............................................. 31 4.3.4. Considerations for Myanmar in the Current State of Affairs ....................... 32
4.4. A Review of Existing Treaties ............................................................................ 32
4.5. Domestic AAR ..................................................................................................... 33
4.5.1. Absence of Domestic AAR .......................................................................... 33
4.5.2. Avoid Nepal’s Overly Complex AARs ......................................................... 34
Cora Cheung version 13 08 2014 V
4.6. Summary .............................................................................................................. 34
4.6.1. General rule: simple and targeted rules with clear implementation
procedure .................................................................................................... 34 4.6.2. Revaluate tax incentives, implement safeguards and conditions ............... 34
4.6.3. Review Existing Treaties and Conclude Treaties with Real Investor
Countries ..................................................................................................... 35 4.6.4. AAR, definitions in treaty to allow Domestic AAR ....................................... 35 4.6.5. Narrow GAAR ............................................................................................. 35 4.6.6. Progressive SAARs ..................................................................................... 36
4.6.7. Plan phases of development ....................................................................... 36 4.6.8. Resources should be spent on data collection and competency building .. 36
5. General Recommendations for Developing Countries ....................... 37
5.1. Achieving the objective ...................................................................................... 37 5.2. General Principles .............................................................................................. 37
5.2.1. Keep it simple .............................................................................................. 37
5.2.2. Target majority ............................................................................................ 37 5.2.3. Conflict prevention and resolution ............................................................... 38
5.2.4. Pro-business attitude .................................................................................. 38 5.2.5. Measurable policies .................................................................................... 38
5.3. Overall evaluation of AARs – Summary Table ................................................. 38 5.4. Moving forward ................................................................................................... 40
Bibliography ................................................................................................ 41
Cora Cheung version 13 08 2014 VI
List of Abbreviations used
(alphabetical list of abbreviations used in the Paper)
AAR Anti-Avoidance Rule
AMT Alternative Minimum Tax
Art., Arts. Article, Articles
BEPS Base Erosion Profit Shifting
CCCTB Common Consolidated Corporate Tax Base
CFC Controlled Foreign Company
COR Certificate of Residence
e.g. Exempli gratia (for example)
Etc. Et cetera
FDI Foreign Direct Investment
FMV Fair Market Value
FRS Financial Reporting Standard
GAAR General Anti Avoidance Rule
GDP Gross Domestic Product
GNI Gross National Income
i.e. id est
IMF International Monetary Fund
LOB Limitation On Benefits
MNC Multi-National Company
MPT Main Purpose Test
OECD Organisation for Economic Cooperation and Development
OECD MC OECD Model Convention (2010)
Para. Paragraph
PE Permanent Establishment
SAAR Specific Anti Avoidance Rule
SPV Special Purpose Vehicle
TFEU Treaty on the Functioning of the European Union
TP Transfer Pricing
Treaty Double Tax Avoidance Agreement
UK United Kingdom
UN United Nation
UN MC United Nation Model Convention (2011)
US United States of America
VCLT Vienna Convention on the Law of Treaties
WHT Withholding Tax
Cora Cheung version 13 08 2014 VII
Executive Summary
This paper aims to provide developing countries with a starting point in designing a set of anti-avoidance
rules that is effective in protecting them against treaty abuse. The anti-avoidance topic has been in the
limelight in recent years and a lot of effort has been put into seeking solutions for treaty abuse, however,
few of these initiatives were made in the perspective of developing countries. Given that developing
countries are in a lesser position to safeguard their tax revenue but are in dire need of funds to operate,
they are in a more critical predicament than their developed treaty partners.
Developing countries have their unique characteristics and therefore have different challenges from
developed countries. Chapter 2 and 3 discuss selected AARs applicable in treaties and in domestic tax
law respectively. The rules are broadly categorised into GAARs and SAARs, and further streamed into
categories based on different approaches. Each of these rules is evaluated on its benefits and risks in the
perspective of developing countries, suggestions are then made based on the evaluation. These
suggestions often involve modifying existing rules or combining them to achieve the desired outcome.
However, it must be proclaimed that these suggestions are not tested and are purely deductions of the
author. The paper also contains new rules which are inspired by certain countries’ practices, discussions
with other professionals and the materials accredited in the bibliography. These new and possibly
controversial rules are proposed here as a hypothesis to general further discussions.
The case study of Myanmar is brought in to demonstrate the practical aspect of introducing AARs in a
developing country. A brief introduction of its economic status is included to provide a basic idea of
Myanmar’s current stage of development. The chapter goes on to discuss issues the country might or is
facing with tax incentives and treaties, and how AARs could address these issues, while drawing
examples from other developing countries. The author has concluded the case study with a set of 8
recommendation points for Myanmar’s consideration.
Finally, a summary table of the AARs evaluation is prepared based on the author’s perspective of the
suitability and priority for implementation in developing countries. The paper concludes with some
general recommendations for developing countries’ tax authorities in designing, maintaining and
progressing with their AARs.
Cora Cheung version 13 08 2014 VIII
Overview of Main Findings
The initial research brought up a key question not considered by the author previously: the effectiveness
of incentives and treaties in attracting FDI is not guaranteed but the loss of tax revenue is real and the
cost of administering both of these tax benefits is high. What make countries dive into them so
frivolously? Through further research on the case study, the author notices that tax competition amongst
peers and pressure from trading partners are the probable causes for entering into a treaty agreement
prematurely. In Myanmar’s case, surrounding countries are mostly ahead in their development and all of
them have tax incentive regimes. The list of top exporting countries is almost identical to the list of
countries that Myanmar has concluded or is negotiating treaties with.
The author believes that developing countries tend to let their treaty partners take the lead in negotiation,
as a result, their treaties have a tendency to vary widely in focus between different treaty partners. The
author also notices that AARs, if available, are often for the residence state’s benefits. Although
developing countries are perceived to have lower bargaining power (due to the need for FDI), they do
have do have leverage over developed countries (opportunities for above average return on
investments). Depending on the competency of the developing countries’ tax authorities, there are still
possibilities to negotiate favourable treaties. Therefore, competency building should be a priority for
developing countries. Further, section 5 suggests some general principles for developing countries to
follow, such as: keeping it (the rules) simple, targeting majority, manage conflict prevention and
resolution, maintain a pro-business attitude and use measureable policies.
In a developing country’s perspective, the motive for introducing treaty AARs is to limit access while
domestic AARs have more direct impact on tax revenue through restricting deductions or deeming
income. However, most developing countries have limited domestic AARs and are unprepared to
administer them. Thus, the author suggests to prioritise the SAARs which have direct measurable impact
on revenue collection.
Although GAAR is favoured by developing countries for its wider scope, SAARs are probably more
effective for them. SAARs do not require case by case investigation, it has direct impact and direct
results. GAAR, on the other hand, raises more uncertainty and is harder to administer. Thus, the
recommendations focuses on SAARs.
Developing countries need to understand that most Model Conventions are based on residence taxation
(an exception is the CARICOM treaty, which is unique and highly criticised), therefore, AARs are
necessary to balance the benefits of source state, especially if the contracting states are at different
stages of economic development.
Cora Cheung version 13 08 2014 1
1. Introduction
1.1. Scope, definitions and assumptions
1.1.1. Scope
It is not the objective of this paper to evaluate all AARs available, the AARs selected for
discussion on this paper aim to display the attributes that should be valued by developing countries.
Through evaluation of the suitability of these rules, it is intended to give developing countries an
understanding of the capacity requirement each type of rule demands.
While it is the intention to evaluate effectiveness based on hard statistics, the lack of reliable
data of developing countries and the wide range of non-tax variables made it difficult to have
conclusive recommendations. Therefore, estimates and inferences based on current conditions are
used in the paper. There are also pertinent issues which will have to be discussed another time, such
as:
TP and its role as an anti-abuse tool is not covered in this paper because it is a large topic on
its own and compared to other AARs, it is not as easy for developing countries with limited
administrative resources to apply.
Unitary taxation as a potential solution is probably a long term goal and more of a theory for
now. It will require consensus and collaboration from the international community for it to work. For
that reason, it is also impractical for developing countries to consider at this stage.
Effectiveness of treaties in attracting FDI is often questioned, many scholars consider
treaties a risky tool to incentivise FDI. In particular, Michael Lang believes that “Developing countries
that have very few or no treaties may in fact be doing the right thing.”1 Understandably there are also
non-tax reasons involved in concluding treaties, therefore it is not the interest of this paper to discuss
treaties’ effectiveness in attracting FDI.
1.1.2. Definitions
1.1.2.1. Developing Vs. Developed Countries
Developing countries are defined according to their GNI per capita per year. Countries with a
GNI of US$ 12,616 and less are defined as developing countries (based on the World Bank’s
classification in 20142). The developing country category is further classified into upper middle, lower-
middle and low income groups. For the purpose of this paper, developing countries are referred to
lower-middle and low income groups.
The case study in Section 4 is based on Myanmar – a low income economy and the
comparisons are drawn from lower-middle and low income groups for consistency: Cambodia (low),
Bhutan (lower-middle), Nepal (low) and Mongolia (lower-middle).
1.1.2.2. GAAR Vs. SAAR
A GAAR3 prevents the entitlement to the treaty while a SAAR targets entities, receipts and
arrangements. There is an exception in the case of LOB, as it is generally categorised as a SAAR
although it is mostly a barrier to access treaty based on the UN MC Commentary.
1 Michael Lang et al, Tax Treaties: Building Bridges between Law and Economics (Amsterdam: International
Bureau of Fiscal Documentation, 2010), pp 455 2 http://data.worldbank.org/about/country-and-lending-groups (accessed on 2 July 2014) 3 Section 34 to 37 of UN Commentary on Art. 1
Cora Cheung version 13 08 2014 2
1.1.3. Assumptions
Treaty has a positive correlation with FDI - As mentioned above, there are arguments
which challenge4 this premise but for the purpose of this paper it is assumed that treaty serves as a
reduction of barrier to enter the markets, without going into statistics supporting or negating this
correlation.
Source state assumption - Developing countries will be assumed as the source state in the
context of this paper unless specifically stated otherwise.
1.2. Characteristics of Developing countries
Fundings required by developing countries are substantial and it is not sustainable to rely on
foreign assistance. In low income countries, the problem with revenue collection is evident: over 20
countries still have tax ratios (tax revenue relative to GDP) under 15% while average tax ratio is 30-
40%5.
Developing countries are generally more reliant on corporate tax revenues (on average close
to 20% of tax revenues, compared to 8-10% for developed countries)6 and this view is echoed by the
IMF in its Fiscal Monitor of October 2013: “Recognition that the international tax framework is broken
is long overdue. Though the amount is hard to quantify, significant revenue can also be gained from
reforming it. This is particularly important for developing countries, given their greater reliance on
corporate taxation, with revenue from this taxation often coming from a handful of multinationals.”7.
Reason for high reliance on corporate tax revenue is also due to weak personal tax system
as it rarely achieve progressivity in developing countries. Some deduced the reason behind that is
because top income earners are often in position of political influence in developing countries, thereby
preventing tax reforms which could result in higher tax rates for themselves.
It has been observed that WHT forms a significant part of developing countries’ tax collection
due to its advance collection nature and because it has fewer tax leakage opportunities. There is no
available data to support this claim, however, the author believes this is a logical inference especially
for developing countries with weak administration and enforcement.
A developing country’s economy is generally composed of a few large companies and a big
pool of small taxpayers (shadow economy), an average of 34.5% of GDP8 of these countries is
contributed by small/informal businesses. The cost to track and tax these enterprises is high while the
return is limited, thus developing countries are heavily dependent on a small group of big taxpayers.
Finally, many developing economies are heavily dependent on international trade and FDI as
it brings about direct tax revenue as well as non-income type taxes therefore they are reluctant to
impose strict anti-avoidance rules.
1.3. Importance of AAR for Developing Countries
According to OECD’s statistics, China, US, Russia and Japan are the largest sources of
outward FDI in 2013 and more than half of global FDI is received in developing countries9. Just to
have a keener sense of the impact of FDI in monetary terms, the OECD estimates the total world FDI
outflow in 2013 is approximately USD 1.3 trillion. This is what developing countries are competing for.
4 Katrin McGauran, Should the Netherlands sign tax treaties with developing countries? (Amsterdam: Stichting
Onderzoek Multinationale Ondermemingen), 2013, pp 19 5 International Monetary Fund, Revenue Mobilization in Developing Countries (Washington D.C: IMF, 2011) 6 Sol Picciotto, 'Base Erosion and Profit-Shifting (BEPS): Implications for Developing Countries' (United
Kingdom: Tax Justice Network, 2014) 7 International Monetary Fund. IMF Fiscal Monitor: Taxing Times. (Washington D.C.: IMF, October 2013) 8 F. Schneider, A. Buehn, and C.E. Montenegro, 'Shadow Economies All over the World: New Estimates for 162
Countries from 1999 to 2007', World Bank Policy Reseach Working Paper No. 5356 (2010), pp 4, 9, 38 9 Organisation for Economic Cooperation and Development. FDI in Figures. International investment stumbles
into 2014 after ending 2013 flat. (Paris: OECD, 2014)
Cora Cheung version 13 08 2014 3
However, how many of these investments generate actual tax revenue for the tax authorities?
The top investors in developing countries are not always the top global investors because they invest
through SPVs. These SPVs are generally established in jurisdictions with preferential tax regimes
and/or jurisdictions with wide treaty network. Developing countries are obliged to give away their
taxing rights on income, gains and profits under the treaties, which is likely more than what they
would if FDI flows in directly from the real investors.
Lack of effective legislation to prevent such abuses, or at least discourage them, leaves gaps
unguarded and provide opportunities for simple but potentially aggressive tax avoidance10. Worst
case scenario for a developing country will be arriving to a point where the economy is highly
dependent on FDI through conduit arrangement, the authority will have too much resistance to
enforce AARs and at the same time value is flowing out of the country tax free. India’s relationship
with Mauritius can be loosely described as such, to-date Mauritius is still the top foreign investor for
India11; there has been discussion to include an LOB clause in the India Mauritius treaty or even
cancel it altogether but nothing has been done since 1996 when the issue was first raised.
1.4. The Two-Fold of Challenges for Developing Countries
1.4.1. Capacity Deficiency
Most if not all developing countries experience the lack of skilled workforce in public and
private sector to enforce and comply with the rules, making it difficult even at the domestic level to
enforce taxation on enterprises. In the domestic context, active income is more difficult to tax than
passive income (withholding at source) as it requires computation, filing, and assessment and
therefore collection is not immediate. Due to low administrative capacity in enforcement, the cost of
relinquishing rights to tax passive income becomes even higher (in a treaty application situation).
The drafting of domestic tax law usually has room for improvement as it forms the basis of
taxation, without which there is no need for treaty because there is no taxation to be relieved.
Developing countries usually adopt the rules left with them by their previous occupiers which are
usually biased against the developing states and not adjusted to their needs. Thus, the domestic tax
act should be first reviewed in the perspective of the state’s benefit.
In an international perspective, developing countries suffer in treaty negotiation due to the
lack of technical expertise and/or bargaining power, resulting in a possibly over generous treaty which
is skewed to the benefit of more affluent treaty partners. This could be inevitable at times but
developing countries should be aware and give up taxing rights only for more important benefits/terms
in the process of treaty negotiation.
Post-treaty, they also face high administrative burden (and related costs) that treaties
imposed on participating states. Without guidance, they may not fulfil their obligations as a treaty
partner and the poor administration of treaty may backfire on the effort to attract FDI.
Due to limited resource, human and technology capacity, developing countries often
encounter difficulties in collecting statistics to make meaningful analysis. It is an issue that affects
their long term development because it would impinge on effective policy making. Local government
needs to be aware of the cost and benefit for each policy that it considers implementing and it needs
to track the effect of what has been implemented.
Thus, capacity building should always be prioritised in a developing country’s agenda.
10 Organisation for Economic Cooperation and Development. Special meeting of the OECD Task Force on Tax
and Development on BEPS and Developing countries and Summary of the BEPS Consultations.(Paris: OECD, 2014)
11 Department of Industrial Policy & Promotion, Government of India. Fact Sheet on Foreign Direct Investment (FDI) From April 2000 to May 2014. (India: Government of India, 2014)
Cora Cheung version 13 08 2014 4
1.4.2. Common types of Abuse1213
1.4.2.1. A description of the issues
Developing countries are usually the source state while most treaty models serve to allocate
taxing right between source and residence state by limiting source state taxation. Even the UN Model
Convention, which is known to be developing-country-friendly, is a residence based treaty model.
Thus, the reason for developing countries to enter into treaties is to attract FDI by giving up source
state taxing rights. AARs are therefore important to act as safeguard from loss of tax revenue through
improper use of the treaties. Following are some examples of common misuse of treaties:
1.4.2.2. Capital gains taxable only in the conduit company’s state – loss of taxing right
By interposing a holding company, established in one of the treaty partner states, between
the real investor and the target company (in source state), the source state could lose taxing rights on
capital gains. The capitals gains would then be remitted back to the real investor’s state absolutely tax
free.
This is a concern because exponential growth in asset value is expected in developing
countries yet the local tax authority is deprived of the taxing rights on such value due to abuse of
treaty.
1.4.2.3. Reducing WHT through conduit arrangement – lose taxing right; enable round tripping
Besides using conduit entities as described above, a conduit arrangement can be made to
benefit from treaties. A back-to-back loan is a good example for these types of arrangement, instead
of paying interest directly to the real lender, an intermediary company is interposed, established in a
treaty state, to benefit from the lower WHT rates. Interest is then paid by the intermediary company to
the real lender tax free.
1.4.2.4. Interest deductions – reduce taxable base
A change in the composition of FDI has been observed: reduction of equity type funding by
40% and increase of 20 folds in debt funding between 2012 and 201314. It is an issue for FDI
receiving countries as debt-funding reduces the taxable base of the country. Excessive debt-funding
allows interest deduction against taxable income, effectively reducing the tax suffered in these
developing countries. The problem is aggravated by abuse of treaties as that allows further reduction
of tax on outflowing interests.
1.4.2.5. Switching character of income to alter source and taxability – reduce taxable base
Although treaties and commentary of the Model Conventions attempt to provide a definition of
different types of income, they still allow for interpretation by treaty partners therefore the differences
in domestic tax laws could give rise to the opportunity for arbitrage. Companies could make use of
legal arrangements to change the form of payments to benefit from preferential treaty rules while
maintaining the outcome of a transaction.
12 International Monetary Fund. Spillovers in International Corporate Taxation: Selected Key Issues for
Developing Countries (Washington, D.C.: IMF Policy Paper, 2014) 13 Philip Baker, 'Improper Use of Tax Treaties, Tax Avoidance and Tax Evasion', Papers on Selected Topics in
Administration of Tax Treaties for Developing Countries, (May 2013) , Tax Avoidance and Tax Evasion By Philip Baker
14 See OECD, supra note 7
Cora Cheung version 13 08 2014 5
1.4.2.6. Permanent Establishment loophole
Restrictive PE definitions in treaties reduce the source state’s taxing rights; investors could
take advantage of these PE rules to limit tax exposure in source states. The OECD MC does not
provide for a “force of attraction” clause, which makes all businesses conducted in source state not
taxable if they are not effectively connected to a PE in that state. By setting up a conduit entity in a
treaty state (which exempts foreign income from tax) to conduct operations in developing countries
while circumventing from PE qualifications, foreign investor could earn tax free income from these
developing countries and enjoy tax deferral in the conduit entity’s state.
1.5. Objective
The aim of this paper is to analyse the applicability of existing AARs for developing countries,
taking into consideration their general economic structure and attributes, the challenges they face
regarding capacity deficiency and abuse of treaty. It should give a basic guidance to developing
countries’ governments in devising AARs to prevent treaty abuse. It also attempts to bring new ideas
for the existing rules to the table for further discussions and debate. Some hypothesis made in this
paper could be controversial and need to be considered with an open mind.
Section 2 and 3 discusses the AARs in treaties and domestic tax laws respectively. The rules
will be evaluated based on benefits and risks in a developing country’s perspective. Suggestions are
made on the suitability of these rules and how they should be applied. Bearing in mind that these
rules are not exhaustive, the evaluation and suggestions are based on available data, estimates,
inferences and experiences of other countries.
A case study is used to illustrate the concepts and application of AARs further. It aims to
provide a practical angle to this paper and at the same time expose the readers to trends and
challenges unique to developing countries. Myanmar was chosen for its eagerness to attract foreign
investment in a very early stage of economic development and its vulnerability as such.
2. International AAR
2.1. UN & OECD on Anti Avoidance
2.1.1. Model Convention and commentary
In seeking guidance on the effect on treaties and its application, the UN MC and OECD MC
are the basic documents relied upon. The UN MC Commentary on Article 1 and the OECD MC
Commentary on Article 1 are by and large identical in their content. The UN commentary often refers
to the OECD commentary and mirrors concepts discussed therein. They too share the same guiding
principle on anti-avoidance, which was added to the OECD commentary in 2003 (emphasis added):
“the benefits of a double taxation convention should not be available where a main purpose
for entering into these transactions or arrangements was to secure a more favourable tax position and
obtaining that more favourable treatment would be contrary to the object and purpose of the relevant
provisions”1516
This guiding principle will be referred to throughout this paper as it is the fundamental building
block of the anti-avoidance initiative. However, it is of interest to note that this insertion in 2003 did not
come without criticism. The UN Commentary highlighted the ambiguous term of “a main purpose” and
proposed to change it to “the main purpose” for more certainty. The drawback in doing so might be
the increased burden of proof in the standpoint of tax authorities. In the case of developing country, it
could indeed be an issue. Having said so, the reverse will increase the burden of proof in taxpayers’
15 Section 9.5 of OECD Comm. on Art. 1 16 Section 23 to 27 of UN Comm. on Art. 1
Cora Cheung version 13 08 2014 6
perspective which is not necessarily fair play either. In the midst of this zealous atmosphere towards
anti-abuse, it is important to bear in mind the primary objective of a treaty is to provide a level playing
field for taxpayers. Therefore the treaty countries “… should carefully observe the specific obligations
enshrined in treaties to relieve double taxation as long as there is no clear evidence that the treaties
are being abused”17(hereon referred to as the “relief until proven abuse rule”).
Another criticism for the OECD’s commentary is the lack of structure in its chapter dealing
with improper use of the Convention. Some AARs have been peppered into the Commentary over
time resulting in a patchwork of rules, it is disorganised and at times difficult to follow. There are also
areas of repetition of concepts under differently named AARs which have similar objectives and
perhaps slight differences in their approaches. On the other hand, the UN Commentary is better
organised but refrains from providing suggestions for wordings and it often refers to OECD
Commentary for basis.
Collectively, these two sets of internationally recognised Model Conventions and
Commentary point in the same direction and complements one another in addressing the problem of
treaty abuse.
2.1.2. BEPS Action 618 suggests 3-pronged approach
The OECD has issued a discussion draft for BEPS action 6 earlier this year which proposed
the following:
Firstly, to include in the title and preamble of treaties contracting states’ intention to prevent
tax avoidance, especially treaty shopping. Secondly, to include the LOB (Section 2.3.2 refers) article
in treaties, which contains a set of SAARs targeting some prevalent treaty abuse arrangements.
Finally, a GAAR is suggested to reinforce and cover situations not addressed by the LOB.
Taking a step back and looking at the framework as a whole, it makes sense. The contracting
states set the tone by voicing their shared intention of anti-avoidance on the outset, and then, they
take on the existing avoidance schemes directly with a full set of dedicated rules provided in LOB.
Finally, they may use the trump card (GAAR) provided for unforeseen abusive scenarios. It looks like
a full kit against treaty abuse.
However, the author finds quite a number of potential issues which needs to be ironed out in
steps two and three. Issues on LOB are discussed in the later section. As for the GAAR, the
discussion draft loosely refers to the guiding principle, MPT and judicial doctrines garnished with a
claim that there is no conflict between the Convention and domestic tax laws19 and that it echoes the
“relief until proven abuse rule”20. The following section will discuss the validity of these claims.
2.2. GAAR
2.2.1. Main Purpose Test
As part of the 3-pronged approach proposed by BEPS action 6, MPT forms an important
component of the GAAR which aims to cover treaty shopping scenarios not dealt with by the LOB.
This also means that even if taxpayers pass the LOB tests, they may still be caught by the MPT. The
recommended wordings for MPT is as follows:
“Notwithstanding the other provisions of this Convention, a benefit under this Convention shall
not be granted in respect of an item of income if it is reasonable to conclude, having regard to all
relevant facts and circumstances, that obtaining that benefit was one of the main purposes of any
arrangement or transaction that resulted directly or indirectly in that benefit, unless it is established
17 Section 22.2 of OECD Comm. on Art. 1 18 Organisation for Economic Cooperation and Development. Public Discussion Draft, BEPS Action 6:
Preventing the Granting of Treaty Benefits in Inappropriate Circumstances. (Paris: OECD, 2014) 19 Section 22.1 of OECD Comm. on Art. 1 20 Section 22.2 of OECD Comm. on Art. 1
Cora Cheung version 13 08 2014 7
that granting that benefit in these circumstances would be in accordance with the object and purpose
of the relevant provisions of this Convention.” 21 (Emphasis added)
This concurs with the guiding principle but took it a step further by giving more room for
subjectivity by including new wordings such as “reasonable to conclude”, “relevant (facts and
circumstances)” and “one of the main purposes”. Further, instead of following the “relief until proven
abuse rule”, the wordings seem to suggest that, notwithstanding the MPT, benefits will be granted
only if it is proven to be in accordance to the object and purpose of the Convention. It might be a
small difference but the burden of proof seems to be transferred to the taxpayer entirely and it seems
to contradict the “relief until proven abuse” principle. Understandably, these issues are still in a fervent
debate, as the international community is concerned about the increased uncertainties and onus for
taxpayers.
Benefits
The MPT provides a direct tool for developing countries to retract treaty benefits in potentially
tax-avoidance situations should they lack the specific domestic laws to do so. It closes the loopholes
and narrows the effect of knowledge gap between tax authorities and international tax advisors, as it
gives tax authorities more power to challenge complex schemes designed by experienced tax
advisors
Risks
This test may be overly onerous and unreasonably arduous for law abiding taxpayers to
justify their transactions or corporate structuring. Further, it is fundamentally contradicting since
treaties are meant to provide tax benefits and many developing countries offer tax incentives in their
domestic laws. According to this rule, if the company considers such tax benefits as one of the
reasons to invest in the developing country (which is the original intention of the government), the
company could be penalised under the MPT for having “tax benefits” as one of the main purposes.
The same argument has been put forth by various parties in the Comments received by the
OECD on the BEPS Action 6 Public Discussion Draft22.
Suggestions
Although it is suggested in the Discussion Draft for MPT to form part of the LOB clause
(typically a SAAR) it is still technically a GAAR. GAARs are like trump cards for tax authorities and
understandably most favoured by developing countries as it saves them the drafting hassle and
provides the overriding right to deny treaty benefits. However, it is a double edged sword: without the
required competency within the tax authorities, it is a nightmare to administer such a provision.
Developed countries often find difficulties in striking the balance and had to rely on case laws in other
countries as reference for their judgements. Developing countries will be in a lesser position to
administer such a provision with limited human capital. Further, developing countries’ key objective in
concluding treaties is primarily to attract FDI, this should not be overshadowed by the paranoia of
treaty shopping. As such, developing countries should refrain from implementing such overly wide-
reaching GAAR.
Instead of adopting a highly criticised provision in their treaties, developing countries could
consider incorporating the “general bona fide provision”23, which is also recommended in the OECD
Commentary, into their GAAR. The said provision is generally accepted by international community
and the suggested wordings could be modified as such: "The foregoing provisions benefits of the
Convention shall not apply be denied where the company resident establishes that the principal
purpose of the company resident, the conduct of its business and the acquisition or maintenance by it
of the shareholding or other property from which the income in question is derived, are motivated by
21 See OECD, supra note 16 22 Organisation for Economic Cooperation and Development. Comments received on Public Discussion Draft
BEPS Action 6: Preventing the Granting of Treaty Benefits in Inappropriate Circumstances. (Paris: OECD, 2014)
23 Section 19 of OECD Comm. on Art. 1
Cora Cheung version 13 08 2014 8
sound business reasons and do not have as primary purpose the obtaining of any benefits under this
Convention." This is reflective of the “Business Purpose” doctrine.
2.2.2. Extension of MPT in distributive provisions:
OECD MC suggests to add the following to each distributive rule:
"The provisions of this Article shall not apply if it was the main purpose or one of the main
purposes of any person concerned with the creation or assignment of the [Article 10: "shares or other
rights"; Article 11: "debt-claim"; Articles 12 and 21: "rights"] in respect of which the [Article 10:
"dividend"; Article 11: "interest"; Articles 12 "royalties" and Article 21: "income"] is paid to take
advantage of this Article by means of that creation or assignment." 24 (Emphasis added)
The same wordings, “…main purpose or one of the main purposes…” were mentioned in the
preceding section 2.2.1. This Commentary was added in the 2003 OECD Commentary along with
Commentary 9.5 – “guiding principle”, preceding the BEPS discussion.
Benefits
This proposed provision reaffirms the applicability of the MPT on each type of income. An
additional benefit would be the added flexibility in implementing the MPT. Albeit the wide reaching
wordings - as mentioned previously, it is specifically stated in the respective distributive provision of
the treaty. This means that the same condition can be waived in certain distributive clause, which
provides a developing country with the tool to target income which is more prone to abuse than others
while relieving taxpayers from unnecessarily onerous provisions for other types of payments.
Risks
Application of these additional clauses in distributive rules has the same effect as a GAAR in
fuelling uncertainties in treaty application. If an aggressive position is taken by the tax authorities,
such additions to the treaties will reduce the beneficial effects of treaties severely.
The terms “creation or assignment” could possibly give rise to uncertainty in interpretation.
Perhaps more familiar terms should be used such as “arising” or “paid” to avoid the complication. If
the intention is to prevent assignment of income rights to a third state, this can be covered by SAARs
(discussed in section 2.3).
Finally, a similar problem exists as per the general MPT clause, such additions to the treaties
leave developing countries’ tax authorities and tax courts with too much power but no capacity to
handle ambiguous situations.
Suggestions
In order to tackle the conflict of tax incentives, the wordings can be adjust to “the main
purpose” only, this way, legitimate investors with bona fide reasons would be excluded from this AAR.
Further, it seems rather redundant for such a general rule to be put into every distributive provision,
unless the state wants to use it for specific distributive rules, which are vulnerable to abuse. It could
be a less intrusive approach compared to the application suggested in BEPS action 6 and perhaps a
more balanced approach for developing countries’ consideration. For instance, it can be used in
article 11 as a safeguard for interest payments if there is no SAARs targeting interest deduction (e.g.
Thin Capitalisation rules) in their domestic tax laws and the treaty provides attractive WHT reductions.
Lastly, to avoid overwhelming the tax courts and tax administration, the tax authorities may
consider issuing soft rules and guidelines for taxpayers. These soft rules may indicate the evaluation
methodology set forth by the tax authorities, example of scenarios where these clauses are applicable
and clear exceptions where the AAR is not applicable.
2.2.3. The Savings Clause
The Savings clause is a US concept which is included in its treaties to allow contracting
states to tax residents based on their domestic tax rules notwithstanding the provisions that restricts
24 Section 21.4 of OECD Comm. on Art. 1
Cora Cheung version 13 08 2014 9
source taxation in the treaty. In addressing the issue of treaty overriding domestic AARs, the BEPS
Action 6 suggested the inclusion of this clause to Article one: “3. This Convention shall not affect the
taxation, by a Contracting State, of its residents except with respect to the benefits granted under
paragraph 3 of Article 7, paragraph 2 of Article 9 and Articles 19, 20, 23, 24 and 25 and 28.”25
The exceptions mainly covers rules which are applicable to resident recipients in residence
states, which means that the general rule applies to most distributive rules. This general rule is not
contingent to only abusive scenarios but it is a general statement. It could in effect erase benefits a
treaty provides in its distributive provisions or at the very least make these benefits very uncertain.
Benefits
It allows states to implement their AARs without restriction from the treaties. However,
developing countries may find this clause redundant as it is drafted in the residence state’s
perspective. A savings clause will not help to effect a source state’s domestic AARs and they could
still be overridden by treaties.
Risks
In exchange for tax sovereignty, developing countries could be paying a high price for it. First
of all, the addition of a savings clause could diminish the applicability and attractiveness of a treaty
severely in the investors’ perspective. Developing countries are not just competing for FDI through
treaties, they are also using treaties to make investments through legitimate locations more attractive
compared to investment via tax haven countries. Without a reliable treaty, investors may revert to
investing through tax haven countries as the tax exposure could be the same (given the uncertainty)
and it is more cost effective to set up in tax havens.
Secondly, it allows taxation by a contracting state of its residents. As a source state,
developing countries do not get much benefit from this rule.
Suggestions
There is still value in a savings clause if the scope is limited to abusive situation and not just
for residence state. For example: “3. This Convention shall not affect the taxation or denial of benefits,
by a Contracting States, in a tax avoidance situations of its residents except with respect to the
benefits granted under paragraph 3 of Article 7, paragraph 2 of Article 9 and Articles 19, 20, 23, 24
and 25 and 28.”26 In fact, this could be combined with a GAAR for better outcome. However, the term
tax avoidance needs to be defined clearly to limit its application. The definition of tax avoidance in
domestic law should also be included and match the definition in treaty to avoid discrepancy in
applying the AARs.
2.3. SAAR
2.3.1. Two General Approaches to SAARs
The OECD has categorised SAARs in two types of approach27: an entity exclusion approach
or an income denial approach (referred to as safeguarding clause in the Commentary) as a counter
treaty shopping measure. The entity exclusion approach will exclude companies which pay low or no
tax (thanks to tax privileges) from treaty benefits. The intention is to prevent harmful tax competition
from countries that couple preferential tax regimes with treaty benefits to drastically reduce effective
tax rates on investment returns. The income denial approach targets income, which is exempt or
suffers minimal tax, instead of the company. This seems to be a more moderate and reasonable way
to address abusive situation without making it too onerous for taxpayers. Most of the SAARs
discussed below will fall into either categories.
Benefits
25 See OECD, supra note 16 26 See OECD, supra note 16 27 Section 21 to 21.3 of OECD Comm. on Art. 1
Cora Cheung version 13 08 2014 10
The entity exclusion type rules target conduit entities while the income denial rules target
conduit arrangements. By excluding these entities and income streams from benefiting from the
treaties, the benefits of setting up conduit companies in treaty partners’ states are effectively nullified.
These are particularly handy provisions for developing countries to include in treaties with popular
conduit jurisdictions with preferential tax regimes such as the Netherlands, Belgium, Luxembourg,
Malta, Singapore, etc.
Risks
Entity exclusion rules may require constant updating on the developing countries’ part.
Depending on the drafting, if the treaties include a closed list of entities which are excluded from
benefiting from the treaties, this list will need to be constantly reviewed and updated mostly by the
developing country since it is to its benefit to do so. If it is an open list of entities which have certain
qualities, it is harder to implement. Tax authorities of developing countries will have to first evaluate
the status of an entity at each point of the transaction to determine the applicability of the treaty.
Status of the companies may change year-on-year, which translates to perpetual administrative
burden on the developing countries.
Income denial rules are rules like “subject to tax clause” (ref. Sec. 2.3.4.1), targeting exempt
or lowly taxed income stream instead of the entity itself. It is perhaps a less restricting and fairer
treatment towards taxpayers as their non-exempt income could still benefit from the treaties. In the
tax authorities’ perspective, it remains burdensome as it still requires them to closely monitor their
treaty partners’ domestic tax law changes. For this rule to work for a source state, developing
countries need to establish that the income will be subject to tax (or be subject to acceptable tax
rates) in the residence state, i.e. they are required to foresee the tax treatment post
payment/remittance. One option is to require the taxpayer to submit a proof of tax payment in the
residence state subsequently or the source state may withhold full amount and provide a refund upon
receipt of the mentioned proof of payment in the residence state. Either ways, it requires the tax
administration to constantly review, assess and follow up with taxpayers on most cross-border
payments which might not be feasible.
Another issue with drafting will be to define “low tax”. Whether it is a set rate; or a percentage
of source state’s headline tax rate compared against the headline tax rate of the treaty partner; or the
effective tax rate, these need to be justified with rationale and need to be regularly reviewed. Further,
considering the reverse scenario whereby source state entity is granted tax incentives and income
was not subject to tax, these entities or income could be caught by this clause and thus unable to
enjoy the treaty protection in the residence state, nullifying all incentives given by the developing
countries as income will be fully taxable in the residence state. The effect is equivalent to the lack of
tax sparing relief clause in the treaty.
Suggestions
Developing countries need to modify standard SAARs to suit their needs and be aware of the
following issues. Firstly, some SAARs can be technically difficult to draft. The developing country risks
making them too restrictive which would deter investments while having a narrow scope would make
them too easy to circumvent. Secondly, they can be administratively demanding. The treaty may
require constant updating (even if it is just for the annexes) and it could strain the enforcement
department unnecessarily if it requires case by case assessment of claims and refunds. Lastly, these
rules could potentially wipe out the tax advantages the developing country’s domestic tax law or the
treaty is granting. This brings us back to square one, no FDI and no tax revenue.
Cora Cheung version 13 08 2014 11
2.3.2. Limitation On Benefits
It is modelled after the LOB article in the US Model treaty, included in both the UN28 and the
OECD29 Commentary and a modified version is recommended in the BEPS action 6. The LOB
article30 is a combination of SAARs put into one Article. Key concepts are embedded in each
paragraph, in Para. 1: introduction of the “Qualified Person” concept as additional criteria for treaty
access which is similar to the effect of adding Beneficial Owner concept to the OECD MC distributive
rules; Para. 2: definition of “Qualified Person”, which encompasses detailed shareholding tests, stock
exchange provision31, management and control test32, physical presence test33 and channel
provision34; Para 3 provides an exception for active businesses, which is similar to the “activity
provision”35; Para 4 gives the competent authority power to grant access to the Convention, part of
the wordings resemble the MPT and the guiding principle.
The LOB provision is proposed as a separate article to the treaty and effectively as an
additional condition to access the treaty on top of the existing Articles 1, 3 and 4 of the OECD MC.
Benefits
Deploying the LOB article would cover a lot of the treaty abuse issues like conduit companies,
stepping-stone arrangement, residency manipulation and artificial arrangement without economic
substance. Moreover, it contains safeguards like the active business exclusion and stock exchange
provision for legitimate businesses, a tangible set of criteria and thresholds for entities to be regarded
as a qualified person.
To wrap it all up, there is even a GAAR-like provision (Para. 4) thrown in for contracting states
to exercise discretion. It does seem to have the characteristics of a magic pill for all abusive ailments.
Risks
The downfall of the LOB article is also the attribute that made it attractive. Having all the rules
packaged into one has its benefits as well as risks. By putting them all into one article, they become
less flexible and may not make sense for all kinds of payments. The problem with such redundancy is
the equivalent risk of it being an obstacle for application of the treaty. For example, it might not be
logical to apply the channel approach within the “qualified person” concept36 to dividend payments but
the rule is non-discriminatory towards all distributive rules, so if the entity does not qualify under the
other provisions to access the treaty, it might be prohibited from benefiting from the treaty due to an
unintended limitation rule.
One may notice within the LOB article that new terms are introduced and defined and the
definitions are further defined to the point of which paragraph 5 is dedicated to define all the new
terms within the article. Problem with this is that it is a vicious cycle, if contracting states wish to drill
into the wordings of such a complex article, they may end up drafting another treaty within the treaty.
Practically, this will not be feasible for developing countries.
Moreover, there is the question of effectiveness of the article, the author agrees that it adds a
layer of protection against the abuse of the treaty; however, it does not seem too difficult to
circumvent it either. In addition, not all countries or potential treaty partners of the developing
countries are willing to include the LOB in their treaties since it is not yet a prevalent article. The
absence of the same in some treaties may be interpreted as having a higher tolerance for tax
avoidance arrangements.
28 Section 20 of UN Comm. on Art. 1 29 Section 20 of OECD Comm. on Art. 1 30 See OECD, supra note 16 31 Organisation for Economic Cooperation and Development. Public Discussion Draft, BEPS Action 6:
Preventing the Granting of Treaty Benefits in Inappropriate Circumstances. (Paris: OECD, 2014), LOB Article paragraph 2(c)(i)
32 Ibid paragraph 2(c)(i)(B) 33 Ibid paragraph 2(e)(i) 34 Ibid paragraph 2(e)(ii) 35 Section 19(b) of OECD Comm. on Art. 1 36 See OECD, supra note 33
Cora Cheung version 13 08 2014 12
The elephant in the room once again is the feasibility of implementation, is it worth the while
for developing countries to devote their limited resources to administer such an article along with
other obligations as treaty partners?
Suggestions
When adopting the LOB article, developing countries can pick and choose concepts from it
and embed them into the applicable distributive rules or they can specify within the LOB article which
types of income, gains or profits these concepts would be relevant for.
A simplified version of the LOB needs to be developed for treaties with developing countries.
The consideration and technical skill required for having such an article challenges even the very
developed countries. The OECD has not prepared Commentary or made any reference to the US
MC’s technical explanation thus far and it is probably not the best idea to rush into it until it has
developed the simplified version of LOB article. It might also better to have a separate GAAR than to
have a watered down GAAR tucked into a set of SAARs as it dilutes the effect of a GAAR but adds to
the formidability of the LOB.
2.3.3. Denying Benefits to Conduit Entities
2.3.3.1. Look-through provision
The look-through provision suggested by the OECD targets the conduit entities by
disregarding them (along with the treaty benefits), which is similar to the Beneficial Owner concept
below. The following wordings were added to the OECD Commentary in 1992: "A company that is a
resident of a Contracting State shall not be entitled to relief from taxation under this Convention with
respect to any item of income, gains or profits if it is owned or controlled directly or through one or
more companies, wherever resident, by persons who are not residents of a Contracting State." 37
The OECD prompted it is necessary, in the adoption of such a provision in a treaty, to
determine the criteria according to which a company would be considered as owned or controlled by
non-residents. This also coincides with the “substantial interest” concept highlighted in the “subject-to-
tax” approach and the “qualified persons” concept in the LOB.
Benefits
The look-through provision is can be more effective than the remittance based provision in
countering “stepping-stone” arrangement. This rule targets the entities with conduit attributes and
disregard their existence thus exclude the resident conduit entity from treaty benefits thereby
addressing the problem head on.
It also seems like a more reasonable rule than, for example, the typical CFC rule, as the look-
through provision would still allow application of treaty between the source state and ultimate
resident’s state, even if the income, gains or profits is not “paid to” the ultimate resident directly (no
“paid to” requirement in this provision).
Risks
Once again the effectiveness of the rule stems on the definition of the term “owned or
controlled”. Generally, the “ownership and control” needs to be defined both quantitatively (e.g.:
percentage requirement) and qualitatively (e.g.: types of rights attach to shares). In a dividend
distribution, percentage of ownership and voting rights threshold are often used as a quantitative
measure while corporate rights attached to the shares are stipulated as qualitative criteria to prevent
the split of legal and economic ownership – a common trick used by tax advisors. The quantitative
threshold may correspond to the ownership requirement agreed in treaties; however, the qualitative
criteria will need to be listed in details. In drafting the list of rights that should be attached to the
shares, developing countries may need to review the type of shares available in the contracting
state’s domestic corporate law to ensure there are no loopholes for abuse.
37 Section 13 of OECD Comm. on Art. 1
Cora Cheung version 13 08 2014 13
Secondly, the repercussion of a look-through provision needs to be considered - should the
income retain its character or should it be deemed a dividend? This could affect the domestic WHT
rate applicable or the treaty distributive rule if another treaty is applicable, the contracting states
needs to agree on the course of action for these repercussions.
Thirdly, there might be an issue of double source taxation when the conduit entity distribute
the income, gains or profits to its shareholder. If the state where the conduit entity is tax resident (it
might be considered conduit in one state but not in others) may exercise its source taxation rights, the
same income might be double taxed. This dual source issue, as stated in article 23 of the OECD
Commentary paragraph 11, has to be dealt with by the Mutual Agreement Procedure.
Suggestions
Needless to say, developing countries will require technical assistance while drafting as well
as during the regular review of this provision. As highlighted above, there is no illusion that this
provision requires bilateral agreement, careful drafting and sophisticated implementation to meet its
objective and avoid causing double taxation.
If the developing country decides to adopt this provision, to ensure the applicability of third
state’s treaty, the “alternative relief provision” may be included: "In cases where an anti-abuse clause
refers to non-residents of a Contracting State, it could be provided that the term "shall not be deemed
to include residents of third States that have income tax Conventions in force with the Contracting
State from which relief from taxation is claimed and such Conventions provide relief from taxation not
less than the relief from taxation claimed under this Convention".38
2.3.3.2. Beneficial Owner Concept
The OECD introduced the Beneficial Owner concept in the distributive provisions in 1977.
The intention was to address abusive situations arising from the literal interpretation of “paid”.
Taxpayers were taking advantage of that loophole to obtain treaty benefits making “payments” to
conduit/nominee entities in treaty countries. Although the term was inserted into the OECD MC, it was
not defined within the treaties. In the Beneficial Owner discussion draft39, the OECD proposed that the
recipient of payment is considered the Beneficial Owner if he has the full right to use and enjoy the
payment unconstrained by a contractual or legal obligation to pass the payment received to another
person. However, the OECD remains ambiguous towards the reliance on domestic definitions of the
term “Beneficial Owner” in the absence of treaty definition, in accordance to Article 3(2) of the OECD
MC.
Benefits
Beneficial Owner is a familiar concept internationally defined after all the debates through the
years and it widens the reach of the distributive provisions in the protection against conduit entities
and arrangements.
Risks
One of the risks are the conflicting position of contracting states in interpreting this term within
the treaties and possible differences in their domestic definition. There is also no discussion in the
OECD Commentary about the course of action upon denying treaty benefit when payment was not
made directly to the Beneficial Owner but the Beneficial Owner is resident of a contracting state in
another treaty. Is the payment a criteria to treaty access? The indirect payment arrangement could be
purely for bona fide reasons for example to reduce currency risk or centralise treasury.
Suggestions
Since newly concluded treaties will have the term “Beneficial Owner” in place, developing
countries should include the definition in the treaty and adopt the same definition in their domestic tax
legislation for clarity.
38 Section 19(e) of OECD Comm. on Art. 1 39 Organisation for Economic Cooperation and Development. Discussion Draft: Clarification of the meaning of
“Beneificial Owner” in the OECD Model Tax Convention.(Paris: OECD, 2014)
Cora Cheung version 13 08 2014 14
Contracting states may consider adopting the “alternative relief provision” (Section 2.3.3.1
refers) and agree on the applicability of “payment” as a condition for granting relief in cases where the
Beneficial Owner is resident of another contracting state. Contracting parties should also provide a
recourse on potential double taxation issues.
2.3.3.3. Deemed Conduit clause
The deemed conduit clause is a SAAR not considered by the OECD so far. Below is an
excerpt from the India-Singapore treaty:
“3. A resident of a Contracting State is deemed not to be a shell/conduit company if its total annual
expenditure on operations in that Contracting State is less than S$200,000 or Indian Rs 50,00,000 in
the respective Contracting State as the case may be, in the immediately preceding period of 24
months from the date the gains arise.
4. A resident of a Contracting State is deemed not to be a shell/conduit company if:
a) it is listed on a recognised stock exchange of the Contracting State; or
b) its total annual expenditure on operations in that Contracting State is equal to or more than
S$200,000 or Indian Rs 50,00,000 in the respective Contracting State as the case may be, in the
immediately preceding period of 24 months from the date the gains arise.
(Explanation: The cases of legal entities not having bona fide business activities shall be
covered by Article 3.1 of this Protocol.)”40
The above is the first of its kind that the author has seen, it is a reverse safe harbour type clause and
akin to a simplified “qualified person” definition.
Benefits
The rule is simple and direct in targeting conduit entities by increasing the cost of conduit
entity establishment. By using a purely quantitative rule, it also allows simple application versus a
qualitative approach. This is also the kind of AAR where result is measurable and could be
anticipated. If the developing countries have statistics on the average expenditure of an operating
entity in the contracting state, they will be able to see the number of entities disqualified by the
threshold; projecting that to volume of relevant cross border payments, the “additional tax revenue”
from denying WHT reduction can be estimated. This gives contracting states valuable control over the
cost and benefit of this AAR.
Risks
The statistics of the contracting state may not be readily available and to set a single
threshold across all industry may not be fair. Further, such a rule may discriminate against legitimate
small foreign investors.
The economic landscape tends to change rapidly in developing countries, this might call for
regular revaluation of the threshold for it to remain relevant. Moreover, expenditure can be made to
related parties of the conduit entity to meet the threshold.
There is also a danger in the reciprocity of the clause as developing countries may not have
the capacity and knowledge to evaluate the adequacy of the threshold proposed by the other
contracting state. For instance, Singapore could have proposed the S$200,000 minimum expenditure
which could be the bare minimum expenditure of a Singapore company and almost all Singapore
entities would qualify, whereas Rs. 5,000,000 is the real average expenditure of an operating Indian
entity and only 50% of the entities would be eligible. This could tilt the obligations of the contracting
states drastically.
Suggestions
This is an entry level clause which developing countries could benefit from. Although there
could be difficulties in setting and reviewing the thresholds. It gives developing countries the rare
40 Agreement Between The Government of The Republic of Singapore and The Government of The Republic of
India for The Avoidance of Double Taxation and The Prevention of Fiscal Evasion with Respect to Taxes on Income- ANNEX B Article 3
Cora Cheung version 13 08 2014 15
chance to estimate the effectiveness of an AAR with tangible figures. It might also incentivise
companies to meet a certain level of local expenditure which is always good for the economy.
Expenditure requirement should exclude related party payments to prevent avoidance.
Finally, to prevent the exclusion of the smaller enterprise, an exception can be added in the
clause for companies with annual turnover below a certain amount. The rule should be included in the
Annex or protocol to allow easy amendment. As the developing countries progress, this may not be
necessary and more refined provisions may replace this one.
2.3.4. Denying Benefits to Conduit Arrangements
2.3.4.1. Remittance based taxation & Subject-to-tax provision41 :
The intention of the remittance based provision is to prevent non-taxation in situation whereby
the resident state taxes only on remittance basis. The rationale is that relief should not be granted as
there is no double taxation. The following paragraph is suggested by the OECD in its Commentary:
"Where under any provision of this Convention income arising in a Contracting State is relieved in
whole or in part from tax in that State and under the law in force in the other Contracting State a
person, in respect of the said income, is subject to tax by reference to the amount thereof which is
remitted to or received in that other State and not by reference to the full amount thereof, then any
relief provided by the provisions of this Convention shall apply only to so much of the income as is
taxed in the other Contracting State." 42
An addition to the above, a time limit for remittance is also suggested for administrative clarity
considering the possible time difference in claiming for benefits and the actual cash remittance, i.e. if
remittance is not made within the time limit, benefits of the treaty will not be granted. In the OECD
Commentary, under Article 10, 11 and 12, abuse through the use of PE was mentioned and a subject
to tax provision was suggested under Article 24 - “… an enterprise can claim the benefits of the
Convention only if the income obtained by the PE situated in the other State is taxed normally in the
State of PE (in 3rd state)” 43
Curiously, the OECD Commentary also mentioned the subject to tax approach and illustrated
the effectiveness of the clause, it even recommended to add a bona fide provision for flexibility. The
difference between these two provisions is minor, subject to tax clause has a wider scope and could
cover the remittance based taxation provision and there is no clarification on the reason for having
separate provisions in the Commentary.
Benefits
These clauses keep the treaty close to its primary objective of eliminating double taxation and
prevent abusive situations such as arbitrage of domestic law differences to achieve non-taxation of
income. This is particularly prevalent with treaty partners adopting remittance based taxation. It
relieves developing countries from their obligation to reduce WHT based on the treaty thus protecting
its tax base.
Risks
Besides the timing issue highlighted in the OECD Commentary44mentioned above, there is
also an issue of defining the term subject to tax. It could be understood as being qualified as a
taxpayer (as per “liable to tax” criteria of Article 4 of the OECD MC) or it can literally mean suffering
tax liability in the other contracting state. It is important to define this term because some countries
may regard a taxpayer earning exempt income to have been subject to tax and the taxpayer may
benefit from the treaty; while in other countries, the benefit does not apply if the income is not subject
to tax in the other contracting state.
41 Section 15-17 of OECD Comm. on Art. 1 42 Section 26.1 of OECD Comm. on Art. 1 43 Section 71 of OECD Comm. on Art. 24 44 Section 26.1 of OECD Comm. on Art.
Cora Cheung version 13 08 2014 16
This clause could wipe out all treaty benefits for contracting states which embrace a territorial
tax system if not drafted properly. It can be argued that this result is still in line with the purpose of the
treaties (since no taxation in contracting state there is no need for relief). However, it is unfair towards
countries practicing territorial taxation as they will not benefit from the treaty as much as the other
contracting state.
Further, developing countries have to consider implementation issues. This rule requires the
tax authorities to not only track the outward remittance but also to foresee the taxability of income
upon remittance into the residence state. Putting the rule into context of dividend distribution, it would
be easier to imagine the magnitude of the required effort, bearing in mind that each resident company
may have multiple shareholders with various tax personalities (natural persons, partnerships,
collective investment vehicles, trusts, cooperation, etc.), subject to different tax regimes across
multiple jurisdictions. Although one may argue that it is not anymore tedious than the regular
distributive rules, the additional requirement has a multiplying effect. Therefore the cost of
implementing such a system could outweigh the benefits of safeguarding the developing state’s
taxing rights.
Suggestions
In all, it does not seem effective for developing countries to enact such a clause, considering
the challenge in agreeing to a definition for “subject-to-tax”. Also, it is easy to side-step this clause
through a “stepping-stone” arrangement or making use of a preferential tax regime where income is
minimally taxed as described in Section 2.3.4. Although safeguards could be used to supplement this
clause in preventing the “stepping-stone” arrangement, developing countries run the risk of making
the treaties unnecessarily complex.
2.3.4.2. Channel Approach
The Channel Approach targets income streams instead of entities, which can be more
effective in tackling “stepping-stone” arrangements than targeting conduit entities. The OECD
provides an example: "Where income arising in a Contracting State is received by a company
resident of the other Contracting State and one or more persons not resident in that other Contracting
State have directly or indirectly or through one or more companies, wherever resident, a substantial
interest in such company, in the form of a participation or otherwise, or exercise directly or indirectly,
alone or together, the management or control of such company, any provision of this Convention
conferring an exemption from, or a reduction of, tax shall not apply if more than 50 per cent of such
income is used to satisfy claims by such persons (including interest, royalties, development,
advertising, initial and travel expenses, and depreciation of any kind of business assets including
those on immaterial goods and processes)." 45 (emphasis added)
The condition that helps target conduit arrangement is in the underlined wordings of the
insertion. This requires tax to be paid on a substantial portion of the remitted income before the tax
benefit would apply, which reduces the likelihood of a conduit arrangement.
Benefits
This approach addresses the issue of conduit arrangements directly. Back-to-back licensing
or financing arrangement will not work under such a provision as the intermediate entity will not be
granted reduced WHT which will result in the same tax liability as the direct borrowing or licensing.
Risks
Inadvertently, this provision may implicate regular taxpayers working on low profit margins.
Since the rule is not industry specific, it would be difficult to set a percentage threshold that is
reasonable across board. Therefore contracting states should evaluate if there is a good rationale for
50% expenditure, if the states’ goal is to secure a minimum effective tax rate, then perhaps the
expenditure threshold should be decided based on the targeted minimum effective tax rate.
45 Section 17 of OECD Comm. on Art. 1
Cora Cheung version 13 08 2014 17
Further, the conditions for expenditure seems too strict, items like travel expenses and
depreciation of business assets (included in the suggested wordings above) actually indicate real
business activities which reduces the possibility that the entity is a conduit. Finally, administratively it
can be demanding as the developing country will need to collect detailed information on the residence
of the other contracting state, and evaluate the profit and loss statement to verify the applicability of
this rule.
Suggestions
Developing countries worried about conduit arrangements can consider modifying this clause
to include a bona fide provision and limit the expenditure type to high risk payments to non-residence
of the contracting state.
If developing countries find the clause too onerous, a watered down version of the condition
such as “... Convention conferring an exemption from, or reduction of, tax shall may not apply if...”.
This will provide the developing country an avenue to pursue this approach at a later stage when it is
better able to address the issue. Such conduit arrangements can also be dealt with by TP regulations
which are a more sophisticated tool that demands strong technical knowledge of the tax
administration.
3. Domestic
3.1. Introduction
3.1.1. OECD and UN clarification on domestic AARs: no conflict
One obvious obstacle for domestic AARs is the potential conflict with treaties. States following
a dualistic legal system may encounter more of such situations. However, both the OECD and UN
MCs have clarified, in abusive situations, there will be no conflict in applying domestic AARs as tax
avoidance is undoubtedly against the object and purpose of treaties anyway. Theoretically, that
makes perfect sense but practical difficulties arises when deciding if it is indeed an abusive situation.
Treaties are mostly bilateral agreements, and “Even if an ambulatory interpretation applies for
treaty purposes, there must be some threshold beyond which the unilateral amendment of a country’s
domestic law constitutes a breach of its treaty obligations.”46 In such situations, guidance shall be
seek from the VCLT. In particular, Articles 31 to 33 of the VCLT are often referred to, as they provide
the rules for interpretation of terms undefined in the treaty. The essence of these paragraphs could be
summarised simply in lay man’s term: as long as interpretation is made in line with the purpose of the
treaty, logically and in good faith, it is not in breach of the VCLT.
Thus, if developing countries are able to justify the enactment of domestic AARs with the
purpose of countering treaty abuse, these rules will not infringe VCLT and it cannot be a point of
accuse for treaty partners. It does not, however, stop the treaty partners from cancelling the treaty.
3.1.2. Pros and Cons of Domestic AAR
Domestic AARs are more flexible than treaty rules by nature because they can be modified
unilaterally whereas treaty rules require consent from treaty partners. As a result, domestic AARs can
be closely tailored to the needs of developing countries as they evolve, has a shorter reaction time
between identification of abusive arrangements and enacting countering rules and be administered at
the level that is compatible to the capacity of the government. There are also possibilities to set a time
period for the rules which would not be possible with treaty AARs and the legislator does not need to
be concerned about reciprocal effects of these rules.
46 Jinyan Li and Daniel Sandler, 'The Relationship Between Domestic Anti-Avoidance Legislation and Tax
Treaties', Canadian Tax Journal(1997)
Cora Cheung version 13 08 2014 18
Downside can be, besides conflicting with treaties, community laws (European Union Law) or
other public laws. There is the possibility of going overboard with AARs and driving FDI away with it.
All the efforts with tax incentives and giving away taxing rights through treaties will be futile if the
domestic AARs are too rigorous and onerous for taxpayers. There is also a risk of them causing
unintended effects when interacting with treaties. Thus, in deploying domestic AARs, all facets of its
effects should be evaluated, including other domestic laws, international laws and the treaties
concluded thus far.
3.2. GAAR
3.2.1. Standard GAAR
Unlike treaty GAAR, domestic GAAR can be very elaborate (e.g. UK) and have a much wider
scope that covers beyond income and capital gains tax. Wordings for a GAAR varies widely but the
general effect of GAAR would empower tax authorities to disregard, for income tax purposes, any
artificial arrangements and transactions with the purpose of obtaining tax benefits that are not
intended by the relevant provision. The terms “artificial arrangements” and “tax benefits” are usually
further defined within the legislation. For the purpose of our discussion, GAAR with the above
elements will be referred to as “Standard GAAR”.
Germany goes further to explain that the GAAR “is applicable if an inappropriate legal
structure is chosen that leads to a tax advantage for which the taxpayer cannot provide significant
non-tax reasons.”47, while Spain goes in a different direction by adopting the substance over form
doctrine in its legislation48 as a GAAR, providing the right to tax transactions based on substance.
Benefits
Just as discussed, GAAR serves as a fall back for tax authorities, it covers the gaps that
SAARs leave. It also gives legislators a break from drafting a never ending list of SAARs, avoiding
over complicating the tax acts.
Risks
Uncertainty is the biggest issue with GAARs, in both taxpayer and tax authorities perspective.
The burden is passed on to the court which, in a developing country, might not have the capacity to
handle tax cases. Many countries do not have a tax court and likelihood of wrongful application of
such rules can be high. Therefore, ambiguous wordings should be avoided, an example of such could
be the Canadian GAAR: “Where a transaction is an avoidance transaction, the tax consequences to a
person shall be determined as is reasonable in the circumstances in order to deny a tax benefit that,
but for this section, would result, directly or indirectly, from that transaction or from a series of
transactions that includes that transaction.”49. Without a full understanding of the Canadian tax
system or tax act, just based on the wordings above, if there is no definition of “avoidance
transaction” the scope seems unnervingly wide, the use of “reasonable” sounds very subjective and
“directly or indirectly….transaction or from a serious of transactions…” gives the impression that the
legislator wishes for the GAAR to reach above and beyond what the tax administration can recognise.
There is also a chance whereby domestic GAAR is overridden by a treaty if the treaty does
not provide a gate way for AARs in abusive situations
Suggestions
Germany’s approach could be useful for developing countries, placing the onus on the
taxpayer to provide significant non-tax reason for an arrangement or transaction. This could
supplement a Standard GAAR to provide a clearer indication of taxpayer’s responsibility. The GAAR
should also have a limited scope to avoid interfering with other tax legislations unintentionally. The
definition of key terms should be concise and unambiguous to allow easy application.
47 German legislation: Section 42 of the Abgabenordnung (General Tax Code) 48 Spanish legislation: Article 16 of the Ley General Tributaria (General Tax Law), Spain 49 Canadian legislation: Section 245(2) of Canadian Income Tax Act
Cora Cheung version 13 08 2014 19
Further, to ensure the applicability of domestic GAAR, first step of the BEPS Action 6 should
be adopted, i.e. including the intention to counter avoidance and evasion in the preamble of treaties.
A judicial doctrine (Section 3.3 refers) could be included in the GAAR to provide more grounds for
judgement when the GAAR is invoked.
3.2.2. Alternative Minimum Tax
Many countries choose to have an AMT rule to supplement their tax code. The format and
wordings varies widely, the US has detailed rules on how to calculate the AMT amount while Labuan
allows the taxpayer to elect from the outset to calculate its tax liability based on a tax rate or just pay
a flat tax. The former is more common but the calculation and parameter used still differs. In
application of AMT, the US and India attempt to spell out the separate set of calculation for AMT
which requires taxpayers to set up another computation and adjust the income figures before applying
the AMT rate; while Cambodia takes on a much simpler approach, i.e. 1% of total turnover.
This can be perceived as a GAAR as no specific income type or entity is targeted, it is a rule
that serves the sole purpose of tax revenue protection. It is an easy option for countries to elect since
it is difficult to anticipate the combined effect of tax incentives, treaty benefits and other short or long
term economic stimulating measures may have on tax revenue.
Benefits
Main feature of the AMT is to secure minimum revenue collection which is better for
budgeting. It also discourages aggressive tax planning since there is a limit to tax savings. In the tax
authority’s perspective, it reduces the need for tax audit and investigation.
Risks
It is definitely going to increase the compliance cost for legitimate businesses depending on
the complexity of AMT calculation. Similarly, tax authorities would need to verify two sets of
calculation for tax assessment. Further, the drafting of AMT rule can be difficult as it requires detail
examination of issues cross disciplines, i.e. accounting, law and economics, something developing
countries may not have the capacity for.
The effectiveness of this rule on conduit arrangements is also doubtful as outward payments
are generally not affected by the general AMT calculations. Just like the subject-to-tax provision, it
doesn’t address stepping-stone arrangements.
On the other hand, if turnover is used as the basis for AMT calculations (tax liability cannot be
reduced through expenditures), it might discourage businesses which works on slim profit margins,
limiting the progression of economic structure for developing countries.
Suggestions
I believe the benefits of this rule outweighs the risks for developing countries. An AMT with
simplified calculation is recommendable. For instance, AMT can be applied on the gross profit based
on the developing countries’ domestic financial reporting standards, keeping the compliance
requirement for taxpayers to minimal. By using gross profits as a basis instead of turnover, the issue
with differing profit margins is reduced. This way, developing countries may secure their tax revenue
without imposing too much burden on taxpayer. Conduit arrangements can be separately addressed
by SAARs.
3.2.3. Black List
Quite a number of countries uses a black list to refuse any form of tax benefits or apply a
higher tax rate to transactions with the listed countries. For example, Brazil imposes a higher tax rate
on outbound remittance of capital gains and service fees to black listed countries50. It is unlikely that
treaty partners end up on the blacklist but such situation does exist.
50 Secretariat of the Federal Revenue of Brazil. List of Favored Taxation and Privileged Fiscal Regimes
Countries and Dependencies.
Cora Cheung version 13 08 2014 20
Kazakhstan, for example, maintains a list of countries with preferential tax regimes and
secrecy laws - the list includes Singapore, China (regarding the administrative territory of Hong Kong)
and some US territories, with whom Kazakhstan has concluded treaties with. Although it has no direct
effect on residents of the treaty partners, i.e. their profit is taxed in accordance with the relevant
treaty, the residents of Kazakhstan who have transactions with the residents of these countries are
subject to limitations on the deduction of interest and must include the profit of their subsidiaries in
their aggregated annual income as mentioned above51.
Benefits
Exclude all black listed countries from any tax benefits and possibly impose disincentive
measures on these countries to discourage investment through them.
Risks
It may not be easy to set the criteria in building such a list. The tax authority will need to look
into each domestic law with sufficient depth to determine the qualification for the criteria. Some
countries ring-fence special tax regimes for investment vehicles under a separate incentive act,
making it difficult to identify these regimes within their tax legislation.
Further, the black listed countries may protest or have implement counter measures against
the developing country which can be detrimental to economic progress.
Suggestions
Developing countries may consider taking a less aggressive approach to black listed
countries by increasing compliance requirements for transactions or structures involving them. More
onerous disincentives can be used for payments which are more susceptible to abuse. This could
also help to hold off the need to conclude information exchange agreements with tax haven countries
- the British Virgin Islands is still in the top 10 list of global investors52, which will relieve developing
countries from the immediate pressure on their tax administrations.
3.3. Judicial Doctrines
Judicial doctrines are the expressed interpretations of tax laws by local courts. Therefore they
also serve as guiding lights for taxpayers to understand the parameters for tax planning. Most of the
judicial doctrines have the same root as the guiding principle advocated by the OECD. Broadly
speaking53, “Economic substance”, “Substance over form” and “Business purpose” concepts aims to
exclude tax motivated arrangements without bona fide commercial reasons, which correspond to the
first condition of the guiding principle; “abuse of law” and “Frau Legis” targets plans which contradicts
the spirit of tax provisions – second condition of the guiding principle.
Most of the AARs are designed around these principles, in treaties and domestic tax laws. It
has been argued that judicial doctrines are more suitable for common law countries but the author
believes that these principles are universal and should be explicitly stated in the legislation for clearer
guidance.
Benefits
The doctrines provide wider scope for application and they allow tax authorities to address
issues based closely on the object and purpose of the convention.
Risks
It has the same problem as GAAR. Judicial doctrine is hard to implement as it is arbitrary and
uncertain. Usually courts rely on them when there is no clear legislation that may address the specific
circumstances in a case, but without a qualified judge, application may not coincide with the judicial
doctrine’s intentions.
51 A. Shaidildinova et al., Kazakhstan, 'Corporate Taxation' , Country Analyses IBFD(accessed on 17 July 2014),
at sec. 10. 52 United Nations Conference on Trade and Development. World Investment Report 2013 (New York and
Geneva: UNCTAD, 2013) 53 Section 28 to 30 of UN Comm. on Art. 1
Cora Cheung version 13 08 2014 21
Suggestions
For developing counties, it might be a challenge for courts to find legislation to rely on for tax
cases as they are still building up the tax acts, therefore it is useful to have judicial doctrines to
provide grounds for judgements. They may consider doing so by incorporating these principles in their
GAARs.
In 2012, the Indian Authority for Advance Rulings issued a ruling denying the benefits of the
India-Mauritius treaty for a share buyback by a Mauritius shareholder of an Indian company. The
Indian Authority for Advance Rulings invoked the “substance-over-form” doctrine to disregard the
legal form of the buyback scheme and to treat it as a distribution of accumulated reserves. In effect,
capital gains on the buyback of shares were recharacterised as dividends. The Indian Authority for
Advance Rulings did so without the support of any provisions from the treaty or domestic tax code but
through judicial precedence. Taxpayer held back the transaction due to this unfavourable ruling. It is
also interesting to note in India’s proposed GAAR, it includes “commercial substance” and “bona fide
reason” as qualifications. The author believes it gives more emphasis on the reliance on these
established judicial doctrines providing tax professionals and authorities with more tangible guidance.
3.4. SAAR
3.4.1. Introduction
Considering the wide variety of SAARs, to facilitate a meaningful discussion, the rules are
categorised by their effects in preventing base erosion. The benefits of each category of rules are
raised in the beginning of each sub-section as the benefits are generic for the rules belonging to the
same category.
3.4.2. Deeming Income & Capital Gains
3.4.2.1. Benefits for this category of rules
These rules allow tax authorities to deem income in abusive situations and tax these income,
profits or gains, protecting the tax base of the countries and penalising abusive arrangements to deter
taxpayers from engaging in them.
3.4.2.2. Controlled Foreign Company
CFC is a basic anti-tax-deferral rule. This is one of the AARs which is designed in the
perspective of residence states, thus the utility for a developing country is limited. The effect of which
allows residence state to, deem a distribution of the undistributed income in a foreign subsidiary, and
impose tax on the amount. Fortunately, the residence state would usually track actual distribution of
income of the foreign subsidiary and provide relief in due time.
The basic works of a CFC rule contain the definition of CFC, a formula to calculate deemed
distribution and exceptions to the rule. The definition generally includes an ownership test which is a
percentage of direct and indirect ownership while the exceptions often include some kind of business
purpose test (e.g.: manufacturing exception for the US). Naturally, developed countries like the US
and Australia has elaborate CFC rules (Subpart F of the US Internal Revenue Code and Part IVa of
the Australian Income Tax Act) while developing countries like China tend to have a more modest
CFC rule.
Risks
It is actually difficult to draft a CFC rule that is effective because SAARs have a narrow scope
which make them relatively easy to circumvent, therefore less effective. Most ownership tests can be
avoided through the use of conduit entities, for example, the ownership threshold can be met if the
shares were split and held through conduit entities in other jurisdictions. Exceptions are also avenues
for abuse as large companies can combine different functions into one entity to qualify.
Cora Cheung version 13 08 2014 22
Some countries like Ireland has voiced concerns of the CFC rule: “It would be contrary to the
general principles underlying the Model Convention and to the spirit of treaties in general if
counteracting measures were to be extended to activities such as production, normal rendering of
services or trading of companies engaged in real industrial or commercial activity, when they are
clearly related to the economic environment of the country where they are resident in a situation
where these activities are carried out in such a way that no tax avoidance could be suspected"54.
Based on the wordings of Article 7 and Paragraph 5 of Article 10, CFC rules could be overridden by a
treaty if no special provisions are made to allow them in the treaty – although Commentary55 provides
that a treaty does not prevent the application of such rules.
3.4.2.3. Deemed Interest on Interest-Free Loans
In the effort of countering interest-free loans within a group of companies, besides using TP
rules, some countries opt for a more direct approach. The rule would apply only to interest-free loans
(usually not low-interest loans as they are dealt with by TP rules) and an interest income will be
deemed by the tax authority – based on their calculation of average prime borrowing rate. This is
typically a residence state SAAR as it serves to protect taxable income base of the lender’s state.
Risks
The application of the deemed interest rule for interest free loans is also a controversial one,
the intent is for the lending state to reclaim their tax base but if the same rule is applied to the
borrower, it would be complicated to deem the interest expense. Should there be WHT on such
deemed interest expense? Would it be deductible against taxable income of borrower’s state? Would
the treaty WHT rates apply? As such, it is also technically demanding to draft this rule as it needs to
consider all repercussion of a fictitious transaction (deemed income).
3.4.2.4. Exit Tax
Exit taxes are also a form of anti-avoidance and anti-deferral rule. The change of residence
could result in a loss of taxing rights by the former residence state. Generally taxing right on gains
from disposal of assets (with the exception of immovable properties) is with the residence state, thus
asset holding persons could change their residence to a state without capital gains tax in order to
dispose their assets and earn tax free capital gains before returning to its original residence state.
Alternatively, assets could be settled into a trust which enjoys tax exemptions until the distribution of
income to beneficiaries takes place, achieving tax-deferral.
In response to such arrangements, some residence states would deem a disposal of assets
upon change of residence or settlement of assets into fiduciaries. A deemed capital gain will be
assessed by the tax authorities based on the market value of the assets at the time of change or
settlement.
Risks
Exit taxes have both logic and implementation issues. The state’s argument for taxing capital
gains upon exit is that the gains were made while the owner is resident of the state. However, it is
unclear if the owner will be considered a resident at the point of deemed disposal as it is a
simultaneous event. If a foreign asset is concerned, would the treaty apply when there is no longer a
resident recipient? Also, if there is a loss based on FMV, will the deemed losses be deductible against
other taxable income upon exit? All these issues will need to be considered in drafting such rules.
Further, this rule could be overridden by Paragraph 5 of Article 13 of the OECD MC if no
special provisions are made to allow it in the treaty.
54 Section 27.5 of OECD Comm. on Art. 1 55 Section 23 of OECD Comm. on Art. 1
Cora Cheung version 13 08 2014 23
3.4.2.5. Suggestions for this category of rules
For developing countries the need for these rules is not dire, considering the complexity of
these rules, the implementation could wait until the developing country is at a stage of development
when outbound investment proliferates and the economy progress towards a residence state.
However, they may start with imposing an obligation to disclose income details of a resident
company’s foreign investment in its tax return, interest-free loans and the change in fair market value
of assets (latter two items are usually available in the taxpayers’ financial report as it is). Developing
countries can use the data collected to monitor and assess the cost and benefit before enacting these
SAARs.
3.4.3. Deduction restriction
3.4.3.1. Benefits for this category of rules
These rules protect the tax base of countries through preventing excessive deductions
against taxable income. It addresses the relentless motivation of tax advisors to reduce the taxable
income through tax deductions.
3.4.3.2. Interest Restriction/Thin Capitalisation Rule
Interest Restriction rules such as Thin Capitalisation Rule limits the deduction of excessive
interest. For Thin Capitalisation Rule, usually the amount of interest deductible is limited to the
allowed debt-equity ratio. For other Interest Restriction rules, usually an item in the financial
statement is used to calculate allowable interest expense. The Singapore interest restriction
formula56, for example, requires companies to separate income-bearing assets and non-income-
bearing assets. The percentage of non-income-bearing asset out of total asset is the percentage of
interest that is not deductible. This is a burdensome exercise for asset heavy companies.
Risks
A pertinent issue about these rules is the potential for double taxation. When interest is paid
part of the expense is not deductible against taxable income, while WHT still applies on the full
interest payment (even the non-deductible part) thus effectively taxing the non-deductible amount
twice.
There is also a possibility that Thin Capitalisation Rule could be overridden by Paragraph 4
and 5 of Article 24 of the OECD MC if there is no provision in the treaty to allow such rules – although
Commentary allow the application “insofar as their effect is to assimilate the profits of the borrower to
an amount corresponding to the profits which would have accrued in an arm’s length situation”57, it
does not address the potential double taxation.
3.4.3.3. Leasing Expense Restriction
This rule targets sale and leaseback schemes whereby an entity leases back an equipment it
has sold to the buyer, creating a tax deductible leasing expense and possibly a capital loss. This
scheme can be a purely legal arrangement, which requires nothing more than paperwork: the
equipment does not need to move an inch and the lessee gets tax deductions while the lessor gets
capital allowances/depreciation deductions on the asset to set off against the rental income it
receives. If found to be a purely artificial arrangement, rental expense will be disregarded.
Most deduction restriction rules circle around related party transactions, which are also
targeted by TP rules. These rules have less of a ripple effect compared to TP rules and generally
simpler to apply.
Risks
56 http://www.iras.gov.sg/irasHome/page04.aspx?id=614#interestadjustment (accessed on 27 July 2014) 57 Section 3 of OECD Commentary Article 9
Cora Cheung version 13 08 2014 24
This rule also has the issue of potential double taxation, when rental income is paid and the
expense is not deductible against taxable income, while WHT still applies on the amount classified as
royalties payment (assuming it is for “the use of industrial, commercial or scientific equipment”58) thus
effectively taxing the non-deductible amount twice.
Further, it needs to be clear when would the situation constitute abuse because it could
actually be industry practice to hold all assets through a separate company from the operating
company for easy management, in which case, taxpayers would be penalised for a bona fide
arrangement.
3.4.3.4. Suggestions for this category of rules
These can be useful rules for developing countries as long as they have a simple formulae for
implementation. Thin Capitalisation Rule especially is easy to apply since there is a ratio. For other
types of interest restriction, a readily available accounting item should be used as the basis. The
deduction limit is often a percentage of taxable income or assets therefore application can be tedious.
For rules that require a qualitative evaluation like the leasing expense restriction, a set of
conditions can be established for easy enforcement and a bona fide provision can be included.
Some deduction restriction rules are also used to discourage certain transactions to prevent
over leveraging and bubbling of the economy. For instance, it has been considered in the US to curb
an over leveraged property market by limiting deduction of interest expense from borrowing for
acquisition of real property59. Although it is out of the scope of this paper, it is a side effect that the
legislator should look out for when drafting such SAARs. The legislator should ensure that a
deduction restriction rule does not result in unintended adverse effect for a particular business sector.
3.4.4. Income Recharacterising Rules
3.4.4.1. Benefits for this category of rules
There are plenty of SAARs with the effect of income recharacterisation. It echoes the
substance over form doctrine, providing the tax authority the right to recharacterise a type of payment
in specific circumstances for income tax purpose. These rules target schemes which take advantage
of the different treatment of income (usually passive income) by artificially changing the nature of
income, gains or profits.
3.4.4.2. Interest Recharacterising Rule
It is usually more attractive for investors to use debt funding as it reduces the taxable income
of the source state entity. To prevent this sort of base erosion investee states either limit interest
expense deduction when the debt-equity ratio threshold is breached or they recharacterise the
excessive portion of interest expense into dividend distribution, i.e. no deduction against income and
WHT is applicable for the deemed dividends. In this case, it is particularly important to have a simple
and clear formulae for calculating the amount to be recharacterised.
3.4.4.3. Substance over form approach
There are variations of the rule dependent on the type of abuse. When dealing with more
complex tax avoidance scheme such as the use of hybrid mismatch instrument, the tax authorities
may adopt a substance over form approach by disregarding the legal form of such instruments and
recharacterising the transaction by comparing the facts of the case to a bona fide situation. Countries
may also go with a mirroring clause (e.g. Denmark) which recharacterise the payments to be in line
58 Art. 12.3 UN Model 2011 59 Wall Street Journal. Should Congress Limit the Mortgage-Interest Deduction? (the United States: WSJ, March
16, 2014)
Cora Cheung version 13 08 2014 25
with residence state’s income recognition. This is extensively discussed in the OECD’s BEPS Action
2 discussion draft.
3.4.4.4. Anti-Dividend Stripping Rule
Finally, a classic example of an income recharacterising rule is the anti-dividend stripping
rule which targets dividend stripping schemes, i.e. an arrangement whereby taxable dividend income
is converted into tax-free or low taxed capital gains. It is commonly done through the sale of shares to
an intermediary entity shortly before a dividend is paid on the shares followed by a repurchase of the
shares by the original shareholder. The difference in sale and repurchase price (capital gain) will have
an uncanny resemblance to the dividend amount. The intermediary would normally be a company set
up in a treaty partner state with a preferential tax regime towards foreign dividends. This could be an
issue for developing countries which do not tax or impose low tax on capital gains but taxes dividend
income. To counter these conduit arrangements facilitated by treaties, some countries instil anti-
dividend stripping rules which involve the recharacterisation of such capital gains to dividends if the
holding period of the intermediary is too short or the transaction is not supported by bona fide
reasons.
There are many more SAARs with the recharacterising effect especially in the digital
economy area but the general principle does not deviate much.
3.4.4.5. Risks for this category of rules
The biggest disadvantage of using a recharacterisation rule is the possible unexpected
repercussion of altering the nature of income. For example, if an interest is recharacterised as
dividend, will it retain its character in the income recipient state? Will the treaty relief for dividend
income be applicable? It could result in double taxation, if a payment of dividend which is not
deductible in the source country (and WHT may apply) is recognised as an interest income in the
resident’s country, no underlying tax will be relieved in residence state.
Drafting a recharacterisation rule requires meticulous consideration across other distributive
rules. These rules often have unforeseen effects. For example, these rules can be challenged on the
basis of reciprocity: instead of interest expense, an interest income is received with the exact same
condition; since interest expense is not deductible, interest income should not be taxable either.
These types of domestic SAARs are highly susceptible to challenges from existing treaty partners if
they affect the benefits of their residents and their taxing rights. In particular for the dividend stripping
rule, it is susceptible to being overridden by Paragraph 5 of Article 13 of the OECD MC if no special
provisions are made to allow it in the treaty.
3.4.4.6. Suggestions for this category of rules
Developing countries could better benefit from such rules if they are able to limit its application
to high risk incomes, such as interests and royalties, and establish an open list of criteria which
taxpayers and tax authorities can follow. They should also provide avenue for recourse so that the
recharacterisation should not manifest beyond that transaction.
It may be sensible for countries to have the corresponding clause within the treaty to avoid
conflict in its application by the contracting parties. This could also avoid the issue of potential dispute
with treaty partners.
3.5. Safe Harbour Rules
3.5.1. Introduction
Rules are not rules without exceptions, safe harbour rules are the exceptions to the GAARs
and SAARs providing a level of certainty and comfort to taxpayers. These rules may also appear in the
Cora Cheung version 13 08 2014 26
form of thresholds for treaty access which would encourage the majority of taxpayers to abide by,
safeguarding tax revenue while limiting the burden on tax authorities’ enforcement unit. These rules
are spread through both treaty and domestic AARs. A few examples are illustrated below to
demonstrate the possibilities these rules provide for developing countries.
3.5.2. Stock Exchange provision – Business Purpose
This is a common exception granted, as the general assumption is that listed entities would
satisfy the bona fide requirement. Therefore this exception is included in many AARs which follow the
substance over form or economic substance doctrine. "The foregoing provisions shall not apply to a
company that is a resident of a Contracting State if the principal class of its shares is registered on an
approved stock exchange in a Contracting State or if such company is wholly owned - directly or
through one or more companies each of which is a resident of the first-mentioned State - by a
company which is a resident of the first-mentioned State and the principal class of whose shares is so
registered." 60.
Benefits
This rule protects legitimate businesses from the compliance burden which AARs inflict. MNCs
which are listed would not be deterred from investing in the developing countries.
Risks
However, one might question the effectiveness of the rule as several tax haven jurisdictions
have their own stock exchange where listing requirements are as relax as their island lifestyle and
there may not be economic substance at all. The second question to raise is, what are the criteria tax
authorities look at to approve a stock exchange? It would be impractical to have an exhaustive list and
most countries include stock exchange in treaty partner states into the list; others may include stock
exchanges of countries that are official members of international organisations (such as the OECD) as
well.
Suggestion
Developing countries may consider an exclusion list instead, by excluding tax haven countries’
stock exchange, it would maintain the integrity of this rule.
3.5.3. Holding Period – Substance Requirement
The holding period requirement is a widely applied criterion to establish substance. The
general assumption is that the longer the holding period, the less likely the arrangement is artificial. In
the perspective of businesses, the inconvenience caused by this rule will likely outweigh the tax
benefits thus this safeguard could be an AAR on its own. Conversely, a business should also be
given the benefit of treaty if the minimum holding period requirement is met, as it is less likely that a
conduit arrangement is set up long term for tax avoidance purposes. This rule was also suggested in
BEPS Action 661 as an additional requirement to access Paragraph 2 of Article 10 of the OECD MC.
Benefits
The rule could prevent conduit arrangements as they are usually done within a short time
frame. Some anti-dividend stripping provisions (section 3.4.3.3. refers), for example, uses holding
period of the intermediate company as a condition. It is unlikely that in a dividend stripping scheme,
the original shareholder would bear the risk of a conduit company holding the shares for an extended
period.
Risks
Difficulty can arise in determining the holding period itself as the basis used to deduce a
suitable time period is arbitrary. It is also hard to collect data on the average holding period of assets
60 Section 19(e) of OECD Comm. on Art. 1 61 See OECD supra note 16
Cora Cheung version 13 08 2014 27
and therefore difficult to estimate the impact of this measure. Legislators also need to look out for
infringement of international laws such as Article 63 of the TFEU on freedom of capital movement.
Suggestions
It is a simple rule to enforce and user-friendly for developing countries. However, application
should be limited to situations where short term holding is advantageous, such as dividend stripping
scheme or back-to-back arrangements. The holding period should be of sufficient “inconvenience” for
avoidance purposes but not disruptive for real businesses. That might not be possible, therefore, a
general time period should be given with the possibility for recourse on application, evaluated on case
by case basis.
This should also be used alongside other substance type rules like expenditure threshold and
headcount requirement. When a minimum business cost is set, it diminishes the incentive of a conduit
situation.
3.5.4. Proof of Approval/Acknowledgement from Other Contracting State – Reciprocity
A basic requirement to access treaty benefits is to provide a COR issued by the treaty
partner. This requirement is usually supplemented by other conditions for treaty access. However,
that could also be the sole requirement, for example, India’s Central Board of Direct Taxes, clarified
that Foreign Institutional Investor’s filing a valid tax residency certificate issued by the Mauritius
authorities would be eligible to claim benefits under the Mauritius–India treaty62. This circular provided
certainty for Mauritius investors and showed India’s reliance on Mauritius authority in validating the
taxpayer’s eligibility to access the treaty.
Taking the concept of reciprocity a step further, BEPS Action 663 suggested an amendment of
Article 3 of the OECD MC to require mutual agreement of treaty partners in deciding residence of
non-individual persons, to prevent double non-taxation due to mismatched residence status. Such an
inclusion may conflict with this type of safe harbour rules.
Benefits
Normally, tax authorities will only grant COR to resident companies that are subject to tax.
This prevents double non-taxation through mismatch arrangements as it denies entitlement to treaty
where there is no double taxation.
Risks
When a rule like this is used, the tax authority is placing a lot of trust in the treaty partner to
conduct itself in the object and purpose of the Convention and not act only in the benefit of their
residents or taxing rights.
Suggestions
Developing countries may consider this rule if they are confident that their treaty partner has
the capacity and procedure to prevent abuse. It is however not recommended to have it as the sole
qualifying condition.
4. Case Studies: Myanmar and neighbouring countries
4.1. Economic status
Walking out of years of turmoil, Myanmar kick-starts its economic, political and governance
reform in 2010 with the newly elected government. As the largest country in Southeast Asia and
strategically located between China and India, it has already caught the attention of international
investors while they are in a period of political and economic transition.
The natural resource rich country’s main export includes petroleum gases, precious stones
(other than diamonds), agricultural produce and live stocks. Based on UN Comtrade’s data,
62 Indian legislation: Circular : No. 789, dated 13-4-2000 63 See OECD supra note 16
Cora Cheung version 13 08 2014 28
Myanmar’s total value of exports in 2010 is USD 7.6 billion64 and according to Myanmar’s statistics its
exports has increased to USD 11.2 billion in 2013-201465. The IMF estimated Myanmar’s GDP to be
USD 64 billion in 2014 with a projected growth rate of 7.3%. China was its main trade partner but now
the country has significant trade with India, Thailand, Singapore, Japan, Malaysia, Republic of Korea,
Ivory Coast, Hong Kong as well as Bangladesh (Figure 1 refers).
In terms of tax revenue, Myanmar has an interesting composition of revenue source: half from
Commodities and Services Tax and Commercial Tax, the other half from income taxes based on local
governmental statistics66, other taxes (state lottery, stamp duties) forms less than 2% of total revenue.
Although there is no explanatory notes on the type of taxes included in “Commodities and Services
tax and Commercial Tax”, it is clear that they rely heavily on income taxes as revenue stream.
Therefore protection against corporate income tax leakage is important for Myanmar.
4.2. Attracting Foreign Investments - Incentives
4.2.1. Improve Effectiveness of Incentives
Myanmar recognised the impact foreign investment could have in pushing their development
forward. FDI in particular could help the country in developing infrastructure, training human capital
and gaining technology and know-how. Thus, developing countries’ governments tend to woo FDI
relentlessly and tax incentives is one commonly used tool.
Myanmar has joined in the race to attract FDI in 2012 by providing the following in its Foreign
Investment Law: a) 5-year tax exemption for production of goods or services, b) exemption for
reinvested profits, c) accelerated depreciation, d) 50% tax relief for export profits, e) special
deductions and exemptions from customs duty and internal taxes on imported materials, machinery
and equipment67. On paper, it is very attractive for MNCs and so far there is a stable increase in FDI
in the country. However, it is unclear what the application procedure will be and it is believed that the
Myanmar Investment Commission will hold a high level of discretion granting these incentives.
However, the long term effect (after tax holidays and incentives expire) has yet to be seen.
The effectiveness of tax incentives has been questioned for a long time and studies testing
this hypothesis are mostly inconclusive due to the vast variables involved. While generally it is agreed
that reducing corporate income tax rates has significant positive influence on FDI, not all tax
incentives prove to be cost-effective68. For instance, tax holidays in Malaysia were found to be of little
value for the target firms69 and Halvorsen70 found that return on investment in supported projects in
Thailand was so high that they would have occurred even without incentives.
Moreover, benefits of incentives could be easily wiped out by the absence of tax sparing
relief71. Not all resident state would have tax-sparing relief and not all treaties have tax sparing
clause. In fact, all of the treaties concluded by Myanmar provides credit relief and does not have a
tax-sparing clause. As such even if the enterprise benefits from a tax holiday in Myanmar, all income
repatriated to investor’s residence state will be taxed fully at their domestic tax rates.
64 United Nation Commodity Trade Statistics Database (accessed 12 July 2014) 65 Myanmar Centre of Statistics. Foreign Trade Summary (accessed 26 June 2014) 66 Myanmar Centre of Statistics. Revenue Composition from Taxes (accessed 26 June 2014) 67 International Bureau of Fiscal Database. Myanmar – Country Key Features (Amsternam: IBFD, accessed 23
July 2014). 68 Kevin Fletcher, 'Tax Incentives in Cambodia, Lao PDR, and Vietnam', International Monetary Fund
Conference on Foreign Direct Investment (Vietnam: IMF, 2002) 69 R. Boadway, D. Chua and F. Flatters, 'Indirect Taxes and Investment Incentives in Malaysia” (Oxford: the
World Bank, 1995) 70 R. Halvorsen, 'Fiscal Incentives for Investment in Thailand', Fiscal Incentives for Investment and Innovation
(Oxford: Oxford University Press, 1996) 71 Vito Tanzi and Howell H. Zee, 'Tax Policy for Emerging Markets: Developing Countries', International
Monetary Fund Working Paper, (March 2000)
Cora Cheung version 13 08 2014 29
Therefore the use of preferential tax regimes to attract FDI should be a well deliberated event
and it should be justified by long term returns be it intangible or qualitative. Myanmar could learn from
the experience of the countries in its region, for example, Bhutan.
4.2.2. Learn from Bhutan’s Mistakes
Bhutan introduced tax incentives in 1992 and a dedicated FDI policy in 2002. According to
world bank’s data Bhutan’s FDI spiked in 2007 but plummeted as quickly as it rose, figures have been
sluggish and unstable thereafter up till 2011 (no later data available)72. The one-off increase in FDI
was due to the hydroelectric project Bhutan has embarked on with the Indian government. In other
words there is no evidence to suggest that its tax incentives have any impact on FDI.
In 2010, the National Council of Bhutan acknowledged the ineffectiveness of its tax
incentives73 and attributed it to non-tax factors such as weak infrastructure or lack of skilled labour.
The government is now left with the remnants of FDI withdrawal, loss of tax revenue, unemployment
and even greater pressure to seek long term FDI. Although it is not established if the fault lies in the
drafting of incentive policy or other non-tax reasons, the Bhutanese government could have
prevented this outcome if it had maintained regular communication with the enterprises to work on
any issues they faced.
Seeing that tax incentive is not the cure to all ailments, Myanmar should evaluate its
attractiveness for each industry so it could assess the elasticity of FDI towards tax incentives for each
of those industries. Only when a strong nexus is established should the government consider
implementing tax incentives. Further, to increase its chances in yielding the expected benefits,
incentives need to be drafted with a direct reach to its objective, as Maria Teresa mentioned in her
paper “the devil lies in the details”74. If the authority do not wish to put in place too many conditions in
applying for the incentives, they may consider using AAR to secure investors’ long term commitment.
For example, countries can consider including a claw-back clause on tax benefits if certain
conditions are not met by the enterprise. An AAR could also be used on expenditure based
incentives, where there is further deduction on expenditures (for example training of staffs) and there
should be a limit towards payments made to related parties. Reinvestment type incentives should also
have a lock down period to show commitment otherwise it is susceptible to abuse. Having said so,
businesses will need more than tax reasons to continue their investments, so the government should
not rely solely on tax policies to drive FDI and should maintain regular open dialogue with enterprises
to understand their needs.
4.2.3. Considering Alternatives to Tax Sparing Relief
To avoid the need for tax-sparing clauses in treaties and residence states’ domestic tax relief
provisions, developing countries can consider providing indirect relief to their investors through a
refund mechanism. To the author’s knowledge this is not currently in practice but perhaps could be
considered for the future. For this hypothesis, a full corporate tax is assessed on income sourced in
the contracting state and paid up front. The entity will therefore satisfy the condition to get a foreign
tax relief in its resident state. A refund will be given after remittance of income is made to the
residence state as the incentive measure. This could circumvent the need for tax sparing provisions in
the treaty and in residence state’s domestic tax law while incentivising FDI.
Malta has a similar concept in their general tax system, not in particular for their tax
incentives. Malta has a relatively high corporate tax rate of 35% but it remains one of the top holding
72 www.IndexMundi.com - based on International Monetary Fund, Balance of Payments Statistics Yearbook and
data files, (Accessed on 17 July 2014). 73 National Council of Bhutan. Review of the Economic Development Policy 2010. (Bhutan: Economic Affairs
Committee, 11 June 2010) 74 Teresa Guin-Sui, Maria, ‘Tax Holidays’, International Monetary Fund Fiscal Affairs Department Guidance Note
(2004)
Cora Cheung version 13 08 2014 30
company jurisdictions. The reason is the refund mechanism their tax system has for payments to non-
residents. Basically for income not retained in Malta, tax will be refunded. The effective tax rate is
drastically reduced by this mechanism (sometimes to 0%).
However, if states adopt such practice, it might be challenged by the international community
as harmful tax competition and it could be considered as breaching VCLT by acting in bad faith as a
treaty partner. It also places a huge administrative burden on the source state’s tax authority as it will
need to track income received, taxes paid and payments made to non-residents to calculate refunds.
Moreover, a refund system places cash flow strains on taxpayers which is still an obstacle for FDI.
The balance between the costs (administrative and loss of revenue), benefits (FDI) and risks
(reputational) needs to be carefully evaluated. This gamble might be too risky for a country like
Myanmar, even if implementation is not an issue, considering the fact that it is a country at its early
stage of development, the larger investors may not have the confidence to rely on such a policy when
evaluating their investment returns. Thus, the impact might not be as favourable as one would expect.
4.3. Treaty partners
4.3.1. Myanmar’s Existing Treaty Network
Besides domestic tax incentives, the general perception is that treaty also plays an important
role in attracting FDI. In Myanmar’s case, that statement may hold true based on the statistics below.
Myanmar’s top foreign investors are China (top investor in 2011), Singapore (top investor in 2013),
Republic of Korea, UK, India, Malaysia, Vietnam, Thailand, Hong Kong, Japan (Figure 1 refers).
Incidentally, most of these countries75 have concluded treaties with Myanmar in the recent years.
Singapore had no investment in 2011 and increased its investment to USD 2 billion, taking the top
foreign investor spot in 2013 – the Singapore–Myanmar treaty was in force from 2010. Similarly,
Thailand from no investment in 2011 and rose to USD 489 million in 2013 – the Thailand–Myanmar
treaty was in force in 2012.
The overall FDI is unstable in the recent years due to political changes therefore it is
inconclusive if the treaties helped increase FDI or merely changed the distribution of investing
countries. Given the uncertainty, perhaps Myanmar should learn from the examples of Cambodia and
Mongolia below, and revaluate its current treaty network.
75 Myanmar has concluded Treaties(8) with India, Rep. of Korea, Laos, Singapore, Malaysia, Thailand, United
Kingdom and Vietnam
Figure 1: Myanmar Foreign Investment by Country (source: Myanmar Centre of Statistics – Foreign Investment)
Cora Cheung version 13 08 2014 31
4.3.2. Understand Why Cambodia Said No to Treaties
There are no public statement from Cambodia refusing to conclude treaties but since the
beginning of its economic reform in the 1990s it has not concluded any treaty. According to The World
Bank’s data, their FDI has tripled between 2009 and 2013. It might be true that with the help of
treaties the figures could be even more impressive but perhaps it is a well-considered decision on
Cambodia’s part. Since it has no AAR framework in their domestic tax laws and possibly lacked the
capacity to fulfil its obligations as treaty partner, Cambodia might have taken its time to build the
necessary infrastructure instead of rushing into the economic boom.
In a presentation by Mr Um Seiha (Deputy Director General, General Department of Taxation,
Cambodia) in IMF-High Level Tax Conference for Asian and Pacific Countries 2012, he note that
technical assistance is needed with treaty negotiation and staffs need to be upgraded. At this point,
they still do not have any treaties in force (under Negotiation with Vietnam and Thailand) and no AAR
in its domestic tax laws except for a GAAR pertaining TP which gives tax authority the power to
allocate income amongst related parties76.
4.3.3. Recognise the Reason for Mongolia’s Termination of Treaties with the Netherlands,
Luxembourg, Kuwait and UAE
The BEPS Action 6 Discussion Draft highlighted the policy considerations countries should
take into before entering into a treaty. The discussion draft proposed the insertion of a new section in
OECD MC Commentary Introduction, which suggests tax policy considerations that are relevant to
the decision of whether to enter into a treaty or amend an existing treaty. This is a prompt to review
existing treaties which may be facilitating treaty shopping. The discussion draft reiterates the primary
objective of a treaty – “to avoid double taxation in order to reduce tax obstacles to cross-border
services, trade and investment, the existence of risks of double taxation resulting from the interaction
of the tax systems of the two states involved” 77, and questions a) the necessity of a treaty in
situations where one of the partner states levies no or low income taxes; and b) the risk of non-
taxation when a treaty exists.
This is resonated by a recent report written by a non-profit organisation78 which discusses
Mongolia’s termination of treaty with several treaty partners including the Netherlands. The reports
suggests that the reason for termination of treaty is due to abuse through conduit entities set up in
these treaty partners states by large natural resource extractive industry companies. The report
further states that the Mongolian Ministry of Finance believes one of the mining projects involving
conduit arrangements with 4 of the (then) treaty partners resulted in 45 million euro of tax leakage.
Credit should be given to the Dutch tax authority for taking on a proactive stance in reviewing its role
as a treaty partner for developing countries. Meanwhile, it is interesting to see Mongolia’s perspective
and understand why it took a punishing approach towards its treaty partners after digesting IMF’s
report79.The report identified that their (then) treaty network is prone to international tax planning as
some treaties contain favourable provisions allowing residents of other countries to substantially
reduce and at occasion prohibit source taxation. Although Mongolia was considering to cancel all its
treaties and start building a new network, the IMF suggested renegotiation of the treaties to amend
provisions which are potentially harmful for Mongolia instead.
76 R. Saw, ‘Cambodia - Corporate Taxation’, International Bureau of Fiscal Database Country Surveys
(accessed 7 July 2014). 77 See OECD supra note 16 78 Katrin McGauran, Should the Netherlands sign tax treaties with developing countries? (Amsterdam: Stichting
Onderzoek Multinationale Ondermemingen), 2013, pp 19 79 International Monetary Fund. Mongolia: Technical Assistance Report Country Report No. 12/306. (Washington
D.C.: IMF, November 2012)
Cora Cheung version 13 08 2014 32
Wearing the hat of the Mongolian tax authority, it seems to be the right decision to cancel
treaties with popular conduit jurisdictions and renegotiate with the other treaty partners on provisions
which proves detrimental to tax collection.
4.3.4. Considerations for Myanmar in the Current State of Affairs
Myanmar is at an earlier stage of development compared to Cambodia but has already
concluded 8 treaties and is under negotiation with more countries. Myanmar needs to ensure its tax
authority is able to satisfy its obligations towards its treaty partners and taxpayers. Meanwhile, it
should slow down with the treaty negotiation and concentrate on capacity building.
Fulfilling treaty obligations is not an easy task for tax authorities, they will have to set up the
following: a) a simple system should be set up for taxpayers to claim treaty benefits, i.e. it should be
automatic and should not require back and forth correspondence between the tax authority and
taxpayers; b) a channel for dispute resolution should be provided for conflict situation; c) a group of
trained tax officers will need to answer queries from the public as constant education; d) a team of
investigators needed to enforce AARs for abusive situations; e) a committee will need to regularly
review the treaties against domestic law changes for contracting states; and finally f) there should
exist another team to handle the exchange of information with other countries.
Myanmar should consider the cost of setting this up along with the taxing right it is giving up
through the treaties as part of the true cost of attracting FDI through treaties. Perhaps the cost would
outweigh the benefits of FDI as per the Mongolian example.
Finally, Myanmar may wish to reconsider its treaties with Singapore and Hong Kong (under
negotiation) as these are popular conduit jurisdictions and Myanmar needs to develop its capacity to
handle the potentially abusive situations. It might be difficult to renegotiate the Singapore treaty now
since it is the top investor for Myanmar at the moment, they should however try to input more
safeguards to limit the entitlement to treaty benefits in abusive situations.
4.4. A Review of Existing Treaties
Most of the treaties concluded by Myanmar are based on the UN MC which is recommended
for developing countries80. However, the AAR varies which suggests that the terms are proposed by
the other parties. This raises the fundamental question of whether Myanmar has the expertise to
handle treaty negotiations and safeguard their interests in a treaty. Reviewing the existing treaties will
reveal a few clauses which might not be in Myanmar’s favour:
The PE clause in the India treaty81 has an extended time period threshold for project PE
compared to the standard UN Model. Given that the main export to India is petroleum gases and
energy resources, it is logical to infer that investment interest is likely in excavation of energy
resources thus, the project PE clause is pertinent in this treaty. Whether this is a conscious effort on
Myanmar’s part to provide an incentive to the Indian investors, only the Myanma authority will know,
but typically for natural resources, such incentives are not crucial in tipping the investors decisions.
Capital gain is highly taxed in Myanmar, thus it is highly likely for a taxpayer to attempt
avoiding capital gains tax by holding an investment through a conduit entity in a treaty state where
capital gains is not taxed. For instance, Singapore’s treaty with Myanmar gives Singapore the full
taxing right on the gain from disposal of shares (if certain thresholds are met) and in any other case
source state tax is limited to 10%82. Singapore does not tax capital gains which means that foreign
80 UN Model based treaties: Singapore (2010), Rep. Of Korea(2004), India(2010), Malaysia (2009), Thailand
(2012), Vietnam (2004) 81 Article 5(3) of the India – Myanmar Income Tax Treaty (ratified in 2008, effective in 2010). 82 Agreement between the Government of the Republic of Singapore and the Government of the Union of
Myanmar for the Avoidance of Double Taxation and the Prevention of Fiscal Evasion with respect to Taxes on Income (2010)
Cora Cheung version 13 08 2014 33
investor could have gains taxed only up to 10% from the sale of Myanma shares. Without a counter-
conduit clause in the treaty, this is almost the logical option for foreign investors.
Limitations on benefits/relief clause is not present in all Myanmar’s treaties with the
exception of India, Singapore, Malaysia and Thailand. India’s LOB is closer to a GAAR where benefits
will not be granted should “...the main purpose or one of the main purposes...”83 be to take advantage
of the treaty. While the others have a Limitation of Relief clause based on remittance which is more
for the benefit of the resident country thus presumably proposed by Myanmar’s treaty partners. Once
again, this could be an indicator of the weakness in the Myanmar Inland Revenue Department in
treaty negotiation and safeguarding its tax base from treaty abuses.
Related party payments are subject to restrictions in the treaties as per the model treaties,
however, there is no domestic law in Myanmar that mirrors such clauses. Therefore the lack of such
domestic mechanism will render it a tool for solely its treaty partners to challenge profit allocation and
not so much the other way round. However, due to the scope of this paper, the TP aspect will not be
discussed here.
Considering Myanmar’s economic characteristics, a stricter PE clause (wider conditions to
qualify as a PE) should be kept to protect its taxing rights especially on the natural resources
extraction industries. Stricter distributive rules should also be considered for other income streams
which are common to extracting industries such as technical services, royalties and interest. Some
countries actually exclude income relating to extractive industry from treaty access (UAE-Georgia
treaty refers84). Myanmar may also consider including a clause to ensure minimum expenditure in
Myanmar for the entitlement of treaty benefits. When it comes to treaties with SPV jurisdictions, there
should be further consideration on treaty shopping/conduit issues. Myanmar could use AARs to
counter such arrangement for treaties with jurisdictions like Singapore and Hong Kong (under
negotiation).
4.5. Domestic AAR
4.5.1. Absence of Domestic AAR
Myanmar has an anti-evasion rule85 instead of AARs, at this stage it may be more concern
about fraudulent activities rather than legal avoidance of taxation. Its legislation also provides the
Inland Revenue Department the right to readjust the capital gains if the transfer price is unjustifiably
below market price. In all, Myanmar does not have a set of AARs in its domestic tax law targeting
treaty abuse situations.
The country does not impose withholding tax on dividend distributions or branch profit
repatriations which reduces the advantages of using debt-capital, along with the tax holidays and
exemptions. This might result in a rare instance where equity funding is preferred over debt. Thus,
thin-capitalisation or interest restriction rules may not be necessary.
Capital gains on the other hand have a hefty tax rate of 40% for non-residents. This may
encourage foreign investors to set up a domestic holding company to benefit from the lower residents’
capital gains tax rate (10%). This could be beneficial to Myanmar as they will be able to capture at
least 10% of the increase in value. However, as discussed above (section 4.4) this could be easily
avoided by through treaties. Further, the domestic law does not protect its tax base from indirect
disposal of shares. Even without a treaty, an indirect disposal of shares would have escaped the
Myanmar’s tax scope. There should be AARs which targets change of ownership beyond the
83 Agreement between the Government of the Republic of India and the Government of the Union of Myanmar
for the Avoidance of Double Taxation (2009) 84 Article 3 of the Agreement between the Government of Georgia and the Government of the United Arab
Emirates for the Avoidance of Double Taxation and the Prevention of Fiscal Evasion with Respect to Taxes on Income and on Capital (2010)
85 Section 21(a) of the Income Tax Law of Myanmar
Cora Cheung version 13 08 2014 34
immediate shareholders level for conduit situations. A mechanism to track such transfer could be built
in gradually.
On the other end of the spectrum, Nepal has a rather sophisticated set of AARs compared to
its neighbours but that could present another set of problems.
4.5.2. Avoid Nepal’s Overly Complex AARs86
Although there is no general anti-avoidance rule in Nepal, the Inland Revenue Department is
given the right to, a) re-characterize an arrangement or part of an arrangement that is entered into or
carried out as part of a tax avoidance scheme; b) disregard an arrangement or part of an
arrangement that does not have substantial economic effect; or c) re-characterize an arrangement or
part of an arrangement the form of which does not reflect its substance. These recharacterisation
rules can be found in domestic AARs of many developed countries; however, these AARs are
sparingly used as it grants high level of discretionary power to the tax authorities which creates
uncertainties for taxpayers.
There are no thin capitalization rules in Nepal instead, there is a limitation on interest
deduction when it is “paid by an exempt-controlled resident entity to a person or an associate of
persons having control over the entity, the allowable deduction for interest cannot exceed the total
interest derived by the entity plus 50% of the entity’s taxable income (calculated without including any
interest derived by the entity or deducting any interest incurred by the entity)”87. This rule seems to be
an attempt to maintain a minimum of 50% of taxable income base, without the full understanding of
their calculation, let’s assume that it could indeed ensure a minimum of 50% taxable income. Even so
it is not difficult to imagine the problems with implementing it, considering the capacity of a developing
state and the calibre of workforce available, this is likely to be unenforced.
For countering tax deferral, Nepal has a CFC rule which leaves tax professionals perplexed. It
seems to give the tax authority power to deem dividend distribution of a CFC based on corporate
rights but there is no clarity in the interpretation of the rule. All in all, the author believes Nepal has a
set of rules too complex for implementation thus does not serve its purpose. Learning from Nepal’s
case, Myanmar should envisage implementing rules which could protect its tax revenue bearing in
mind its capacity as a developing nation.
4.6. Summary
Myanmar has few MNCs, large pool of small taxpayers and an unknown size of shadow
economy therefore it is understandable that its main concern is high risk of fraudulent or erroneous
filing. However, the existing anti-evasion rule will not be sufficient for anti-avoidance purposes. The
following policy suggestions should be considered by Myanmar moving forward:
4.6.1. General rule: simple and targeted rules with clear implementation procedure
As a general rule, policies should be simple and direct for the understanding of taxpayers and
administrators. This includes appreciation of the spirit of the policies which should follow by an
automatic application or benefits-claiming procedure.
4.6.2. Revaluate tax incentives, implement safeguards and conditions
Looking at the examples of Bhutan and Mongolia, if Myanmar still believes that tax incentives are
essential for it to attract FDI, it should consider: a) using an unique incentive for the each targeted
groups of taxpayers for easy tracking of “tax revenue loss” and effect of these incentives, b)
supplementing the incentives with tangible conditions (amount of investment, expenditure,
86 P. Gupta, ‘Nepal - Corporate Taxation’, International Bureau of Fiscal Database Country Surveys (accessed 7
July 2014) 87 See P. Gupta, supra note 83
Cora Cheung version 13 08 2014 35
employment etc.) and/or AARs to achieve the desired results, and most importantly, c) negotiating for
tax sparing relief in treaties.
It should also be overtly stated that taking advantage of tax incentives does not contravene the GAAR
or MPT of the treaty or respective states’ domestic tax law.
4.6.3. Review Existing Treaties and Conclude Treaties with Real Investor Countries
Looking at the inconsistency in existing treaties, Myanmar may need to review them for tax
avoidance risks, they should also take the opportunity to evaluate the effect of these treaties against
available data. Special attention should be paid to jurisdictions with preferential tax regime, LOB may
be included for these jurisdictions. In larger scheme of things, Myanmar should aim to conclude
treaties with the Real Investor Countries so there will be less reasons for conduit arrangements.
4.6.4. AAR, definitions in treaty to allow Domestic AAR
To further the effectiveness of the AARs in Myanmar’s treaties and domestic tax laws, terms
should be clearly defined in its domestic tax laws, if otherwise, in the treaties themselves. Domestic
laws give the state more flexibility for amendments in the future should they see the need to do so as
changing domestic laws will be easier than amending all their treaties. The drawback is the possibility
of treaty partners denying such changes made in Myanmar’s domestic law of terms used in treaties.
Based on our evaluation above (Section 2.3 & 3.4) a clear definitions of “Beneficial
Ownership”, “Special Relations” and “Qualified Person” in the treaties and domestic tax law will be
helpful in providing consistency between domestic and international rules.
4.6.5. Narrow GAAR
Generally, developing countries prefer a GAAR due to its broad coverage which allows the
tax authorities to exercise their rights easily, especially when advantage is taken based on legislative
loopholes. However, a GAAR can also be detrimental when a tax authority is not established or has
an aggressive reputation. For example, India’s GAAR implementation has been pushed by for 6 years
due to pressure from international community88. It is therefore wiser to implement a narrow GAAR
which provides higher level of certainty initially. As the country build rapport with the international
community, ascertaining its ability to administrate a GAAR by international standards, it may consider
a GAAR with wider scope.
In a study made in the 2011 by Graham Aaronson for the UK government, he suggested: “A
general anti-abuse rule narrowly targeted to deter such schemes, while not affecting responsible tax
planning, should lead to a fairer, more principled and ultimately simpler tax system and I strongly
recommends that such a rule should be introduced into our tax laws”89. Aaronson made strong
arguments for the moderate approach to GAAR and this is probably the balance that developing
countries need in their system. After all, it is not realistic to try and stop 100% of tax avoidance. If the
rule has the efficiency to tackle majority of avoidance cases, it would be a marked achievement.
Based on our evaluation in previous sections (Section 2.2 & 3.2) Myanmar may consider a
treaty GAAR that contains most part of the guiding principle but for an amendment of “a the main
purpose”. At the same time, the domestic GAAR may be modified to incorporate the business
purpose doctrine and a safe harbour rule such as the “activity provision”90. A further guidance similar
to Germany’s approach (Section 3.2.1 refers) would also lower the level of uncertainties a GAAR
brings.
88 Triggered by the Vodafone case, a coordinated letter was sent by international trade associations (America’s
Business Roundtable, Confederation of British Industry, etc), Reuters, by Jeff Glekin, 2 April 2012 89 Graham Aaronson Q.C., 'GAAR STUDY- A study to consider whether a general anti-avoidance rule should be
introduced into the UK tax system' (London: Information Policy Team, 11 November 2011) 90 Section 19(b) of OECD Comm. on Art. 1
Cora Cheung version 13 08 2014 36
Myanmar could also consider building a black list and incorporate it into its GAAR adding
extra compliance requirement on transactions involving black listed countries.
4.6.6. Progressive SAARs
Similarly, in implementing SAARs, Myanmar should start with rules targeting specific income
which may later be expanded to cover income groups. Strict distributive rules related to the extraction
industry should be implemented and a PE clause that allows source state to better capture income
needs to be negotiated. Myanmar could also adopt the deemed conduit clause in their treaties with
jurisdictions that have high conduit risk.
Domestically, it could also be useful to adopt the concept of Beneficial Ownership to prevent
domestic conduit arrangements, since developing countries tend to have varying tax rates within the
state (special economic zones, industry incentives, etc.). Further, legislator may consider to start with
SAARs which has quantitative rules and measurable benefits for easy implementation and tracking.
Thin Capitalisation rule should be included for interest deduction restriction but it should adopt a
simple formula such as the debt-equity ratio to keep it simple. CFC is probably not necessary at the
moment since it is a residence state rule, while simple income recharacterising rules can be
considered.
“Result-based” rules such as AMT should be used with care, it needs to be drafted in such a
way that is easy for both taxpayer and tax administration to implement. If this is done properly, it
would be a great tool for developing countries.
4.6.7. Plan phases of development
As imminent as it may be to have all these rules in place, it is unrealistic for developing
countries like Myanmar to implement all these rules at once. Myanmar should have a plan to
incorporate these rules by phases, starting from the basics.
Granted Myanmar has already concluded treaties with 8 countries and is negotiating more
treaties, a treaty GAAR should be prioritised along-side with a domestic GAAR. Its domestic tax
legislation should be strengthened to ensure taxation of enterprises with local sourced income. For
example, it should provide clear taxing rights to tax authorities to tax profits of a PE. Currently, there
is no scope to tax PEs in Myanmar in their domestic legislation although the PE concept exists in its
treaties.
Once the basic taxing rights are established, the state may move towards implementing
SAARs in their treaties and domestic tax laws. In later stages, rules which require higher capacity of
the tax authorities may be enacted. Continuous evaluation of ARRs is required to ensure their
relevance. A framework as such would enable the country to keep itself on track with progressive
reform and not lose sight of its objectives.
4.6.8. Resources should be spent on data collection and competency building
Information gathering is the toughest yet most essential part of policy making. Especially for
developing countries where there is no experience to rely on, the ability to react quickly to changes in
the external and internal environment becomes vital. Through data mining, policy makers will be able
to observe the fluctuations of their economy indicators and therefore able to a) assess the
effectiveness of their policies, b) determine the timing of policy implementation, c) deduce the needs
and new objectives, etc.
Myanmar has the Centre of Statistic Office under their Ministry of National Planning &
Economic Development which provides basic data captured from 2011 onwards. Although information
is limited and presented in basic formats, without explanation on source, calculation basis and
limitations, it is a good starting point and could be improved gradually. Myanmar may consider
Cora Cheung version 13 08 2014 37
capturing wider economic benefits of FDI for different industrial groups. This could help them to focus
their policies on high value generating industries.
Training, needless to say is an on-going process that all tax authorities need to embark on. In
particular for developing countries like Myanmar, training should be provided for both taxpayers and
tax administrators proactively. Learning kits may be developed and made available on their website
for easy access, seminars can be conducted for corporates and individuals on requests. Besides
enabling the implementation process, the tax office could build rapport with taxpayers through such
initiatives. Cost of such trainings could be reduced, via webinars, podcasts, downloadable training
kits, printed summary pamphlets and limited period of consultations, but these investments are
indispensable.
The Inland Revenue Department of Myanmar’s website has a knowledge sharing platform
showing its intention to be transparent and to provide information to the public. It does however
require constant up keeping and it should be so because it will be the first impression and judgement
foreign investors have of the government’s competency.
5. General Recommendations for Developing Countries
5.1. Achieving the objective
A special meeting conducted by the OECD91, on the BEPS for developing countries, has led
to several key points which developing countries are concerned about. The priorities seem to be the
need to limit base erosion via interest deductions and other financial payments (Action 4), prevent
treaty abuse (Actions 6) and counter artificial avoidance of PE status (Actions 7) amongst others
actions proposed. The meeting has also highlighted the granting of wasteful tax incentives as a
problem which may erode the country’s tax base with little demonstrable benefit and the significant
difficulties developing countries face in obtaining relevant data. Further, the Co-Chairs Statement92
published also acknowledges the need for capacity building in developing countries as poor drafting
of legislation could leave opportunities for tax avoidance.
The meeting seems to have confirmed these well-known issues for developing countries but
has yet to address the difficulties arises in the details. Bringing it back to the objective of this paper,
below is an attempt to summarise the analysis made and provide general recommendations in the
context of developing countries.
5.2. General Principles
5.2.1. Keep it simple
The biggest problem of developing countries is often implementation; therefore they must
have simple and direct AARs for easy understanding and implementation. The better taxpayers and
tax officers understand the rules, the smoother the implementation will be.
5.2.2. Target majority
While the goal is to close all gaps to prevent treaty abuse, developing countries should focus
on targeting the majority and material abuse situations first to get as much return as possible for their
effort.
91 See OECD, supra note 10 92 Organisation of Economic Cooperation and Development. Co-Chair Statement – special meeting of the OECD
Task Force on Tax and Development on BEPS and Developing Countries and Summary of The BEPS Consultations. (Paris: OECD, 2014)
Cora Cheung version 13 08 2014 38
5.2.3. Conflict prevention and resolution
As far as possible, treaties should be clear in allowing the application of domestic AARs.
Domestic AARs should also be in line with internationally accepted principles and should not go
against the object and purpose of treaties. When conflict inevitably arises, there should be a direct
channel for recourse.
5.2.4. Pro-business attitude
Another issue that developing countries face is a reputational one. It is important to
demonstrate a sensible approach towards tax planning while managing tax leakage through AARs.
FDI is easily spooked by aggressive tax authorities, relentless appeals by tax authorities in tax courts.
Retrospective amendments to tax acts can be immensely detrimental to the country’s international
reputation.
5.2.5. Measurable policies
Most developing countries are learning their ways in policy making as each government and
jurisdiction is unique. Therefore the way to learn the effectiveness of their policies is to be able to
assess the results.
5.3. Overall evaluation of AARs – Summary Table
Summary table provides an overview of the AARs discussed in the previous sections,
highlighting the salient points made for easy reference.
Overall
Suitability
Priority Adjustments needed
International GAAR
MPT Fair Medium Change to “The” main purpose
Incorporate business purpose clause
Extension of MPT in
distributive provisions
Good Medium Change to “The” main purpose
Incorporate business purpose clause
Apply only to high risk distributive provisions
Guidelines needed for application
The Savings Clause Low Low Expand the application to source state
Limit the scope to tax avoidance situations
International SAAR
LOB Fair Medium Pick concepts and rules from the standard
LOB and embed them in existing distributive
provisions
Exclude “GAAR-like” provision in paragraph 4
Look-through
provision
Good High Define “Control”
Include “alternative relief provision”
Beneficial Owner Fair Medium Define “Beneficial Owner” in treaty and
domestic law
Include “alternative relief provision”
Clarify application of “payment” condition
Cora Cheung version 13 08 2014 39
Deemed Conduit
Clause
Good High Use available statistics to set threshold and
estimate benefits of the rule
Disallow payments to related party to qualify
as “expenditure”
Include exception for small foreign investors
with active business
Remittance based
taxation & subject-to-
tax provision
Low Low Define “subject to tax”
Include Bona Fide provision
Channel Approach Fair Medium Include Bona Fide provision
Narrow restricted expenditure to non-
operating type of expense
Domestic GAAR
Standard GAAR Good High State explicitly the obligations of taxpayer
when queried by tax authority (e.g.: providing
significant non-tax reason for corporate
structure or payment arrangement)
Include a suitable judicial doctrine to illustrate
the tax authority’s focus when checking a
structure or transaction for abuse
Insert preamble to treaty as per BEPS Action
6 suggestion
AMT Good High Simplified AMT calculation
Use ready figures in financial statements
Black List Good Low Adopt a less aggressive approach towards
black-listed countries
Domestic SAAR
CFC Fair Low Residence state type rules
Start collecting relevant data for
implementation of these rules at a later stage
Deemed interest Fair Low
Exit Tax Fair Low
Interest restriction/
Thin Capitalisation
Good High Simple formula for calculation
Readily available items from the financial
statement should be used
Leasing expense
restriction
Good High Set of conditions that determines the
application of restriction should be clearly
stated
Bona Fide clause can be used for flexibility
Interest
Recharacterisation
Fair Medium Establish clear threshold/formula
Address the reliefs applicable to deemed
dividends
Substance over form
Approach
Fair Medium Establish a list of criteria that would
recharacterise each type of income
Focus on high risk income type
Cora Cheung version 13 08 2014 40
Anti-dividend stripping
rule
Fair Medium Add holding period requirement to Art 10
Generally, AARs should be implemented bearing in mind the country’s capacity for
implementation and enforcement. Gradual enactment and implementation of AARs could avoid over-
burdening the administration and confusing taxpayers while supplementing SAARs with safe harbour
rules could increase the level of certainty for taxpayers.
5.4. Moving forward
Developing countries are in a highly volatile political and economic environment, making it an
arduous task for policies to keep up. However, the efforts are necessary. With a good understanding
of the macro environment, developing countries can apply an effective combination of GAAR and
SAAR to protect tax revenue.
A good administration should be ahead of changes. Being able to catch trends and recognise
influencers would allow the government to plan and even take advantage of these shifts in the
international economic environment. Similarly, early detection of tax avoidance schemes gives the
authorities more reaction time to evaluate their severity and address them with well-considered
solutions.
Finally, keeping abreast with international initiatives in anti-avoidance would allow constant
review of AARs to be more aligned with the international standards, thereby avoiding domestic tax
law conflicts and most importantly, it would demonstrate the competency of the administration.
Cora Cheung version 13 08 2014 41
Bibliography
Aaronson, Graham Q.C., 'GAAR STUDY- A study to consider whether a general anti-avoidance rule
should be introduced into the UK tax system' (London: Information Policy Team, 11 November 2011)
The author aims to propose a moderate GAAR which would deter artificial schemes and provide a more level playing field for businesses. To avoid adding to the notoriously long and complex legislation, a GAAR is considered. While having a GAAR has the benefit of wider reach, the UK wishes to maintain that it will not affect responsible tax planning. Based on these principles, the author suggested the concept of a narrow GAAR.
Baker, Philip, 'Improper Use of Tax Treaties, Tax Avoidance and Tax Evasion', Papers on Selected
Topics in Administration of Tax Treaties for Developing Countries, (May 2013)
In this brief paper, the author highlighted problems of treaty abuse and provided general comments on GAARs and SAARs. However, he believes the provisions for administrative assistance by exchange of information or assistance in cross-border collection of taxes available in tax treaties can give countries a powerful weapon to detect and counter tax avoidance or tax fraud.
Boadway, D. Chua and F. Flatters, 'Indirect Taxes and Investment Incentives in Malaysia” (Oxford:
the World Bank, 1995), pp375-389.
The chapter delved into Malaysia’s investment incentives and is unable to conclude that it has a positive correlation with investments. Tax holidays in particular is found to be ineffective.
Fletcher, Kevin, ‘Tax Incentives in Cambodia, Lao PDR, and Vietnam', International Monetary Fund
Conference on Foreign Direct Investment (Vietnam: IMF, 2002)
This paper attempts to find some support for the conclusions that tax incentives can be costly and are rarely the most important determinant of investment. Moreover, while low rates of taxation may promote investment, no evidence is found for the notion that complicated regimes of discriminatory tax incentives are more effective in promoting investment than simple tax regimes with low, uniform rates of taxation.
Halvorsen, R., 'Fiscal Incentives for Investment in Thailand', Fiscal Incentives for Investment and
Innovation (Oxford: Oxford University Press, 1996).
The author evaluated the tax incentive scheme in Thailand and attempt to measure its effectiveness. It has reached the general conclusion that there is no clear evidence to suggest it is an influential factor. Other variables, such as infrastructure for businesses, industry atmosphere, external economic factors, etc., played a larger part to the changes in FDI.
International Monetary Fund. Revenue Mobilization in Developing Countries (Washington D.C: IMF,
2011).
This paper draws on that experience to review issues and good practice, and to assess prospects in improving developing countries’ revenue mobilization. The authors recognised the need for additional revenue is substantial in many developing countries, but improving revenue mobilization has importance beyond that. Experience shows that progress can be made—given strong political will. And that significant additional revenue can be raised in many developing countries by established methods, adapted in emphasis and sequencing to countries’ circumstances.
International Monetary Fund. Mongolia: Technical Assistance Report, Country Report No. 12/306.
(Washington D.C.: IMF, November 2012).
The report evaluate the loopholes in Mongolia's treaties, highlighting its vulnerabilities and suggests renegotiation of some clauses in certain treaties to protect the country from base erosion.
International Monetary Fund. Spillovers in International Corporate Taxation: Selected Key Issues for
Developing Countries (Washington, D.C.: IMF Policy Paper, 2014).
This paper explores the nature, significance and policy implications of spillovers in international corporate taxation—the effects of one country’s rules and practices on others. The analysis also finds that spillovers are especially marked and important for developing countries. These countries typically derive a greater proportion of their revenue from corporate tax. Limiting adverse spillovers on developing countries requires not just capacity building, but also addressing weaknesses in domestic law and international arrangements.
Lang, Michael et al, ‘Tax Treaties: Building Bridges between Law and Economics’ (Amsterdam:
International Bureau of Fiscal Documentation, 2010), pp 455.
This paper brings together the experts from the field of economics and experts from the field of law, whom take a different view of treaty issues from each other. A cross-disciplinary conference was held to discuss selected treaty issues from both a legal and economic perspective. Twenty-five conference papers on eight topics were prepared by lawyers and economists. The effectiveness of treaties is one of the topics discussed.
Li, Jinyan and Sandler, Daniel, 'The Relationship Between Domestic Anti-Avoidance Legislation and
Tax Treaties', Canadian Tax Journal (1997).
The authors discuss the issue of conflict between domestic anti-avoidance rule and treaty in the case of Canada. They believe the treaty allows for domestic interpretation and the guidance provided by VCLT is clear on that. However, it is not clear to which extend could domestic tax law obstruct treaty benefits.
Cora Cheung version 13 08 2014 42
Maria, Teresa, ‘Tax Holidays’, International Monetary Fund Fiscal Affairs Department guidance note
(2004).
The paper investigate the value of using tax holidays as incentives to attract FDI. The author attempts to measure the costs and effects compared to other types of tax incentives. A long term impact of such incentives have on the economy is also considered.
McGauran, Katrin, Should the Netherlands sign tax treaties with developing countries? (Amsterdam:
Stichting Onderzoek Multinationale Ondermemingen), 2013, pp 19.
This research is based on a literature study and data analysis on treaties, on their impact on levels of foreign direct investment (FDI) and on developing country revenues. Treaty shopping and anti-abuse provisions are also discussed. It also aims to provide information for relevant stakeholders (parliamentarians, policy-makers, journalists and civil society organisations) on the impact of DTAs in developing countries. An impact analysis is particularly important in the context of the new 2011 Dutch fiscal treaty strategy, which announced the government’s plan to extend its treaty network to more developing countries.
National Council of Bhutan. Review of the Economic Development Policy 2010 (Bhutan: Economic
Affairs Committee, 11 June 2010).
It is an internal evaluation on the performance of Bhutan's economy. Many non-tax aspects were discussed and the committee concluded that the incentive plans did not draw as much investments as expected. They suggested a review on the incentive policies.
Organisation for Economic Cooperation and Development. Public Discussion Draft, BEPS Action 6:
Preventing the Granting of Treaty Benefits in Inappropriate Circumstances. (Paris: OECD, 2014).
The OECD suggested the 3-pronged approach (preamble insertion, LOB introduction and GAAR addition) and inclusion of savings clause to prevent conduit arrangement and treaty shopping.
Organisation for Economic Cooperation and Development. Comments received on Public Discussion
Draft BEPS Action 6: Preventing The Granting of Treaty Benefits in Inappropriate Circumstances.
(Paris: OECD, 2014).
The OECD called for comments on its discussion draft and collated these comments. The criticisms are similar and had a few main points which are repeated, namely, the need for clearer illustration of MPT, the complexity of LOB, the use savings clause as a protection of residence state's taxable base, etc.
Organisation for Economic Cooperation and Development. Discussion Draft: Clarification of the
meaning of “Beneificial Owner” in the OECD Model Tax Convention. (Paris: OECD, 2014).
There is an attempt to clarify OECD's definition of Beneficial Owner however, it does not disallow domestic law's interpretation. The ambiguity persists.
Organisation for Economic Cooperation and Development. FDI in Figures. International investment
stumbles into 2014 after ending 2013 flat. (Paris: OECD, 2014).
Key findings of the report are: 1)global FDI flows increased by 4.5% in 2013 due to increase in intercompany loans, 2) China, US and Japan are the largest source of outward FDI, 3) Developing economies received over half of global FDI inflows in the 2nd consecutive years.
Organisation of Economic Cooperation and Development. Co-Chair Statement – special meeting of
the OECD Task Force on Tax and Development on BEPS and Developing Countries and Summary of
The BEPS Consultations. (Paris: OECD, 2014).
A list of issues is summarised based on the discussion which is supposed to give focus for further discussion on BEPS project. The statement recognised issues which are constantly raised by developing countries however does not provide any concrete action plan in tackling these issues. These information will be considered by the G20 Development Working Group for further research.
Picciotto, Sol, 'Base Erosion and Profit-Shifting (BEPS): Implications for Developing Countries'
(United Kingdom: Tax Justice Network, 2014).
This is a brief analysis on the BEPS Action Plan, the author highlighted issues pertinent to developing countries and evaluated BEPS effectiveness in solving them.
Schneider, A. Buehn, and C.E. Montenegro, 'Shadow Economies All over the World: New Estimates
for 162 Countries from 1999 to 2007', World Bank Policy Research Working Paper No. 5356 (2010),
pp 4, 9, 38
This paper presents estimations of the shadow economies for 162 countries, including developing, Eastern European, Central Asian, and high-income countries over the period 1999 to 2006/2007. The authors find a clear negative trend in the size of the shadow economy: The weighted average of the 162 countries in 1999 was 34.0% and in 2007 31.0 percent; hence a reduction of 3 percentage points. The driving forces of the shadow economy are an increased burden of taxation (both direct and indirect), combined with labour market regulations and the quality of public goods and services, as well as the state of the “official” economy.
Cora Cheung version 13 08 2014 43
Tanzi, Vito and Howell H. Zee, 'Tax Policy for Emerging Markets: Developing Countries', International
Monetary Fund Working Paper (March 2000)
The authors believe that tax incentives is secondary in promoting sustained investment. Best practice should be
providing stable and transparent legal and regulatory frameworks as well as adequate supporting institution and
facilities, and a tax system that is in line with international norms. The paper also provides a comparison between
different types of incentives and concluded accelerated depreciation is most effective.
United Nations Conference on Trade and Development. World Investment Report 2013 (New York
and Geneva: UNCTAD, 2013)
The report provides an overview of global investment trends. It contains statistics on FDI inflow and outflow, by
countries, regions and level of development.
Wall Street Journal. Should Congress Limit the Mortgage-Interest Deduction? (US: WSJ, March 16,
2014)
Homeowners are allowed to deduct interest expense on mortgages against their taxable income. There were
discussion in the congress to limit this interest deduction to curb an overly leveraged real estate market and increase
tax base.