On March 24, 2016, the Organization for Economic Co-operation and Development (OECD) released a public consultation document seeking input with respect to treaty entitlement of non-collective investment vehicle (non-CIV) funds. Responses to the consultation document are requested by April 22, 2016.

The consultation document follows up on the OECD's final Base Erosion and Profit Shifting (BEPS) report on Action 6 (Preventing the Granting of Treaty Benefits in Inappropriate Circumstances) released last fall Tax Alert 2015-2002 (Action 6 Report). In the Action 6 Report, the OECD stated that it would continue to examine issues relating to the treaty entitlement of non-CIV funds to ensure that new treaty provisions included in the report would adequately address the treaty entitlement of non-CIV funds.

To that end, the consultation document includes a number of specific questions related to concerns identified in comments received on previous discussion drafts related to the work under Action 6, and how the new treaty provisions could affect the treaty entitlement of non-CIV funds, as well as possible ways of addressing these concerns. It is noted that the proposals included in the consultation document were previously put forward by commentators and do not represent proposals by the Committee on Fiscal Affairs or its subsidiary bodies, and are included to obtain further information for purposes of analyzing the proposals. Specifically, input is requested in response to a number of questions relating to the application of the Limitation on Benefits provision, the Principal Purpose Test rule, anti-conduit rules, and the "special tax regime" proposal, discussed in previous discussion drafts or reports under Action 6.

Responses will be considered at the May 2016 meeting of Working Party 1 of the OECD.

Issues for comment

In addition to asking, more generally, for comments regarding any new approaches that could be examined as regards the way in which the provisions included in the Action 6 Report may be modified to address issues related to the treaty entitlement of non-CIV funds, the consultation document specifically seeks feedback with respect to issues relating to the following four approaches aimed at preventing treaty shopping, and discussed in previous discussion drafts or reports.

1. Limitation-on-benefits (LOB)

The consultation document notes that most of the concerns previously raised related to the effect the LOB provision would have on non-CIV funds with a geographically diversified base. It groups suggestions received on how to address this issue into several categories.

Regulated and/or widely-held non-CIV funds

A number of commentators suggested creating an exception to the LOB provision for non-CIV funds that are subject to certain types of regulatory frameworks. Others suggested that an exception should be granted for funds that are "sufficiently widely-held." The OECD asks for details on the types of regulatory frameworks that should qualify, and what the threshold would be to be considered "widely held," as well as with respect to some more specific concerns relating to such approaches. One of the questions notes that the suggested approach of providing an exception that would apply regardless of who invests in the funds would seem to be relatively easy for investors who would not otherwise be entitled to the same or better treaty benefit to invest in the fund, and asks how this treaty-shopping concern might be addressed. Moreover, the consultation document asks what features could be incorporated into a specific non-CIV exception to make it more acceptable to countries that support the inclusion of an LOB provision.

Non-CIV funds set up as transparent entities

According to the consultation document, some commentators suggested that a non-CIV fund should be able to elect to be treated as fiscally transparent for treaty purposes. The consultation document notes, however, that would be a matter of domestic law and could hardly be provided in tax treaties as it would require domestic tax law provisions that would attribute the income of a non-CIV to the investors of the non-CIV rather than to the non-CIV fund itself. Another suggestion noted is that a non-CIV fund be allowed to claim treaty benefits on behalf of its ultimate investors who themselves would be entitled to treaty benefits under the transparent entity provision that is contained in the BEPS Report on Action 2. The consultation document notes, however, that a key practical difficulty in the application of the transparent entity provision to non-CIV funds would be that it would require the source State to be provided with all of the relevant information concerning the investors in the non-CIV fund. Moreover, it is noted that a number of commentators had previously indicated that at least some types of non-CIV funds may be unable to identify the tax residence of their investors. In this regard, the consultation document asks whether there are ways to address these practical difficulties and whether there are other practical problems that would prevent the application of the new transparent entity provision in this context.

Non-CIV funds with a large proportion of investors entitled to benefits

Other commentators previously suggested a derivative benefits test be included in the LOB provision whereby non-CIV funds would be granted treaty benefits if they met certain conditions and had a sufficiently high portion of investors (e.g., 80%) entitled to the same or better treaty benefits. Because the treaty benefits would be granted to the fund itself — unlike in the case of transparent funds in the above proposal — treaty shopping concerns would continue to be an issue, necessitating the inclusion of additional criteria for funds to qualify. In addition to general questions about the application of such an approach, the consultation document also asks specific questions with respect to identifying the investors in a non-CIV, preventing treaty shopping, preventing deferral, and issues related to including a derivative benefits test similar to the provision in the 2016 US model treaty.

Non-CIV resident of a State with which it has a substantial connection

Another proposal previously suggested by commentators would be to modify the provisions of the LOB article to provide that the activities of certain non-CIV funds would be considered to constitute the active conduct of a business based on a "sufficiently substantial connection" with the fund's State of residence. The consultation document asks generally whether there is a practicable design to such an approach that would not raise treaty-shopping and tax-deferral concerns.

"Global Streamed Fund" regime

Although it goes beyond the scope of the specific issue of the application of the LOB to non-CIV funds, the consultation document also asks for feedback with respect to a recently proposed "Global Streamed Fund" approach that was suggested by an industry representative. Under this approach, investment income would be exempt from tax when derived by a qualifying "Global Streamed Fund," but this fund would be required to distribute its income on a regular basis, and tax would be collected upon those distributions by the State of residence of the fund and remitted to the State of source of the income. The tax so collected would be determined by the treaty entitlement of the ultimate investor under the treaty between the State of residence of that ultimate investor and the State of source of the income.

2. Principal purposes test (PPT)

Some commentators expressed concerns that the PPT rule included in the Action 6 Report might restrict treaty entitlement of non-CIV funds when a large portion of its investors are residents of States other than the fund's State of residence. While the OECD has declined to accept suggestions to exempt specific groups of entities from the application of the PPT rule, it invites comments on new examples that should be included in the Commentary regarding the application of the PPT rule to common, legitimate arrangements entered into by non-CIV funds, focusing on common transactions that do not raise treaty shopping or inappropriate granting of treaty benefits concerns.

3. Anti-conduit rules

With respect to concerns expressed about the application of the anti-conduit rule to non-CIV funds, the consultation document requests examples of where the PPT rule could apply to legitimate types of arrangements that are commonly entered into by non-CIV funds that could be seen as conduit arrangements under the examples in the existing Commentary.

4. "Special tax regimes" proposal

The consultation document also seeks additional input from commentators who have expressed concerns about the unintended effects of the proposal for new treaty rules on "special tax regimes," included in the May 2015 discussion draft. Specifically, the document asks whether such commentators may have similar or different concerns with respect to the "special tax regimes" proposal included in the new 2016 US model tax treaty, released in February 2016.

Implications

Interested parties should evaluate the different approaches outlined in the consultation document and consider submitting comments in response to the specific questions raised. In addition, the consultation document asks, more generally, for comments regarding any new approaches to address issues related to the treaty entitlement of non-CIV funds. The consultation document acknowledges that a number of questions are likely to be relevant only for commentators who supported specific approaches to protect against treaty shopping. Responses should be submitted by April 22, 2016, and will be discussed at the upcoming May meeting of Working Party 1.

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