Hybrid Entities and Conflicts of Allocation of Income Within Tax Treaties: Is New Article 1(2) of the OECD Model (Article 3(1) of the MLI) the Best Solution Available?
British Tax Review, Issue 3 (2018)
43 Pages Posted: 19 Dec 2018
Date Written: October 29, 2018
The benefits of a tax treaty are generally granted to persons who are residents of one of the Contracting States. The determination of such tax residence status is, however, not always an easy task and is particularly problematic in relation to entities whose tax characterisation differs from one Contracting State to another thereby giving rise to conflicts of allocation of income. As a remedy for this, the OECD has introduced a new Article 1(2) in to the OECD Model Tax Convention 2017 (the OECD Model), the text of which is also replicated in Article 3(1) of the Multilateral Instrument (MLI). This provision, which reproduces the principles already settled within the 1999 OECD Partnership Report and which uses a wording which mirrors Article 1(6) of the US Model, is presented as the most effective way of dealing with the use of hybrid entities within the context of tax treaties. This is, however, only partially true. As will be argued by the author, Article 1(2) of the OECD Model—and by extension Article 3(1) of the MLI—is not designed to interplay properly with other attribution rules within the relevant tax treaties, especially with regard to the beneficial ownership requirement of Articles 10, 11 and 12 of the OECD Model. Accordingly, Article 1(2) of the OECD Model maintains an unjustified preference for the interests of the residence state over those of the source state thereby generating concerns especially for developing (source) countries. As stressed in this article, a better solution might perhaps be found outside the treaty context, specifically through the use of a domestic rule that co-ordinates the characterisation of entities for tax purposes. This solution would not only eliminate any potential hybrid entity mismatch before the application of a treaty, but would also indirectly provide more consistent tax treaty outcomes without the need to replace or modify the current wording of Article 1(2) of the OECD Model.
Keywords: tax treaties, hybrid entities, tax transparent entities, OECD Model, Multilateral Instrument, saving clause, BEPS
JEL Classification: K33, K34
Suggested Citation: Suggested Citation