Developing a Multilateral Instrument to Modify Bilateral Tax Treaties

On 30 September 2022, South Africa ratified the Multilateral Instrument which will enter into force for South Africa on 1 January 2023.

This will affect Africa’s bilateral tax treaties with other jurisdictions that have already, or will in future, also ratify the MLI, which includes the majority of our main trading partners. The MLI arises from the OECD/G20 Project to tackle Base Erosion and Profit Shifting (‘BEPS’) – tax planning strategies to exploit gaps and mismatches in tax rules that seek to shift profits to low-tax jurisdictions.

Action 15 of the OECD’s BEPS Action Plan provided for the development of a multilateral instrument to implement tax treaty-related BEPS measures to enable jurisdictions that wish to do so to implement measures developed in the course of the work on BEPS and amend bilateral tax treaties.

The Action 15 Report entitled “Developing a Multilateral Instrument to Modify Bilateral Tax Treaties” concluded that a multilateral instrument, providing an innovative approach to enable countries to swiftly modify their bilateral tax treaties to implement measures developed in the course of the work on BEPS, was desirable and feasible.

The MLI entered into effect in the UK on 1 January 2019 and in Germany on 1 January 2022. The USA is not a signatory to the MLI. The only African countries besides South Africa that are currently signatories to the MLI are Egypt and Mauritius.

If the MLI has entered into force for both jurisdictions, you would need to determine whether both jurisdictions have notified the OECD that they wish to modify the specific bilateral treaty with regard to the MLI; in other words, whether the treaty is a ‘Covered Tax Agreement’ as defined in the MLI.

The MLI makes the following choices available:

Choices amongst alternatives in certain of the provisions of the MLI;
Choices whether or not to apply optional provisions; and
Choices to opt out through reservation with respect to all of their Covered Tax Agreements or certain Covered Tax Agreements.

Jurisdictions may not choose to opt out of provisions of the MLI that are a BEPS minimum standard.

Once the MLI has entered into force in relation to a jurisdiction, the date on which its provisions enter into effect must be determined. A provision of the MLI may only apply to a Covered Tax Agreement if that provision has entered into effect for both Parties to a Covered Tax Agreement. The provisions (other than those relating to mutual agreement procedures) enter into effect as follows:

  1. Withholding taxes: on the first day of the first calendar year following the entry into force – for South Africa this is for events that give rise to the withholding tax occurring from 1 January 2023 onwards; and
  2. Other taxes: for taxable periods beginning on or after six calendar months after the entry into force date – for South Africa this is for taxable periods commencing from 1 July 2023 onwards.

Multinationals will need to carefully consider the treaty positions adopted by each of the jurisdictions in which they operate, with respect to each relevant bilateral treaty. In most cases, the MLI provisions are subject to one or more of the choices described above, except where the provision is a BEPS minimum standard.

Article 3 Transparent entities: Income derived by or through an entity or arrangement that is treated as wholly or partly fiscally transparent under the law of either contracting jurisdiction shall be considered to be the income of a resident of a contracting jurisdiction, but only to the extent that the income is treated, for tax purposes by that contracting jurisdiction, as the income of a resident of that contracting jurisdiction.

Article 4 Dual resident entities: The competent authorities of a dual resident entity shall endeavour to determine by mutual agreement the jurisdiction of which the entity shall be deemed to be a resident for purposes of the relevant bilateral tax treaty. In making this determination, the competent authorities are required to take into account the place of effective management, place of incorporation and any other relevant factors. In principle, treaty benefits will be denied in the absence of such agreement except to the extent and in such manner as may be agreed upon by the competent authorities.

Article 7 Prevention of treaty abuse: Jurisdictions may choose between the principal purpose test on its own or the principal purpose test in combination with the simplified limitation on benefits rule. Parties that prefer to address treaty abuse by adopting a detailed limitation on benefits rule are permitted to opt out of the principal purpose test and agree to endeavour to reach a bilateral agreement that satisfies the minimum standard.

South Africa has chosen the principal purpose test. This means that a benefit under the bilateral tax treaty will not be granted in respect of an item of income or capital if it is reasonable to conclude, having regard to all relevant facts and circumstances, that obtaining that benefit was one of the principal purposes of any arrangement or transaction that resulted directly or indirectly in that benefit, unless it is established that granting that benefit in the circumstances would be in accordance with the object and purpose of the relevant provisions of the bilateral tax treaty.

Article 8 Dividend transfer transactions: Provisions of a bilateral tax treaty that exempt or limit the rate of dividend withholding taxes paid by a company that is a resident of a contracting jurisdiction, provided that the beneficial owner or the recipient is a company which is a resident of the other contracting jurisdiction that owns, holds or controls more than a certain amount of the capital, voting rights or similar interests of the company paying the dividends, shall only apply if the ownership conditions are met throughout a 365-day period that includes the day of the payment of the dividends. For purposes of computing this holding period, no account shall be taken of changes of ownership resulting from corporate reorganisations such as mergers or divisive reorganisations.

Article 9 Capital gains from alienation of shares deriving value principally from immovable property: South Africa has chosen the alternative whereby gains derived by a resident of a Contracting Jurisdiction from the alienation of shares or comparable interests, such as interests in a partnership or trust, may be taxed in the other Contracting Jurisdiction if, at any time during the 365 days preceding the alienation, these shares or comparable interests derived more than 50 per cent of their value directly or indirectly from immovable property situated in the other Contracting Jurisdiction.

Article 13 Artificial avoidance of permanent establishments through specific activity exemptions: A permanent establishment shall be deemed not to include activities specifically listed in the bilateral tax treaty, the maintenance of a fixed place of business solely for the purpose of carrying on any activity for the enterprise, or a combination of these activities, if such specific activity or the combination of these activities of the fixed place of business is of a preparatory or auxiliary character. In addition, an anti-fragmentation rule applies for activities carried out by the same enterprise or closely related enterprises in the same jurisdiction.

Article 16 Mutual agreement procedure: If a person considers that the actions of one or both contracting jurisdictions will result in taxation not in accordance with the provisions of the bilateral tax treaty, the taxpayer may present the case to either of the competent authorities. The case must be presented within three years as of the first notification of the action resulting in taxation not in accordance with the provisions of the bilateral tax treaty.

South Africa has chosen to opt out of the above wording on the basis that it intends to implement element 1.1 of the BEPS Action 14 (‘making dispute resolution mechanisms more effective’) minimum standard through administrative measures.

Article 19 Mandatory binding arbitration: Provides mandatory binding arbitration, upon request by the applicant, in case jurisdictions are unable to reach an agreement to resolve the dispute using the mutual agreement procedure.

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