• The Multilateral Convention to Implement Tax Treaty Related Measures to Prevent Base Erosion and Profit Shifting and its impact on the Costa Rican Tax Treaties Network

    By Jennifer Ebrecht

    30-08-2017

    The Multilateral Convention to Implement Tax Treaty Related Measures to Prevent Base Erosion and Profit Shifting hereinafter “MLI”, was developed as part of an ambitious plan named “BEPS” (Base Erosion and Profit Shifting).

    The BEPS action plan consists of 15 actions with minimum standard in order to prevent base erosion and profit shifting between countries.

    The last action plan (Action 15) is regarding MLI and is an important element in order to prevent the Base Erosion and Profit Shifting, specifically in Treaty Shopping; Permanent Establishment; Dual Residence and other topics that will be mentioned in this article.

    On 7 June 2017, the Vice-President of Costa Rica, Mr. Helio Fallas, signed the MLI simultaneously with representatives from over 70 jurisdictions participating in the OECD ceremony, whose main objectives was to prevent tax evasion by multinational enterprises, to enhance Tax Controversy between countries and to update the Double Taxation Treaty Network, which consists of 3,000 tax treaties around the world.

    At the same time, the MLI stablishes procedures in order to coordinate and develop agility when negotiating Tax Treaties under only one instrument.

    Costa Rica currently has 3 Double Tax Treaties and only two, with Spain and Germany, are in force. The third one was signed with Mexico, but it is still being analyzed prior to its final approval.

    The MLI has direct impact on the Costa Rican Tax Treaty Network, as the above mentioned treaties have to comply with MLI regulations, especially on minimum standard principles for treaty abuse prevention under Action 6 and on minimum standard for dispute resolution improvement under Action 14. Also it has to undergo hybrid mismatch arrangements under Action 2 and the strengthened definition of permanent establishment under Action 7 of BEPS.

    It is worth noting that Costa Rica made some reservations to the MLI which will not to be applicable to the Tax Treaty network.

    Although a rigid framework, the MLI provides sufficient flexibility to adjust to different country policies in various ways.

    In this context, countries may choose which existing tax treaties they would like to have modified by the MLI. Moreover, flexibility is provided for countries to meet BEPS minimum standards on treaty abuse and dispute resolution, as countries may opt out of or provide alternative provisions that are not reflected to BEPS minimum standards. Once a tax treaty has been listed by the two treaty partner countries, the treaty becomes an agreement to be covered by the MLI.

    The most substantial impact on the Costa Rican Tax Treaty Network is regarding the following topics:

    Article 4: Dual Residence Entities.

    It is necessary to clarify that the concept used on the Costa Rican Local law is the one of “Domicility” and not “Residence”. However, by doing so, resulted in some interpretation controversy in the past. This has now been resolved by considering both the concepts of “Domicility and Residency” as equal.

    In this case, it is stablished that when the Countries could not resolve dual residency controversies through mutual agreement, the taxpayer will not have the right to claim any exemption, withholding reduction or benefit covered under the Tax Treaty.

    Consequently, we can conclude that when the Taxpayer has dual residency in both countries and the countries claim the tax payment to each other, given the situation where they weren’t able to come to an agreement over residency discrepancies, the taxpayer will lose the right to apply for Tax Treaty benefits, leaving him totally unprotected and subject to an arbitrary double taxation.

    Article 7: Prevention of Treaty Abuse.

    In order to prevent Treaty Abuse, the MLI establishes that benefits under the Tax Treaty, shall not be granted regarding an item of income or capital and so, it is reasonable to conclude, taking into account 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.

    According to this regulation, the benefits under the Tax Treaty can be denied in the case that, according to facts and circumstances, only a fiscal planning was made with the sole purpose of obtaining the benefit derived from the treaty.

    With this regulation, a question comes to mind: Is this the end of tax planning in this new BEPS era? Maybe we could answer this on another article.

    Nevertheless, the taxpayer can request from the Tax Authority to determine whether the benefits would have been granted to that taxpayer in absence of the transaction or arrangement.

    Article 8: Dividend Transfer Transaction.

    In case of exception of dividends, or rate limitation to dividends applying to a company who is a resident in one country, or in case the beneficial owner or the recipient of dividends were residents in the other contracting country, and when it holds or control more than certain amount of the capital, shares, stock, voting power, voting right or similar ownership interest of the company who made the payments. The benefit shall apply if the ownership conditions comply the requirements of the 365 days’ period including the day of the payment.

    Article 9: Capital Gains from alienation of interest of entities derived their value principally from immovable property.

    This regulation, refers to the capital gains obtained from share sales or interest from entities when value comes from immovable property.

    In one hand, the Spanish and Mexican Tax Treaties establish a general regulation in which income obtained from the sale of shares could be taxable in that country. This happens when at least 50% of its origin comes from immovable property situated in the other country.

    A similar regulation can be found in the German Tax Treaty. It refers to the sale of shares or rights of passive income, that involves companies which their assets coming directly or indirectly from immovable property with the above mentioned 50% requirement.

    On the other hand, the MLI improved the previous arrangements by establishing that in case of sales of shares or interest (company interest or trust interest) income could be taxable in the source country in any moment within the 365 days before the sale, those shares or interests, obtain more than 50% of its value, which are directly or indirectly coming from immovable property.

    Article 10: Anti-Abuse Rules for Permanent Establishment situated in third jurisdiction.

    The Costa Rican Tax Treaty Network doesn’t have a regulation regarding this issue, therefore the regulation under Article 10 is entirely applicable to Tax treaties.

    The Anti- Abuse rules for Permanent Establishment situated in third jurisdiction applies when the company has tax benefits on any transaction or operation in a third country and those benefits are not taxable in that country Therefore the income will be taxable on the permanent establishment residence country. In addition to this, this rule is only applicable in case the tax figure on the third country is lower than the 60% rate of the country of residence.

    In other words, the regulation is applicable in case of suspicion of Permanent Establishment existence in the third country with low or null taxation. Therefore, it is the residence country who has to tax the mentioned income.

    Article 12: Artificial Avoidance of Permanent Establishment Status through Commissionaire Arrangement and Similar Strategies.

    In this case, we have a distinction between dependent agents and independent agents. Dependent agent refers to an agent who acts as a legal representative of the company i.e. who concludes agreements, transacts, has rights or provides services on behalf of the company. Therefore, in the case of a dependent agent, a permanent establishment will be considered.

    Article 15: Definition of Person Closely Related to an Enterprise.

    This Article presents an innovation of the concept of “Person”, placing it closer, and more related to the concept of enterprise when, under relevant facts or circumstances, one has control of the other, or both are under the control of the same person or enterprise.

    In any case, a person will be considered related to an enterprise, when having directly or indirectly more than 50% of the beneficial interest in the other, or in the case that another person has directly or indirectly acquired more than 50% of the beneficial interest in the person and enterprise.

    As a consequence of this Article a system of rules called Controlled Foreign Company will be created, under the Costa Rican Tax System, because in the Local Tax Law, we don’t have this disposition.

    It is worth mentioning that, on these MLI Articles, we have Mutual Agreement Procedures between jurisdictions, we won’t be elaborating on that, but we have to have in mind that Costa Rica and other Countries subscribe these procedures without reservation, and it will be necessary to analyze them in case of any controversy.

    Summing up, it is necessary to clarify that the impact of the MLI on the Costa Rican Tax Treaty Network is very important, especially for the Permanent Establishment matters. Companies must be careful when restructuring or analyzing the tools used in operations or transactions between related companies because any form of vehicle could result in a Permanent Establishment.

    The OECD intends for the changes mentioned in the MLI to be implemented in the local laws in 2018. Given this requirement, I think each country will have its own timing for implementation, perhaps even different to the OCDE timing, but on the celerity of the internal procedure of countries involved.

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  • The information provided in this article is for general information purposes only. The information is not intended to be comprehensive or to include advice on which you may rely. You should always consult a suitably qualified professional on any specific matter.

Jennifer Ebrecht

Jennifer Ebrecht is an International Tax Lawyer based in Costa Rica, she was born and raised in Argentina. Her practice concentrates on direct taxes, including tax planning, M&A, BEPS, transfer pricing and cross-border investments in Latin-America. In June 2013 she won a public competition as a Tax researcher in the Tax Investigation Department of Argentinian Association of Fiscal Studies (AAEF). She obtained a Master Degree in International Taxation on Torcuato Di Tella University in Buenos Aires.

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