What is the Principal Purposes Test and how does it address treaty abuse?

The Principal Purposes Test that is introduced in all treaties covered by the MLI is an effective instrument to counter arrangements such as those described above that have been put in place for the principal purpose to obtain the benefits of a tax treaty.

The Principal Purposes Test (PPT) is an anti-abuse rule based on the principal purposes of transactions or arrangements. This rule provides a general way to address cases of treaty abuse, including treaty-shopping situations, such as certain conduit financing arrangements that are not covered by more specific anti-abuse rules.

Once introduced to a tax treaty through the MLI or bilateral negotiations, the PPT would apply to the treaty in its entirety and would address all cases of treaty abuse. Under the PPT, if one of the principal purposes of transactions or arrangements is to obtain treaty benefits (e.g. a lower withholding tax in the case of a treaty shopping scheme), these benefits would be denied unless it is established that granting these benefits would be in accordance with the object and purpose of the provisions of the treaty. The PPT is a subjective test based on an assessment of the intentions behind a transaction or arrangement. This approach is similar to approaches taken under domestic anti-abuse rules or doctrines applied by countries around the world, such as general anti-avoidance rules or an ‘abuse of laws’ doctrine.

The PPT provisions included in the MLI establish that a tax authority may deny the benefits of a tax treaty where it is reasonable to conclude, having considered all the relevant facts and circumstances, that one of the principal purposes of an arrangement or transaction was for a benefit under a tax treaty to be obtained. The<a href=”http://www.oecd.org/tax/preventing-the-granting-of-treaty-benefits-in-inappropriate-circumstances-action-6-2015-final-report-9789264241695-en.htm” target=”_blank”>Action 6 Report </a> of the <a href=”http://www.oecd.org/ctp/beps-2015-final-reports.htm” target=”_blank”>BEPS  Package </a>  includes detailed guidance and examples in the form of the commentary that was developed during the course of the BEPS Project and has particular relevance in this regard.

In reality, treaty shopping schemes typically involve the use of layered structures abusing the provisions of multiple tax treaties. Now that the PPT will be introduced in a large number of treaties, the treaty shopping routes will be blocked effectively.