OECD Discussion Draft on BEPS: Funds’ Treaty Access under Threat

June 24, 2015

The Organisation for Economic Co-operation and Development (OECD) published a revised discussion draft on 22 May 2015, in relation to Action 6 of the BEPS (Base Erosion and Profit Shifting) Action Plan (Action Plan 6), which is concerned with measures to address treaty abuse. Given the extensive submissions made by various parties on behalf of the fund industry, it was hoped that the revised discussion draft would contain measures to address the special requirements of funds and, in particular, provide a clear path to treaty access post-BEPS. Unfortunately, the discussion draft provides no comfort that these concerns will be addressed and raises the prospect that funds will face increased tax leakage in the future. 


The BEPS Action Plan was launched by the OECD in 2013, in response to perceived abusive tax avoidance – in particular, by multinational companies often involving the shifting of profit from high-tax to low-tax jurisdictions. Action Plan 6 is focussed on measures to counter “treaty shopping” and is designed to ensure that treaty benefits are not accorded in inappropriate circumstances. 

The Working Party in relation to Action Plan 6 had proposed in the original discussion draft that OECD member countries would include either or both of the following in their double-taxation treaties: 

(i) a “limitation on benefit” (LOB) clause similar to that included in US tax treaties; and/or 

(ii) the principal purpose test (PPT), focusing on whether it is reasonable to conclude that obtaining a treaty benefit was one of the principal purposes of the arrangement or transaction. 

Both of these potentially present major problems for funds. The LOB clause broadly requires the fund to have a significant connection with the country in which it is resident for tax purposes – such as, a majority of its investors having residence there or a listing of its interests on a local stock exchange. The PPT test is also difficult to apply in practice, particularly where funds seek to retain overall tax neutrality for investors by interposing treaty-entitled intermediary vehicles to facilitate treaty access for a range of investors resident in a variety of different jurisdictions. Further, the monitoring of investors for purposes of the PPT test would be a major challenge – if not impossible – for funds (such as open-ended funds) with frequent dealing days or securitisation vehicles. 

Latest Proposals 

The Working Party is now proposing that, provided the treaty contains a PPT, it can include a simplified form of LOB that contains a less stringent “derivative benefits” test than the original proposal. The revised test can be satisfied if “equivalent beneficiaries” (persons who would themselves be entitled to equivalent relief under this or another treaty) own, directly or indirectly, more than 75% of the equity of the claimant. While the inclusion of a simplified LOB is a step forward, its application is subject to the satisfaction of the PPT and would still require identification of ultimate beneficial owners and verification of their treaty entitlement. 

In line with past OECD reports considering treaty access for funds, the Working Party distinguished between collective investment vehicles (CIVs – broadly, funds regulated in their home jurisdiction) and non-CIVs (which would cover other funds, including hedge and private equity funds). The Working Party concluded that treaty benefits should be available to CIVs in line with guidance set out in the 2010 OECD report on The Granting of Treaty Benefits with Respect to the Income of Collective Investment Vehicles (2010 Report). Broadly speaking, the 2010 Report provided various suggestions aimed at preserving treaty benefits for CIVs – particularly those held by investors who would themselves be entitled to equivalent treaty benefits. The Working Party also noted the OECD’s Treaty Relief and Compliance Enhancement (TRACE) project. The TRACE project is designed to facilitate treaty claims through a certification process operated by intermediaries (such as brokers and depositories/clearing agencies) who are involved in the fund payment chain. In particular, the Working Party noted that the implementation of the TRACE project would be important for the practical implementation of the group’s proposals. 

In contrast to the findings regarding CIVs, the Working Party reached no substantive conclusions in relation to most non-CIV funds (although the Working Party agreed that pension funds should be treaty-entitled, despite being entitled to the benefit of tax exemption or a special tax status). While the Working Party recognised the economic importance of these funds and the need to grant treaty benefits where appropriate, the group expressed concern regarding the possible opportunities for treaty-shopping by such funds, as well as the potential for the deferred recognition of any income benefitting from a successful treaty claim. 

Where does this Leave Future Treaty Access for Funds? 

The fund industry had hoped that, in the light of the acknowledged economic importance of funds, a user-friendly test could have been introduced to ensure treaty access for “widely-held” funds. Failing that, it was hoped that some satisfactory test could have been devised to distinguish treaty-eligible “bona fide” funds from other funds that might be more at risk of treaty-shopping. However, post-BEPS, funds may need to show that they can satisfy the PPT test, as well as the simplified LOB, in order to access treaty benefits. As a consequence, this could lead to the following: 

  • Existing fund structures will become uneconomic due to the effective withdrawal of treaty relief, as such existing structures will not be able to satisfy the new tests. 
  • New funds that must rely on treaty access will be forced to focus on the new tests in order to have any realistic chance of delivering a satisfactory return. This may give rise to funds with a specific geographic focus and/or the extensive vetting of investor treaty-eligibility status. 
  • TRACE will (hopefully) be given a new lease of life and, as a consequence, financial intermediaries will come under significant pressure to collect information in relation to investors and other intermediaries, beyond the proposed Common Reporting Standard requirements. 

What Else can be Done? 

The OECD had invited comments on the revised discussion draft by 17 June. However, it also made it clear that these comments should be short and to the point. The Working Party will meet again in June, although it would be surprising if a radical change of heart emerged from that meeting in relation to non-CIV funds. The Working Party also acknowledged that work on non-CIV funds could continue after September 2015, but should be completed before December 2016. A more satisfactory solution to safeguard treaty access for non-CIV funds will only be achievable if the Working Party can be persuaded that the solution adequately addresses treaty-shopping concerns. Clearly, the fund industry’s plea to grant automatic treaty access to “widely-held” funds has fallen on deaf ears – therefore, any future efforts will need to accommodate additional workable safeguards to have any prospect of success.

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