INTRODUCTION AND BACKGROUND OF MLI, INCLUDING APPLICABILITY, COMPATIBILITY AND EFFECT

The development and roll-out of Multilateral Instruments or MLI is the latest global tax transformational process under the BEPS initiative. The BCAJ, in this Volume 53, will run a series of articles by practitioners to bring out basic concepts, de-jargonise terminology and bring out practical implications and deal with hurdles that they bring in our day-to-day practice. We would welcome your comments and suggestions and even generic questions which can be taken up by the authors.

A. INTRODUCTION TO MLI
1. The Action Plan on Base Erosion and Profit Shifting (the BEPS Action Plan), published by the Organisation for Economic Co-operation and Development (OECD) at the request of the G20, identified 15 actions to address BEPS in a comprehensive manner and set deadlines to implement those actions. Action 15 of the BEPS Action Plan provided for the development of a Multilateral Instrument (MLI).

2. As per the Explanatory Statement to the MLI, its object is to Implement Tax Treaty-Related Measures to Prevent Base Erosion and Profit Shifting i.e., tax planning strategies that exploit gaps and mismatches in tax rules to artificially shift profits to low or no-tax locations where there is little or no economic activity, resulting in little or no overall corporate tax being paid.

3. FAQ 1 of Frequently Asked Questions on MLIs explains that the MLI helps fight BEPS by implementing the tax-related treaty measures developed through the BEPS Project in existing bilateral tax treaties in a synchronised and efficient manner. These measures will prevent treaty abuse, improve dispute resolution, prevent the artificial avoidance of permanent establishment status and neutralise the effects of hybrid mismatch arrangements.

B. IMPORTANT EVENTS OF MLI AND MLI STATISTICS
1. Background of MLI – from conception to entry-into-effect1: On 12th February, 2013 the report ‘Addressing Base Erosion and Profit Shifting’ (BEPS) was published recommending the development of an ‘Action Plan’ to address BEPS issues in a comprehensive manner. In July, 2013 the OECD Committee on Fiscal Affairs (CFA) submitted the BEPS Action Plan to the G20 identifying 15 actions to address BEPS in a comprehensive manner and set out deadlines to implement those actions. Action Plan 15 interim report provided for an analysis of the possible development of a Multilateral Instrument (MLI) to implement tax treaty-related BEPS measures. Based on the Action 15 interim report, a mandate was developed by the CFA in February, 2015 to set up an Ad hoc Group for the development of an MLI which was also endorsed by the G20 Finance Ministers and the Governors of Central Banks. The development of MLI was open for participation of all interested countries on an equal footing. On 24th November, 2016 the Ad hoc Group concluded the negotiations and adopted the text of the MLI as well as its accompanying Explanatory Statement which was signed by representatives of over 70 governments on 7th June, 2017 at a high-level signing ceremony in Paris. Thus, on 1st July, 2018, the MLI began its legal existence. However, the MLI would enter into force with respect to each of its parties on the first day of the month following three calendar months after the deposit of their instrument of ratification, acceptance or approval.

2. Applicability of MLI: As stated earlier, the MLI and its explanatory statement were adopted by the Ad hoc Group on 24th November, 2016 and MLI began its legal existence on that date. The first high-level signing ceremony took place on 7th June, 2017 when India signed the MLI by depositing its provisional document of notifications and ratifications. Thereafter, it filed its final document of notifications and ratifications on 25th June, 2019. As on 18th February, 2021, 95 tax jurisdictions are signatories to the MLI as per the website2 of OECD. Out of these, the MLI has come into effect qua 57 tax jurisdictions, including India. With reference to India, as per the MLI Matching database available on the OECD website3, out of its 90 tax treaties with other countries, 60 tax treaties are Covered Tax Treaties (CTAs). In other words, 60 tax treaties would stand modified by the MLI. Out of the said 60 treaties, MLI has already come into effect or is to come into effect qua India with respect to 42 tax treaties as the treaty partners have already deposited their final instrument of notifications and ratifications. Thus, with regards to the other 18 treaties (60 minus 42), the MLI would come into effect only when the necessary procedures with regard to deposit of final instruments of notifications and ratifications are complied with by the treaty partners.

1   https://www.oecd.org/tax/treaties/multilateral-instrument-BEPS-tax-treaty-information-brochure.pdf

3. Global list of countries in respect of which MLI has come into effect as on 18th February, 2021:As stated earlier, MLI has already come into effect qua 57 countries globally as on 18th February, 2021. To get a detailed list of countries and to be updated with the latest position, one may go to the OECD website4 and click on ‘Signatories and Parties (MLI Position)’.

4. Countries with which MLI is in effect qua India or is to come into effect for India5:

2   http://www.oecd.org/tax/treaties/multilateral-convention-to-implement-tax-treaty-related-measures-to-prevent-beps.htm

3   https://www.oecd.org/tax/treaties/mli-matching-database.htm#:~:text=MLI%20Matching%20Database%20(beta)%20The%20Multilateral%20Convention%20to,MLI%20by%20matching%20information%20from%20Signatories’%20MLI%20Positions

4   http://www.oecd.org/tax/treaties/multilateral-convention-to-implement-tax-treaty-related-measures-to-prevent-beps.htm

5              https://www.oecd.org/tax/treaties/mli-matching-database.htm#:~:text=MLI%20Matching%20Database%20(beta)%20The%20Multilateral%20Convention%20to,MLI%20by%20matching%20information%20from%20Signatories’%20MLI%20Positions

5. India’s significant treaties which are not CTAs under the MLI:

1. ENTRY INTO EFFECT OF MLI, i.e., EFFECTIVE DATE OF APPLICABILITY OF MLI BETWEEN INDIA AND ITS TREATY PARTNER
2. MLI 34 deals with ‘entry into force’ and MLI 35 deals with ‘entry into effect’. There is a difference between the two. ‘Entry into force’ indicates the date of adoption of the MLI by a country which is determined with reference to the date of filing the instrument of ratification by it. By itself, ‘entry into force’ does not make MLI applicable. It only signifies the MLI position adopted by a particular country. On the other hand, ‘entry into effect’ indicates the date of applicability of MLI between two countries. The ‘entry into effect’ makes MLI applicable and effective qua the two contracting states. The ‘entry into effect’ is determined by taking into consideration the dates of ‘entry into force’ of two contracting states.

2. MLI 35(1)(a) and (b) provide for different timelines for entry into effect of MLI in respect of taxes withheld at source and entry into effect of MLI in respect of all other taxes, respectively. The application of different timelines for withholding and other taxes could vary based on the interpretation of principles of levy of tax and its recovery and the domestic tax laws of contracting states dealing with the levy and recovery of tax.

3. We may consider one possible interpretation while being mindful of contrary views. In the Indian context, withholding in respect of payments to non-residents u/s 195 would apply in respect of all sums which are chargeable to tax. Ordinarily, chargeability to tax and withholding are inseparable. The obligations of a non-resident do not get discharged merely because taxes are liable to withholding. Recourse can be had to non-resident where tax is not withheld or short withheld. Compliance obligations like filing return and other reporting requirements would apply to such non-resident as well as be subject to specific exceptions, viz., sections 115A(5), 115AC(4) and 115BBA(2).

4. This may not be the position in case of India’s DTAA partner country. In such DTAA partner country, the domestic law may have two ‘boxes’ of incomes. The ‘first box’ would consist of incomes which are subject to withholding by the payer with no recourse to the recipient in case of non- / short deduction. The ‘second box’ consists of incomes which are not subject to withholding but are liable to be taxed directly in the hands of the person earning the income. The first box would be similar to the case of equalisation levy version 1 introduced by the Finance Act, 2016 which levies tax on a non-resident but enforces the same through deduction by the resident payer. The second box would be similar to the case of equalisation levy version 2 introduced by the Finance Act, 2020 whereby the liability is on the non-resident to pay the levy directly.

5. In this regard, reference may be made to Paragraph 4 of the OECD Commentary on Article 31 (Entry into force) of the OECD Model Tax Convention, 2017. The said Paragraph recognises that the relevant Article dealing with ‘entry into force’ of certain treaties provides, as regards taxes levied by deduction at the source, a date for the application or termination which differs from the date of application of the treaty to taxes levied by assessment. This would indicate that there may be countries whose domestic laws may have two boxes of incomes as referred to in the previous paragraph.

6. Consider Article 30(2)(a) of the Indo-USA DTAA which provides for a different time point for entry into effect of the DTAA in respect of taxes withheld as compared to other taxes. This may be because as per the US domestic taxation law, income of a non-resident in the US that is effectively connected with the conduct of a trade or business in the US is not subject to NRA withholding.[Source: https://www.irs.gov/individuals/international taxpayers/withholding-on-specific-income.]

At this juncture, a reference may be made to Paragraph 60 of the recent judgment of the Supreme Court in the case ofEngineering Analysis Centre of Excellence Private Limited vs. CIT [2021] 125 taxmann.com 42 (SC) where, after referring to the OECD Model Commentary and Article 30(2)(a) of the Indo-USA DTAA, the Court concluded that adoption of such different dates for application of the treaty was for reasons connected with USA’s municipal taxation laws.

7. Now, consider a case where the MLI has come into effect only in respect of taxes withheld. In such a case, the CTA as amended by the MLI may be applied by the DTAA partner country for determining the taxes to be withheld (incomes of first box). However, the CTA amended by the MLI cannot be applied by the DTAA partner country in respect of incomes not subject to withholding but that are taxed directly in the hands of the person earning the income (incomes of second box). In such cases, the provisions of the CTA unamended by MLI will be applied till such time as the MLI comes into effect for the purposes of all other taxes.

8. Thus, in the Indian context the different timelines would not be relevant as non-residents earning Indian income are subject to comprehensive obligations. However, in a given case, from the DTAA partner country’s context, different timelines would matter.

D. SYNTHESISED TEXTS

• Every CTA will have to be read along applicable protocol and applicable portions of the MLI. The said exercise would be complex and cumbersome particularly when the applicability of the MLI depends on reservations and notifications by contracting states.

2. The OECD encourages the preparation of consolidated texts or synthesised texts which would reproduce the
text of each CTA as modified by the MLI. The same has been explained in Paragraph 1 at Page 9 of the ‘Guidance for the development of synthesised texts’ issued by OECD.

3. However, the parties to the MLI are under no obligation to prepare synthesised texts. This has been clarified in Paragraph 13 of the Explanatory Statement on the MLI. This paragraph is referred to in Paragraph 4 at Page 9 of ‘Guidance for the development of synthesised texts’ issued by OECD.

4. In Paragraph 3 at Page 9 of the ‘Guidance’, it has been noted that the purpose of synthesised texts is to facilitate the understanding of the MLI. However, for legal purposes the provisions of the MLI must be read alongside Covered Tax Agreements as they remain the only legal instruments to be applied, in light of the interaction of the MLI positions of the contracting jurisdictions.

5. Thus, the synthesised texts would only help the users in better understanding of the CTA as modified by the MLI. In case of conflict between the synthesised text and the CTA read independently with applicable portions of the MLI, the latter would prevail.

6. As of date, India has synthesised texts in respect of tax treaties with the following jurisdictions:

1. MINIMUM STANDARDS
2. In the final BEPS Package, in order to combat the issues relating to Base Erosion and Profit Shifting, it was agreed that a number of BEPS measures are minimum standards, meaning that countries have agreed that the standard must be implemented. Thus, countries which are parties to the OECD / G20 inclusive framework on BEPS are required to comply with the following five minimum standards:

•  Action Plan 4: Limiting Base Erosion Involving Interest Deductions and Other Financial Payments (Adoption of a fixed ratio rule which limits an entity’s net deductions for interest to a percentage of EBITDA to entities in a multinational group is a minimum standard as per the Executive Summary to this Action Plan, AP4);

•  Action Plan 5: Countering Harmful Tax Practices More Effectively, Taking into Account Transparency and Substance;

•  Action Plan 6: Preventing the Granting of Treaty Benefits in Inappropriate Circumstances;

•  Action Plan 13: Transfer Pricing Documentation and Country-by-Country Reporting;

•  Action Plan 14: Making Dispute Resolution Mechanisms More Effective.

2. While some of these minimum standards in BEPS Actions 6 and 14 have been implemented through MLI, others have been implemented via domestic amendments.

3. The following are the minimum standards implemented by way of domestic amendments:

4. The following are the minimum standards implemented through MLI:

5. Paragraph 14 of the Explanatory Statement to the MLI explains the flexibility with respect to the provisions relating to minimum standards. It has been stated that opting out of provisions that reflect minimum standards is possible only in limited circumstances where the provisions of the Covered Tax Agreement already meet the minimum standard. However, it clarifies that where a minimum standard can be met in several alternative ways, the convention gives no preference to any particular way of meeting such minimum standard.6. MLI 6(1) dealing with the ‘preamble text’ is a minimum standard. Opting out is possible only if the CTA already contains the text which is equal to or broader than the said ‘preamble text’. Therefore, MLI 6(4) provides for an exit option only where the CTA already contains preamble language which is similar to the preamble text of MLI 6(1) or is broader than the said preamble text of MLI 6(1).7. MLI 7(1) dealing with the ‘Principal Purpose Test (PPT)’ is also a minimum standard. Opting out is possible only if parties to the CTA intend to reach a mutually satisfactory solution which meets the minimum standard, or if the CTA already contains a PPT. MLI 7(15)(a) provides an exit option where parties to a CTA intend to reach a mutually satisfactory solution which meets the minimum standard for preventing treaty abuse under the OECD / G20 BEPS package. MLI 7(15)(b) provides for an exit option only where the CTA already contains a PPT.8. MLI 17(1) dealing with the ‘corresponding adjustments’ is another minimum standard. Opting out is possible only if the CTA already contains a provision providing for corresponding adjustment or on the basis that it shall make appropriate corresponding adjustment as referred to in MLI 17(1), or that its competent authority shall endeavour to resolve the case under the provisions of the CTA. This is accordingly provided in MLI 17(3).

   9. India has reserved its right under MLI 17(3)(a) for the entirety of MLI 17 not to apply to those of its CTAs that already contain a provision described in MLI 17(2).

   10. India has notified the list of DTAAs which contain a provision for corresponding adjustment. One such example is Canada where Article 9(2) of the DTAA already provides for corresponding adjustment. Hence, the same would remain unamended by MLI 17(1). One may notice this from the synthesised text of the Indo-Canada DTAA published by the CBDT.

   11. One may also take note of the DTAA between India and France. Article 10 of the DTAA which deals with ‘Associated Enterprises’ does not provide for corresponding adjustment. Hence, India has not notified the DTAA with France under MLI 17. Thus, in the absence of a provision providing for corresponding adjustment, MLI 17(1) would get added to Article 10 of the Indo-France DTAA. This may be observed from the synthesised text of the Indo-France DTAA published by the CBDT.

   F. COMPATIBILITY

6. MLI provisions may either be newly added into CTA or may overlap with the existing provisions of CTA. While in the former the provisions of the MLI can be applied without any conflict with the provisions of the CTA, in the latter there is a conflict between the provisions of the MLI and the provisions of the CTA.

2. In order to address such conflicts, the provisions of the MLI contain compatibility clauses which may, for example, describe the existing provisions which the Convention is intended to supersede, as well as the effect on CTAs that do not contain a provision of the same type. This has been explained in Paragraph 15 of the Explanatory Statement to the MLI.

3. The Glossary to the Frequently Asked Questions on the Multilateral Instrument defines ‘compatibility clause’ as ‘clauses which define the relationship between the provisions of the MLI and existing tax treaties in objective terms and the effect the provisions of the MLI may have on Covered Tax Agreements.’

4. We may understand the application of compatibility clauses with reference to MLI 4:

4.1 MLI 4(1) deals with tie-breaker test in the case of dual-resident entities (person other than individual). MLI 4(2) provides that the text of MLI 4(1) would apply in place of or in absence of a clause in the existing text of the CTA which provides for a tie-breaker in the case of person other than individuals.

4.2 MLI 4(3) provides various reservations including reservation of right for the entirety of MLI 4 not to apply to the CTAs, under MLI 4(3)(a).

4.3 MLI 4(4) provides for notifications by the parties to the Depository where reservations under MLI 4(3)(a) have not been made. It provides that the text of MLI 4(1) would replace the existing provision of CTA where all parties have made such a notification. In all other cases, the provisions of the CTA would be superseded by the text of MLI 4(1) only to the extent that those provisions are incompatible with MLI 4(1).

4.4 If both the parties to the CTA notify the same Article number of the CTA, the text of MLI 4(1) would replace the existing text of such Article. Otherwise, the text of MLI 4(1) would supersede the text of the CTA only to the extent that those provisions are incompatible with MLI 4(1). The latter situation may arise, for example, when there is a mismatch in the notification of Articles by the parties.

4.5 In the Indian context, the applicability of MLI 4 is as per the following table:

4.6 As may be seen from the above table, there is no notification mismatch. Therefore, there is no compatibility issue.

4.7 MLI 4(1) deals with cases of persons other than individuals. However, some CTAs may contain a common tie-breaker test in respect of both individuals and non-individuals. In such a case, Paragraph 52 of the Explanatory Statement to the MLI observes that where a single tie-breaker rule exists in the tax treaty for both individuals and persons other than individuals, the text of MLI 4(1) shall modify only that portion of the rule which deals with determination of residence for persons other than individuals. In other words, that portion of the tie-breaker rule dealing with individuals would remain unaltered or unaffected by MLI 4(1). One such example is Article 4(2) of the Indo-Japan DTAA. One can observe from the synthesised text of the Indo-Japan DTAA that the text of Article 4(2) would remain modified by the text of MLI 4(1) only to the extent that it deals with tie-breaker tests in the case of non-individuals.

5. We can understand the application of compatibility clauses with reference to MLI 6:

5.1 MLI 6(2) provides that the text of MLI 6(1) would apply in place of or in the absence of the preamble language of the Covered Tax Agreement referring to an intent to eliminate double taxation, whether or not that language also refers to the intent not to create opportunities for non-taxation or reduced taxation.

5.2 Paragraph 81 of the Explanatory Statement to the MLI explains that the preamble text in MLI 6(1) replaces the existing preamble language of CTAs that refers to an intent to eliminate double taxation (whether or not that language also refers to an intent not to create opportunities for non-taxation or reduced taxation), or is added to the preamble of CTAs where such language does not exist in the preamble of the Covered Tax Agreements.

5.3 MLI 6(5) provides that each party shall notify the Depository of whether each of its CTAs, other than those that are within the scope of a reservation under MLI 6(4), contains preamble language described in MLI 6(2), and if so, the text of the relevant preamble paragraph. Where all contracting jurisdictions have made such a notification with respect to the preamble language, such preamble language shall be replaced by the text described in MLI 6(1). In other cases the text described in MLI 6(1) shall be included in addition to the existing preamble language.

5.4 It may be noted that India has not made a reservation under MLI 6(4). India has also not made any notification under MLI 6(5). Other contracting states may have notified the existing preamble texts. For example, France has notified the existing preamble text with its treaty with India. Thus, there is a notification mismatch (i.e., India has not notified while France has notified). In such a case, the text of MLI 6(1) being a minimum standard would be added to the existing preamble text contained in the CTAs.

5.5 We may also refer to some of the following CTAs of India where the text of MLI 6(1) has been added to the text of the CTA:

5.5.1 Indo-Luxembourg DTAA:

5.5.2 Indo-Japanese DTAA:

1. 
   RESERVATION
   1. It would be pertinent to note that the MLI cannot impinge upon the sovereign taxing rights of a contracting jurisdiction.

2. Thus, where a substantial provision of the MLI does not reflect a minimum standard, a party (contracting jurisdiction) is given the flexibility to opt out of the provision entirely, or in some cases partly.

3. Reservation means a party opts out of a provision of the MLI. When reserved, the relevant provision of the MLI so reserved would not amend the CTA. A reservation of an MLI provision would thus mean the CTA provision applies as it is. More and more of reservation means less and less of MLI affecting the CTA.

4. However, a reservation is not permitted for a minimum standard unless the CTAs contain clauses which meet the minimum standard. This has been dealt with in Paragraphs E6-E11 above.

5. It may be noted that MLI 28 deals with reservations. MLI 28(5) provides that reservations shall generally be made at the time of signature or when depositing the instrument of ratification, acceptance or approval, subject to certain exceptions. After such deposit, no further reservation is permissible. This would prevent further dilution of the impact of MLI by subsequent reservations.

6. At the same time, MLI 28(9) permits a party to withdraw a reservation made earlier at any time or to replace it with a more limited reservation. This would mean that it is permissible to further enhance the impact of MLI by subsequent withdrawal of reservations.

7. On reservation, in the Indian context, an example is the reservation made by India under MLI 3(5)(a). By virtue of this, India has reserved its right for MLI 3 not to apply in entirety to its CTAs. Thus, irrespective of whether contracting jurisdictions choose to apply MLI 3 qua India, the provisions of MLI 3 would not amend the provisions of India’s CTAs.

8. Consider the impact of reservation under MLI 12(4) by Australia on Article 5(PE) of the Indo-Australia DTAA. Though India has notified the relevant article numbers of the Indo-Australia DTAA under provisions of MLI 12(5) and MLI 12(6), Article 5 of the Indo-Australia DTAA would remain unamended by MLI 12 as Australia has reserved the application of MLI 12 in its entirety with respect to all its CTAs.

9. A party cannot make a reservation with respect to a particular CTA. It has to either be across-the-board or with respect to a subset of CTAs based on an objective criterion. This has been taken note of at Page 5 of the Explanatory Statement to the MLI. In other words, reservations cannot be country-centric but must be parameter-centric.

10. A country may still achieve the desired result in certain cases in light of specific reservation clauses. One such example could be of MLI 4(3)(f) which enables a party to reserve the right for MLI 4 not to apply in its entirety to those of its CTAs where the other party to the CTA has opted for MLI 4(3)(e). Thus, where a reservation is made under MLI 4(3)(f) it would only seek to target those treaties where the treaty partners exercise option under MLI 4(3)(e).

11. It may be noted that qua India, three countries, namely, Australia, Fiji and Indonesia, have exercised reservation under MLI 4(3)(e). If India wished it could have exercised reservation under MLI 4(3)(f). However, India has not chosen to make such a reservation.

H. NOTIFICATION

• Notification represents an expression of choice of option by a party to the MLI or it ensures clarity about existing provisions that are within the scope of compatibility clauses.

2. This is clear from Page 11 of the FAQs to the MLI which provides that it is the information submitted to the Depository to ensure clarity and transparency on the application of alternative or optional provisions of the MLI and on the application of provisions of the MLI, and on the provisions that supersede or modify specific types of existing provisions of a CTA.

3. Notification is thus a communication by a contracting state who is party to the MLI. Notifications are issued for expressing reservations or exercising options or indicating the provisions of CTA to be amended by MLI.

I. INDIA’S MLI POSITION AS ON 18TH FEBRUARY, 2021

1. India’s MLI position as per the MLI Matching Database available on the OECD Website6 stands as follows:

2. As per MLI 2(1)(a)(ii), in order for a tax treaty to be a CTA, it will have to be notified by each party to such treaty. From the above table it is clear that in the case of ten tax treaties there seems to be a notification mismatch as to the relevant tax treaty sought to be modified by the MLI. Thus, one will have to check whether both India and the corresponding treaty partner have notified the same treaty sought to be modified by the MLI before applying the MLI.

6   https://www.oecd.org/tax/treaties/mli-matching-database.htm#:~:text=MLI%20Matching%20Database%20(beta)%20The%20Multilateral%20Convention%20to,MLI%20by%20matching%20information%20from%20Signatories’%20MLI%20Positions.

1. CONCLUSION

MLI is a reality and is in effect or is to come into effect in respect of treaties with 42 jurisdictions qua India. While examining the tax consequences under the treaty one will have to be mindful of the provisions of the MLI and the interaction between the provisions of the MLI and the provisions of the treaty. In doing so, one will have to refer to the compatibility clauses. One may also have to refer to the Explanatory Statement to the MLI which would explain each provision of the MLI and the object behind such insertion, the BEPS Actions which have formed the basis for conclusion of the MLI, the Frequently Asked Questions on MLI, the OECD Model Tax Conventions and Commentaries thereon.