Article 3 of MLI states that the critical requirement for granting treaty benefits is that the person should be a resident of the Contracting State. Article 4 of the OECD Model Tax Convention clarifies that a person’s treaty residence depends on the domestic laws of each contracting state, resulting in a person being treated as a tax resident of both states because of the difference in residency rules of two countries.
For a quick view on Article 4 of MLI – click here
- Limitation of the tie-breaker POEM rules:
- Structure of Article 4 of the MLI
- Article 4(1) of the MLI | Determining the tax residence of dual resident entities
- Article 4(2) of the MLI | Compatibility clause
- Article 4(3) of the MLI | Reservation clause
- Article 4(4) of the MLI | Notification clause
In general, in the case of a person other than individuals, the tax residency is based on whether the person is liable to tax in a jurisdiction by its domicile, residence, place of effective management, or any other criteria. Often it leads to a person being tax resident in two or more countries. Article 4(3) of the OECD Model Tax Convention is a tie-breaker rule in dual resident entities (other than individuals). It provides that the dual resident entity shall be deemed a resident only of the state where its Place of Effective Management (POEM) is situated.
Limitation of the tie-breaker POEM rules:
The OECD recommends POEM as a tie-breaker rule for determining residency and an alternative to let the competent authorities determine the residency by mutual agreement on a case-to-case basis. Often, the entities where dual resident situations arise due to aggressive tax planning involve a low tax jurisdiction as POEM.
Some limitations of tie-breaker POEM tests are:
- Cannot curb tax avoidance as entities avail low tax jurisdiction as their POEM.
- POEM is not defined under OECD Model Tax Convention. Each contracting jurisdiction determines POEM based upon their domestic laws. There is no uniformity or clarity under the current tie-breaker test for determining the POEM of an entity.
- The dual resident entity may have a third country as POEM, hence failing to determine the entity’s tax residence.
Structure of Article 4 of the MLI
Article 4 of the MLI comprises of 4 paragraphs:
- Parapragh 1: Determining the tax residence of dual resident entities
- Paragraph 2: Compatibility clause
- Paragraph 3: Reservation Clause
- Paragraph 4: Notification Clause
Article 4(1) of the MLI | Determining the tax residence of dual resident entities
Text of Article 4(1) of the MLI is as follow
Where by reason of the provisions of a Covered Tax Agreement:
- a person other than an individual
- is a resident of more than one Contracting Jurisdiction,
- the competent authorities of the Contracting Jurisdictions shall endeavour to determine by mutual agreement
- the Contracting Jurisdiction of which such person shall be deemed to be a resident for the purposes of the Covered Tax Agreement,
- having regard to its place of effective management, the place where it is incorporated or otherwise constituted, and any other relevant factors.
- In the absence of such agreement, such person shall not be entitled to any relief or exemption from tax provided by the Covered Tax Agreement except to the extent and in such manner as may be agreed upon by the competent authorities of the Contracting Jurisdictions.
Let us try to understand what the provision states.
Paragraph 1 of Article 4 of the MLI is a substantive provision. It reflects the measures given under BEPS Action Plan 2 and Action Plan 6, aiming to ensure that dual resident entities do not obtain the undue benefits of treaties. Article 4(1) replicates the recommendation of BEPS Action Plan 6 for Article 4(3) of the OECD Model Tax Convention.
Paragraph 1 of Article 4 of the MLI provides where a person other than the individual is a dual resident, then the competent authorities of the jurisdictions will attempt to determine the single residency for that person. It will be through mutual agreement on a case-to-case basis considering effective management(POEM), the place where it is incorporated or otherwise constituted, and any other relevant factors.
Additionally, Article 4(1) of the MLI provides that if competent authorities do not reach the agreement for determining the single residency for the dual resident entity, then in such case, the entity will not be entitled to any relief or exemption from tax under the Covered Tax Agreement except to extent and manner agreed by the competent authorities.
Article 4(2) of the MLI | Compatibility clause
Text of Article 4(2) of the MLI is as follow
Paragraph 1 shall apply
- in place of or in the absence of provisions of a Covered Tax Agreement
- that provide rules for determining whether a person other than an individual shall be treated as a resident of one of the Contracting Jurisdictions
- in cases in which that person would otherwise be treated as a resident of more than one Contracting Jurisdiction.
- Paragraph 1 shall not apply, however, to provisions of a Covered Tax Agreement specifically addressing the residence of companies participating in dual-listed company arrangements.
Article 4(2) of the MLI is the compatibility clause that interacts between Article 4(1) of the MLI and the Covered Tax Agreements provisions.
According to provisions of Article 4(2) of the MLI, Article 4(1) of the MLI is applicable (as modified by Article 4(3) of the MLI) in place of or in the absence of the relevant provisions in CTA regarding the dual resident entities.
To explain further, in case the Covered Tax Agreements already contain the provisions for determining the residency of the dual resident entities, then Article 4(1) of the MLI would be replacing such provisions.
In case the Covered Tax Agreements does not contain the provisions for determining the residency of the dual resident entities, then Article 4(1) of the MLI would be added to such a tax treaty.
Provisions of Article 4 of the MLI will replace all tie-breaker rules for the residence of persons other than individuals only. Where a single provision of a CTA provides for a tie-breaker rule for both individuals and entities, then Article 4(1) of the MLI would apply in place of that provision only to the extent that it relates to persons other than individuals.
The last part of Article 4(2) of the MLI states that Article 4(1) does not apply to Dual-listed company arrangements.
What is a dual-listed company arrangement?
Explanatory Statement to the MLI explains A dual-listed company arrangement generally refers to an arrangement, adopted by certain publicly-listed companies, that reflect a commonality of management, operations, shareholders’ rights, purpose, and mission through an agreement or a series of agreements between two parent companies, each with its stock exchange listing, together with special provisions in their respective articles of the association including in some cases, for example, the creation of special voting shares. Under these types of structures, while the participating companies retain their separate entity legal status, the position of the parent company shareholders is, as far as possible, the same as if they held shares in a single company, with the same dividend entitlement and same rights to participate in the assets of the dual-listed companies in the event of a winding-up. Arrangements of this type occur in relatively few jurisdictions, and treaty provisions addressing them are typically customized in detail to the circumstances of those jurisdictions to ensure the determination of a single Contracting Jurisdiction of residence for each participating company
Article 4(3) of the MLI | Reservation clause
Provisions of Article 4 of the MLI are not a minimum standard. Hence Paragraph 3 of Article 4 of the MLI provides for reservation clauses allowing flexibility to countries to opt-out of this provision entirely or partially. The various alternatives for reserving the right concerning the article are as follow:
Article 4(4) of the MLI | Notification clause
Article 4(4) of the MLI is procedural, explaining the actions required and consequences in the event of reservation which are as under:
- Suppose any country has not made a reservation on the provisions of Article 4. In that case, it should notify the depository about the provisions of its tax treaties where a similar provision described in Article 4(1) of the MLI is already present.
- If two countries have notified the relevant provisions in their CTA, then the provision of Article 4(1) of the MLI will be replaced in the existing tax treaties
- If both or one of the countries do not notify the provisions of the tax treaty, then to the extent that the provisions f the tax treaty is not compatible with the provisions of Article 4(1) of the MLI, Article 4(1) will supersede the tax treaty provisions.
- If any country reserves the right not to apply Article 4 of the MLI, the provision will not apply to the concerned tax treaty.