Five Things to Know About the OECD’s Multilateral Instrument

The Tax Management Transfer Pricing Report ™ provides news and analysis on U.S. and international governments’ tax policies regarding intercompany transfer pricing.

By Kevin A. Bell

Sixty-eight nations, with the notable exception of the U.S., came to Paris June 7 and signed a document created by the OECD—the Multilateral Convention to Implement Tax Treaty Related Measures to Prevent Base Erosion and Profit Shifting .

The convention, which the Organization for Economic Cooperation and Development is calling the “multilateral instrument” (MLI), is expected to have huge ramifications for global companies’ tax planning going forward. But what is it, exactly, and how does it work?

1. What is it, and how did it come about?

The MLI is a unique document, a kind of master treaty through which the OECD, as depository, serves as a clearinghouse for changes to countries’ treaties with one another.

The document is essentially the last piece of the OECD’s comprehensive plan to rewrite the global tax rules, the Action Plan on Base Erosion and Profit Shifting. The BEPS plan generated new guidance from the OECD in a number of areas, some of them involving changes to regulations and others involving changes to treaties. The MLI, called for under Action 15 of the BEPS project, reflects the treaty changes from four other actions:

  •  Action 2, designed to eliminate the use of “hybrid mismatch arrangements,” where a payment creates a tax deduction in one jurisdiction without a corresponding increase in income in another—or, in some cases, where a deduction can be claimed on both ends of a transaction;
  •  Action 6, intended to shut down “treaty shopping,” where companies route profits through low- or no-tax countries to avoid paying taxes in a third country;
  •  Action 7, which revised the definition of a permanent establishment—a taxable presence in a country created through activities carried out in the country by a foreign enterprise; and
  •  Action 14—one of the few actions taxpayers like—intended to improve the process under which governments resolve their overlapping tax claims on a multinational company’s income.

2. How does it work?

The 68 countries that signed the MLI had the option of adopting or “reserving on"—opting out of—a vast menu of options tied to the four action items described above. The treaty instrument has already spawned more than 2,000 pages of “positions” detailing the 68 governments’ choices and opt-outs.

Countries that have signed the MLI next must ratify the instrument through their domestic procedures. This isn’t quite as involved in some countries as it is in the U.S., which is one reason the U.S. didn’t sign it. The MLI will go into effect once it’s been ratified by five countries.

Determining how the instrument would affect the bilateral treaty of two countries that have signed it requires a matching process. For example, France and Germany both signed the MLI but reserved on different provisions. Where either country opted out of a provision, it wouldn’t apply. Once France and Germany have ratified the MLI and notified the OECD of that fact, the instrument will take effect for them as long as three other countries have also ratified it.

The countries that signed the MLI generally took a conservative approach, reserving on provisions when in doubt. They can change those reservations before ratifying the instrument.

The OECD has said the MLI will change more than 1,000 bilateral tax treaties in the course of a couple of years—as opposed to a couple of decades, which would have been the case under traditional government-to-government negotiations.

3. Why didn’t the U.S. sign the instrument?

The U.S. may sign the MLI down the road, but it chose not to at the signing ceremony June 7, a U.S. official said. Among the reasons given by Henry Louie, deputy international tax counsel at the U.S. Department of Treasury, were:

  •  The U.S. tax treaty network is already robust enough to prevent treaty shopping. The U.S. didn’t sign the MLI because the U.S. tax treaty network has a low degree of exposure to base erosion and profit shifting.
  •  The MLI is consistent with U.S. tax treaty policy, including the “savings clause” that preserves the right of each country to tax its own companies as if no tax treaty existed. The U.S. also has treaty rules that prevent third-country investors from routing their investment through the treaty partner to avoid tax.
  •  The State Department has to approve the treaty text negotiated by Treasury, which means explaining “every deviation from the U.S. model tax treaty provisions.” Getting the State Department’s approval would have required a lot of heavy lifting, Louie said.
  •  Finally, the U.S. Senate has to approve tax treaties negotiated by Treasury, and it would probably have wanted “some kind of assurance, at the very least, that all of our treaty partners share our interpretation of what the MLI has done to the bilateral treaties.” That might mean needing to see an agreed consolidated text, which “puts you back into the question of ‘if you needed to do all these consolidated texts, maybe you could just have done them bilaterally to begin with.’”

4. Why do U.S. multinationals care about the MLI?

Even though the U.S. didn’t sign the MLI, the instrument will amend many non-U.S. treaties that affect the tax consequences for foreign-to-foreign entity relationships within multinational groups.

Many of the provisions in the treaty instrument are intended to eliminate transactions companies now use to minimize tax, and they will need to alter their structures accordingly. Pascal Saint-Amans, who heads the OECD’s tax unit, has made much of the MLI’s anti-treaty-shopping provision. Part of that provision is a “principal purpose test,” embraced by all 68 countries that inked the treaty instrument June 7. The test is a powerful tool for governments because it allows them to disregard transactions based on a multinational group’s motivation for executing them.

U.S. multinationals also will want to monitor which countries adopt the provision for mandatory binding arbitration of cross-border tax disputes, part of the Action 14 initiative. These disputes are likely to increase as more countries adopt other changes from the BEPS project, causing more instances of overlapping tax claims. An arbitration clause forces governments that fail to resolve these double-tax disputes after two years to turn the case over to an independent panel.

5. How soon will we see an impact?

The OECD has said the first impact on multinational group tax structures is likely to take place by 2018 as companies prepare for new treaty provisions a year or two later.

A former OECD official predicted a couple of countries will ratify the MLI this year, and that for most countries, actual changes to treaties will take effect in 2019 or 2020. In particular, the principal purpose test, which countries apply through withholding, likely won’t take effect until 2019, said Marlies de Ruiter, who led the OECD’s BEPS work on tax treaties. De Ruiter, now a partner with Ernst & Young Belastingadviseurs LLP in Rotterdam, Netherlands, said it will be hard for countries to get a treaty to enter into effect for withholding taxes before Jan. 1, 2019.

To contact the reporter on this story: Kevin A. Bell in Washington at

To contact the editor responsible for this story: Molly Moses at

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