Simplified Limitation of Benefit (SLOB), also known as Specific Anti-Abuse Rules, is one of the three alternative rules provided in the BEPS Action 6 Report on Preventing the tax treaty benefits in inappropriate circumstances.
Simplified Limitation of Benefits is an objective test to define the normative criteria and attributes that determine whether the income recipient would be qualified to receive the treaty benefit. A person will not qualify for treaty benefit if it does not satisfy the SLOB test.
Paragraph 8 to 13 of Article 7 of Multilateral Instruments defines the SLOB tests.
- Contents of Simplified Limitation of Benefits Provisions:
- Paragraph 8 of Article 7
- Paragraph 9 of Article 7
- Paragraph 10 of Article 7 of MLI
- Paragraph 11 of Article 7 of MLI
- Paragraph 12 of Article 7 of MLI
Contents of Simplified Limitation of Benefits Provisions:
Paragraph 8 of Article 7
Text of Paragraph 8 of Article 7:
“Except as otherwise provided in the Simplified Limitation on Benefits Provision, a resident of a Contracting Jurisdiction to a Covered Tax Agreement shall not be entitled to a benefit that would otherwise be accorded by the Covered Tax Agreement, other than a benefit under provisions of the Covered Tax Agreement:
- which determine the residence of a person other than an individual which is a resident of more than one Contracting Jurisdiction by reason of provisions of the Covered Tax Agreement that define a resident of a Contracting Jurisdiction;
- which provide that a Contracting Jurisdiction will grant to an enterprise of that Contracting Jurisdiction a corresponding adjustment following an initial adjustment made by the other Contacting Jurisdiction, in accordance with the Covered Tax Agreement, to the amount of tax charged in the first-mentioned Contracting Jurisdiction on the profits of an associated enterprise; or
- which allow residents of a Contracting Jurisdiction to request that the competent authority of that Contracting Jurisdiction consider cases of taxation not in accordance with the Covered Tax Agreement,
unless such resident is a “qualified person”, as defined in paragraph 9 at the time that the benefit would be accorded.”
Grant of treaty benefits for a person not qualified under SLOB Test
A resident of a contracting jurisdiction will be entitled to the following benefits, even if he is not a qualified person for treaty benefits as per Paragraph 9 of Article 7:
- A benefit under provisions of the CTA determines the residence of a person who has a dual residence.
- A benefit under provisions of the CTA for allowing the secondary adjustments made by Contracting Jurisdictions on the profits of associated enterprise.
- A benefit under provisions of the CTA allows residents to request the competent authority consider cases of taxation not per the CTA.
Paragraph 9 of Article 7
Text of Paragraph 9 of Article 7
“A resident of a Contracting Jurisdiction to a Covered Tax Agreement shall be a qualified person at a time when a benefit would otherwise be accorded by the Covered Tax Agreement if, at that time, the resident is:
- an individual;
- that Contracting Jurisdiction, or a political subdivision or local authority thereof, or an agency or instrumentality of any such Contracting Jurisdiction, political subdivision or local authority;
- a company or other entity, if the principal class of its shares is regularly traded on one or more recognised stock exchanges;
- a person, other than an individual, that:
- is a non-profit organisation of a type that is agreed to by the Contracting Jurisdictions through an exchange of diplomatic notes; or
- is an entity or arrangement established in that Contracting Jurisdiction that is treated as a separate person under the taxation laws of that Contracting Jurisdiction and:
- that is established and operated exclusively or almost exclusively to administer or provide retirement benefits and ancillary or incidental benefits to individuals and that is regulated as such by that Contracting Jurisdiction or one of its political subdivisions or local authorities; or
- that is established and operated exclusively or almost exclusively to invest funds for the benefit of entities or arrangements referred to in subdivision A);
- a person other than an individual, if, on at least half the days of a twelve-month period that includes the time when the benefit would otherwise be accorded, persons who are residents of that Contracting Jurisdiction and that are entitled to benefits of the Covered Tax Agreement under subparagraphs a) to d) own, directly or indirectly, at least 50 per cent of the shares of the person.”
Individual – Article 7(9)(a) of MLI
An individual being a resident of a Contracting Jurisdiction will be a qualified person for availing the treaty benefits under the SLOB test. According to OECD Commentary under some treaty provisions, a collective investment vehicle must be treated as an individual for the purposes of applying the relevant treaty; where that is the case, such a collective investment vehicle will therefore constitute a qualified Person.
Governments – Article 7(9)(b) of MLI
The Contracting States and any political subdivision or local authority thereof constitute the qualified persons. According to OECD Commentary on Action 6 Report, the provision also applies to any part of a State, such as an agency or instrumentality or sovereign wealth funds that do not constitute a separate person.
Publicly-traded companies and entities – Article 7(9)(c) of MLI
It is recognised as a general rule that where shares are regularly traded, they are unlikely to be in a given jurisdiction with a treaty shopping motive.
Paragraph 13 of Article 7 defines few critical terms used for better understanding:
Recognized Stock Exchange – Article 7(13)(a) of MLI
The term ‘recognised stock exchange’ means :
- Any stock exchange established and regulated as such under the laws of either Contracting Jurisdiction
- Any other stock exchange agreed upon by the competent authorities of the Contracting Jurisdiction.
For keeping qualification’s scope well targeted, it is required that the principal class of shares should be listed on the recognised stock exchange in one of the contracting states or any other State as agreed by the competent authorities.
Principal class of shares – Article 7(13)(b) of MLI
The term “principal class of shares” means
- the class or classes of shares of a company
- which represents the majority of the aggregate vote and value of the company or
- the class or classes of beneficial interests of an entity which represents in the aggregate a majority of the aggregate vote and value of the entity;
According to the explanation given under the OECD Commentary on Action 6 Report, the term ‘principal class of shares’ refers to the ordinary or common shares of a Company but only if these shares represent the majority of the voting rights and the value of the company.
If a company has only one class of shares, it will naturally constitute its “principal class of shares.” Suppose a company has more than one class of shares. In that case, it is necessary to determine which class or classes constitute the “principal class of shares,” which will be the class of shares, or any combination of classes of shares, that represent, in the aggregate, a majority of the voting power and value of the company.
Charitable Organisations and Pension Funds – Article 7(9)(d) of MLI
A person, other than an individual that is
- either a Non-profit organisation (as agreed by Contracting Jurisdictions) or
- is an entity established in the Contracting Jurisdiction as a separate taxable entity,
- established and operating exclusively to provide retirement benefits or ancillary benefits and is regulated by the Contracting Jurisdictions or by its subdivisions; or
- is established and operated to invest funds for the benefit of the entities mentioned above.
Ownership/Base Erosion – Article 7(9)(e) of MLI
Any entity resident of another State will qualify for benefit if at least 50% of the shares/interest in that entity are owned, directly or indirectly, by one or more qualified persons for at least half of the days of a twelve-month period.
This test does not apply to individuals. The entity or arrangement should meet the ownership requirement of at least half of the twelve-month period, including the date when the income recipient claims treaty benefit.
Paragraph 10 of Article 7 of MLI
Text of Paragraph 10 of Article 7 of MLI
- “A resident of a Contracting Jurisdiction to a Covered Tax Agreement will be entitled to benefits of the Covered Tax Agreement with respect to an item of income derived from the other Contracting Jurisdiction, regardless of whether the resident is a qualified person, if the resident is engaged in the active conduct of a business in the first-mentioned Contracting Jurisdiction, and the income derived from the other Contracting Jurisdiction emanates from, or is incidental to, that business. For purposes of the Simplified Limitation on Benefits Provision, the term “active conduct of a business” shall not include the following activities or any combination thereof:
- operating as a holding company;
- providing overall supervision or administration of a group of companies;
- providing group financing (including cash pooling); or
- making or managing investments, unless these activities are carried on by a bank, insurance company or registered securities dealer in the ordinary course of its business as such.
- If a resident of a Contracting Jurisdiction to a Covered Tax Agreement derives an item of income from a business activity conducted by that resident in the other Contracting Jurisdiction, or derives an item of income arising in the other Contracting Jurisdiction from a connected person, the conditions described in subparagraph a) shall be considered to be satisfied with respect to such item only if the business activity carried on by the resident in the first-mentioned Contracting Jurisdiction to which the item is related is substantial in relation to the same activity or a complementary business activity carried on by the resident or such connected person in the other Contracting Jurisdiction. Whether a business activity is substantial for the purposes of this subparagraph shall be determined based on all the facts and circumstances.
- For purposes of applying this paragraph, activities conducted by connected persons with respect to a resident of a Contracting Jurisdiction to a Covered Tax Agreement shall be deemed to be conducted by such resident.”
Eligibility based upon active conduct of business
Paragraph 10 of Article 7 sets forth an alternative test of SLOB, under which a resident of a contracting state may receive treaty benefits to certain items of income that are connected to an active business conducted in the State of residence.
Paragraph 10 of Article 7 recognizes that :
- where an entity is a resident of a Contracting State (say the Netherlands) actively carries on business in that State, and
- derives income from other Contracting states (say, Germany)
- in connection with, incidental to, such business activities (activities conducted in the Netherlands)
- granting treaty benefits for such income does not give rise to treaty-shopping concerns
- regardless of the nature or ownership of the entity.
To explain in simple terms:
Any entity resident of another State will qualify for treaty benefit if:
- the entity is engaged in the active conduct of business in the State of residence and
- Income chargeable in source State emanated from or is incidental to such business in State of Residence.
However, clause a of Paragraph 10 of Article 7 expressly states that the term active conduct of business does not include the following activities or combination of the following activities:
- operating as a holding company;
- providing overall supervision or administration of a group of companies;
- providing group financing (including cash pooling); or
- making or managing investments, unless these activities are carried on by a bank, insurance company, or registered securities dealer in the ordinary course of its business as such.
Active Conducted of business via Connected Person
Article 7(10)(b) extends the treaty benefits for income which a resident may derive from business carried out in the source State provided the business in the State of residence is substantial and complementary to business carried out in the State of the source.
In addition to the above, the benefit is also available in respect of income earned from the connected person in the Source State if the connected persons carry on complementary trade or business in the source State and the resident earns income as part of substantial business activities carried on in the State of Residence.
What is meant by “Connected persons”?
According to Article 7(13)(e) two persons shall be “connected persons” if :
- one owns, directly or indirectly, at least 50 per cent of the beneficial interest in the other or,
- another person owns, directly or indirectly, at least 50 per cent of the beneficial interest in each person;
- a person shall be connected to another if, based on relevant facts and circumstances, one has control of the other or both are under the control of the same person or persons.
What is “same business activity”?
The OECD Commentary on Action 6 Report states that a business activity generally will be considered part of a business activity conducted in the State of source:
- if the two activities involve the design, manufacture or sale of the same products or type of products, the provision of similar services.
- The line of business in the State of residence may be upstream, downstream, or parallel to the activity conducted in the State of the source.
Thus, the line of business includes:
- Providing inputs for a manufacturing process that occurs in State of the Source
- It is selling the output of that manufacturing process or the same sorts of products sold by the business carried on in the State of the source.
What is “complementary business activity”?
The OECD Commentary on Action 6 Report states that For two activities to be considered to be “complementary,” the activities need not relate to the same types of products or services, but they should be part of the same overall industry and be related in the sense that the success or failure of one activity will tend to result in success or failure for the other.
Where more than one business is conducted in the State of source and only one of the businesses forms a part of or is complementary to a business conducted in the State of residence, it is necessary to identify the business to which an item of income is attributable. Royalties generally will be considered to be derived in connection with the business to which the underlying intangible property is attributable. Dividends will be deemed to be derived first out of profits of the treaty-benefited business and then out of other profits. Interest income may be allocated under any reasonable method consistently applied.
What is “incidental business activity”?
OECD Commentary 2017 on Article 29 provides that an item of income derived from the State of Source is “incidental to” the business carried on in the State of residence is earning of the income facilitates the conduct of the business in the State of Residence.
Paragraph 11 of Article 7 of MLI
Text of Paragraph 11 of Article 7 of MLI
“A resident of a Contracting Jurisdiction to a Covered Tax Agreement that is not a qualified person shall also be entitled to a benefit that would otherwise be accorded by the Covered Tax Agreement with respect to an item of income if, on at least half of the days of any twelve-month period that includes the time when the benefit would otherwise be accorded, persons that are equivalent beneficiaries own, directly or indirectly, at least 75 per cent of the beneficial interests of the resident”
Derivative Benefit Rules
Paragraph 11 of Article 7 of MLI sets forth a derivative benefits test that is potentially applicable to all treaty benefits, although the test applies to individual items of income only. In general, this derivative benefits test entitles certain companies that are residents of a Contracting State to treaty benefits if the company owner would have been entitled to at least the same benefit had the income in question flowed directly to that owner.
This paragraph is based upon an “equivalent beneficiary” test. An Equivalent beneficiary is a resident of a third state who would have been entitled to an equivalent or more favorable treaty benefit for an income derived by the actual income recipient had that income accrued directly to the equivalent beneficiary instead of the actual income recipient.
The above provisions grant treaty benefit if at least 75% of the actual income recipient is owned, directly or indirectly, by the Equivalent beneficiary for half of any twelve-month period in which the treaty benefit is claimed.
Who is an “equivalent beneficiary”?
Article 7(13)(c) defines the term “equivalent beneficiary” means any person who would be entitled to benefits for an item of income accorded by a Contracting Jurisdiction to a Covered Tax Agreement under the domestic law of that Contracting Jurisdiction, the Covered Tax Agreement or any other international instrument which are equivalent to, or more favorable than, benefits to be accorded to that item of income under the Covered Tax Agreement; for the purposes of determining whether a person is an equivalent beneficiary with respect to dividends, the person shall be deemed to hold the same capital of the company paying the dividends as such capital the company claiming the benefit with respect to the dividends holds;
The rationale for this concession is that when a large part of the owners is equivalent beneficiaries, it is unlikely that the entity in treaty jurisdiction is used for treaty shopping.
Paragraph 12 of Article 7 of MLI
Text of Paragraph 12 of Article 7 of MLI
“If a resident of a Contracting Jurisdiction to a Covered Tax Agreement is neither a qualified person pursuant to the provisions of paragraph 9, nor entitled to benefits under paragraph 10 or 11, the competent authority of the other Contracting Jurisdiction may, nevertheless, grant the benefits of the Covered Tax Agreement, or benefits with respect to a specific item of income, taking into account the object and purpose of the Covered Tax Agreement, but only if such resident demonstrates to the satisfaction of such competent authority that neither its establishment, acquisition or maintenance, nor the conduct of its operations, had as one of its principal purposes the obtaining of benefits under the Covered Tax Agreement. Before either granting or denying a request made under this paragraph by a resident of a Contracting Jurisdiction, the competent authority of the other Contracting Jurisdiction to which the request has been made shall consult with the competent authority of the first-mentioned Contracting Jurisdiction.”
Discretionary relief by Competent Authorities
Paragraph 12 of Article 7 of MLI provides relief when the resident of one Contracting state is not a qualified person for treaty benefit as per Paragraphs 8 to 11 of Article 7, but based upon the Competent authorities’ approval, and he is treated as a qualified person.
Competent authorities can grant discretionary relief if the resident of Contracting Jurisdiction has demonstrated and satisfy that neither the resident’s establishment, acquisition, or maintenance, nor the residents’ conduct had one of the principal purposes of obtaining a benefit under the Covered Tax Agreement. Relief is granted based upon the Consultation with the Competent authorities of State of Source and State of Residence.