Following recent developments in the field of international and EU tax law, it is apparent that the concept of substance is more than a simple catchphrase in cross-border planning. The introduction of the MLI and ATAD I & II are evidence that the international tax world is shifting to a substance over form paradigm; notably, ATAD I entered fully into force on January 1st 2019 coinciding with the MLI’s provisions on withholding taxes.
Both the ATADs and the MLI are expected to trigger profound changes in the application of tax treaties and EU Directives introducing and incorporating the concept of substance. The concept of substance is expected to play a key role in anti – abuse and treaty residence rules affecting in addition transfer pricing structures, and CFC rules among other.
While no definition of the term may be found in domestic law or Double Tax Treaties, nonetheless international jurisprudence identifies substance with a combination of Functions, i.e. allocation of wages, Assets, i.e. premises, office, and Risk allocation, i.e. risk-free back to back transactions. The level of substance required to avoid challenges by the tax authorities may be determined on a case by case basis; however, it seems that the required level is specific to each structure or activity under review. In this respect, for a holding company managing a single shareholding to meet substance requirements the mere avoidance of letter box / brass plate companies may suffice. However, the lack of a universally excepted definition of substance is bound to lead to a rising of tax disputes around the world.
On a tax treaty level per the OECD’s Model Tax Convention where a company is considered to be a resident of both states involved, the conflict is resolved according to the place of effective management (POEM) tie-breaker rule, essentially, the place where key management and commercial decisions are made in substance. i.e. according to all the facts and circumstances pertaining to the case.
It must be noted that in the revised art. 4 of the OECD MTC 2017 edition and art. 4 of the MLI cases of residence conflict may be resolved under the Mutual Agreement Procedure which takes under consideration a variety of factors including the POEM tie-breaker rule. It should be pointed that where states fail to reach an agreement, treaty benefits may be denied to the taxpayer.
Furthermore, the MLI introduces a Principal Purpose Test in most Tax Treaties aiming to limit treaty benefits in situations where the tax benefit was the, or one of the, main purpose of the arrangement or transaction. The broad scope of the PPT and its inherent subjective nature may give considerable leeway to tax authorities to exclude from treaty benefits structures or transactions where the principal purpose test is deemed to be application of a treaty benefit.
The interplay between the PPT and the EU Tax law where the application of the anti-abuse provision is limited only to wholly artificial arrangements without economic activity or substance should provide interesting results.
* Το άρθρο δημοσιεύεται στο Business Partners Magazine