Main Purpose Test: What should businesses be prepared for?

What should businesses be prepared for?

After Oksana Markarova, the acting Minister of Finance of Ukraine, signed the MLI-convention on July 23, 2019, the lawyers faced a lot of questions, as the test of the main purpose stipulated by the convention will be effective by the end of this year. What it is and what the businesses should be prepared for was explained at a KPMG seminar held in Ukraine on August 13. Olexander Boboshko, Director, International tax group, KPMG in Ukraine, moderated the event.


The MLI-convention or the Multilateral Convention to Implement Tax Treaty Related Measures to Prevent Base Erosion and Profit Shifting is an agreement by accession to which a country becomes able to simultaneously amend all or some of the applicable Conventions on Double Taxation Avoidance (DTT).

Larysa Antoshchuk, a lawyer, Head of Tax litigation group KPMG Law Ukraine, says that for a year and a half the fiscal authorities demonstrated to some extent the transition from the beneficial owner concept to the test of the main purpose. “There is a certain approbation because both the courts and the tax authorities are learning how to analyze the things that their foreign counterparts already did five or six years ago. For example, the cases of Amazon, Apple, Fiat, Starbucks - they all raised the issue of analyzing the economic substance of the transactions and the economic substance of a group of companies structure, because it turned out that by using classical tax planning the companies are abusing the double tax avoidance treaties”, - says Mrs. Antoshuk.

This type of abuse in English is called “treaty shopping”, where through the use of various double tax avoidance treaties, the effect of double taxation is achieved. If the fiscal authority now finds the company without economic substance, it will challenge its right to apply for tax benefits under the double taxation avoidance conventions of a particular payer who pays the passive income to a counterparty from some other jurisdiction.

What benefits it deals with?

According to Andriy Buznytskyi, Senior consultant at KPMG in Ukraine, that applies to such benefits as the application of the non-discrimination provision, the reduced rate (exemption) of withholding tax, and the exemption from double taxation in the form of a tax credit. At the same time, he said, the comment to the OECD Model Convention implies that the purpose is not considered to be the main one when obtaining the benefit was not a major factor in creating the structure or carrying out the transaction that enables it to be granted. Therefore, when the arrangement is linked to the principal commercial activity and its form was not stipulated by the receipt of a benefit, it is unlikely that the primary purpose of the arrangement would be to obtain a tax benefit.

Mr. Buznytskyi calls the principle of economic presence of a foreign company as one of the most important elements of the main purpose test. “When we talk about a substance that is important for the application of the primary purpose test, it is not about the regulatory requirements to presence, which exist in foreign jurisdictions for obtaining a tax resident certificate. In most jurisdictions, the requirements for obtaining the said certificate are limited to the fact that the foreign company must have an office, staff, and that the principal activity of the foreign company is to be carried out in the jurisdiction in which it is registered. Not just physical presence but also the economic one, which is related to the functional profile of the company, is important for the purposes of the test. In other words it should be the presence that will be consistent with the nature of the company operations,” the expert said.

The foreign court practice dealing with the main purpose test was presented by Iryna Khilyak, a senior lawyer, Tax Dispute Resolution group, KPMG Law Ukraine. Analyzing the EU Court rulings on the said issue, the abuse of a tax benefit takes place if two conditions are met simultaneously:

- transactions lead to the receipt of a tax benefit, the provision of which is contrary to the idea of the tax laws rules;

- a number of objective factors evidence that the primary purpose of the taxpayer operations is to obtain tax benefits.

According to the courts, the compliance with the formal requirements of the double taxation avoidance convention (for example, proof of residency for a non-resident) for the sole purpose of obtaining tax benefits demonstrates the improper use of the terms of the convention and entails a justified refusal by the state to grant those benefits.

"Potentially, those are the conclusions that may soon become applicable in Ukrainian courts, and, therefore, the business should be prepared to prove that a lowered rate of withholding tax applied was not the main purpose of operations," the speaker stressed.

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