OECD releases consultation document with proposed changes to Commentaries to OECD Model Tax Convention on Article 9 (Associated Enterprises) and related articles

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April 13, 2021
2021-0753

Executive summary

On 29 March 2021, the Committee of Fiscal Affairs of the Organisation for Economic Co-operation and Development (OECD) released as a public consultation document a discussion draft proposing changes to the Commentaries on the OECD Model Tax Convention (OECD Model). The document contains the recommendations on the interpretation and application of Article 9 (Associated Enterprises) and other related articles of the OECD Model, made by Working Party 1 (the subgroup of the OECD Committee on Fiscal Affairs (CFA) responsible for work on the Model) in consultation with Working Party 6 (the subgroup of the OECD CFA responsible for work on the taxation of multinational enterprises, including transfer pricing matters) and the Forum on Tax Administration’s Mutual Agreement Procedure (MAP) Forum.

The consultation document indicates that the CFA has examined various issues related to the interpretation of Article 9 of the OECD Model. In essence, the proposed changes would specify that the conditions for the deductibility of expenses are a matter to be determined by domestic law. Under the proposed changes, if domestic law rules would result in fewer expenses being deductible than the arm’s-length amount, this would not be considered to cause economic double taxation of the type that the provisions of the OECD Model seek to eliminate and there would be no obligation on the other Contracting State to make corresponding adjustments under Article 9 of the OECD Model in these circumstances. The proposed changes would mean that domestic law limitations on deductibility of expenses, even if such limitations are applied exclusively to controlled transactions and not to similar uncontrolled transactions, would not be considered to lead to economic double taxation that would be subject to relief under Article 9 of the OECD Model.

The OECD invites interested parties to submit comments on the discussion draft before 28 May 2021.

Detailed discussion

Background

The OECD Model is regularly reviewed and updated to address new tax treaty issues, with the technical work led by Working Party 1. The most recent update to the OECD Model, released in 2017, reflects the treaty-related recommendations developed in the Base Erosion and Profit Shifting (BEPS) project.

As part of the OECD BEPS Action Plan,¹ a specific work stream focused on developing detailed guidance on the most frequent transfer pricing issues in the area of financial transactions. The final reports on BEPS Action 4 (limiting interest deductions) and BEPS Actions 8-10 (aligning transfer pricing with value creation) mandated follow-up work on the transfer pricing aspects of financial transactions. Under this mandate, a discussion draft was released in July 2018. In February 2020, the OECD released its final report related to transfer pricing guidance on financial transactions, clarifying the application of the principles included in the 2017 edition of the OECD Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations (OECD Transfer Pricing Guidelines), including in particular the accurate delineation analysis under Chapter I, to financial transactions.² The proposed changes that are the subject of this public consultation are directly related to that 2020 guidance.

Proposed changes

On 29 March 2021, the OECD proposed a number of changes to the Commentary on Article 9 (associated enterprises), Article 7 (business profits), Article 24 (non-discrimination), and Article 25 (MAP) of the OECD Model. The proposed changes are the result of the work of the OECD/G20 Inclusive Framework on BEPS to amend the Commentary on Article 9 to clarify its application, especially as it relates to domestic laws on interest deductibility such as those recommended in the final report on BEPS Action 4 in light of questions raised regarding the interaction of Article 9 with such domestic law rules.

In essence, the proposed changes to the Commentary on Article 9 of the OECD Model would specify the following:

The Contracting State making a determination on the extent to which a financing transaction is regarded as a loan or an equity contribution would do so taking into account factors in its domestic laws (including its judicial doctrine) or in the OECD Transfer Pricing Guidelines.
Once a controlled transaction has been priced in accordance with the arm’s-length principle, the proposed Commentary would provide that the domestic law of a Contracting State is to determine whether and how such profits should be taxed. The proposed changes would stipulate that the conditions for the deductibility of expenses are a matter to be determined by domestic law, subject to the provisions of the OECD Model and, in particular, paragraph 4 of Article 24.
Hence, when domestic law limits the deductibility of otherwise arm’s-length payments that would not be considered to result in economic double taxation for purposes of paragraph 2 of Article 9 of the OECD Model and therefore a corresponding adjustment would not have to be made.

The public consultation document also includes a proposed change to the Commentary on Article 7 of the OECD Model to modify the reference to corresponding adjustments related to Permanent Establishment.³ In addition, the public consultation document proposes to change the Commentary on Article 24 of the OECD Model to include the reversal of the burden of proof as an element of the additional information requirements that are not prohibited with respect to payments made to nonresidents. Finally, the consultation document includes a proposal to add a new paragraph to the Commentary on Article 25 of the OECD Model that is designed to confirm the practices of OECD member countries regarding the admission of cases into MAP and to reinforce one of the conclusions of the final report on BEPS Action 14 (improving MAP).

Implications

The consultation document includes proposed changes to the Commentary on the OECD Model that would effectively specify that once a transaction between associated enterprises is priced at arm’s length, it is up to the domestic legislation of the relevant country whether the payment is deductible or not. Any resulting mismatch in domestic law treatment would not be considered to result in economic double taxation of the type that the provisions of the OECD Model seek to eliminate, and there would be no obligation on a Contracting State to make corresponding adjustment under Article 9 of the OECD Model in these circumstances. In this regard, the public consultation document appears to have links to the analysis of the Inclusive Framework on BEPS of the interaction between the proposed Pillar Two Global Anti-Base Erosion (GloBE) rules and tax treaty law. The Pillar Two Blueprint released on 12 October 2020 reflects the view that the proposed GloBE rules would not be in conflict with treaty obligations, contending that tax treaties are not intended to restrict a jurisdiction’s right to tax its own residents. However, some comment letters on the Pillar Two Blueprint, including the EY submission, expressed concern that the GloBE rules appear to be at odds with the existing Commentary and could undermine the arm’s-length principle embodied in the existing treaty network. Given the significant implications of this issue for the deductibility of payments between related parties, it will be important to monitor developments with respect to both this current consultation document and Pillar Two.

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For additional information with respect to this Alert, please contact the following:

EY Société d’Avocats, Marseille