Tax Treaty Shopping Post-BEPS: What Still Works and What Doesn't

Treaty Shopping: The Pre-BEPS Landscape

Tax treaty shopping — the practice of routing income through an entity in a third country solely to access that country's favourable treaty network — was widespread before the BEPS project. The classic structure involved a payment (typically dividends, interest, or royalties) flowing from a source country through a conduit entity in a treaty-favourable jurisdiction, to the ultimate recipient in a high-tax or no-treaty country.

The conduit jurisdiction provided no economic function. It existed solely to access the reduced withholding tax rate available under its treaty with the source country. An Italian company paying dividends to a Cayman Islands parent might route the payment via a Netherlands BV — accessing the 0% withholding under the Italy-Netherlands treaty — where a direct Cayman receipt would attract 26% Italian withholding tax.

BEPS Action 6 (Preventing the Granting of Treaty Benefits in Inappropriate Circumstances, published September 2014) identified treaty shopping as one of the most significant base erosion concerns and recommended two anti-abuse provisions as minimum standards to be included in all treaties.

The Principal Purpose Test (PPT)

The Principal Purpose Test (PPT) is the primary BEPS Action 6 anti-abuse measure. It is set out in Article 29(9) of the 2017 OECD Model and reads:

"Notwithstanding the other provisions of this Convention, a benefit under this Convention shall not be granted in respect of an item of income or capital if it is reasonable to conclude, having regard to all relevant facts and circumstances, that obtaining that benefit was one of the principal purposes of any arrangement or transaction that resulted directly or indirectly in that benefit, unless it is established that granting that benefit in these circumstances would be in accordance with the object and purpose of the relevant provisions of this Convention."

The PPT is an objective test, not a subjective one. It asks whether it is "reasonable to conclude" that obtaining the treaty benefit was a principal purpose — not necessarily the only purpose or the dominant purpose. A transaction can have genuine commercial purpose and still fail the PPT if the treaty benefit was "one of the principal purposes."

PPT vs Limitation on Benefits

The Multilateral Instrument (MLI, the OECD's multilateral treaty modification mechanism that amended thousands of bilateral treaties simultaneously) offered implementing jurisdictions a choice between:

• The PPT alone
• The PPT plus a simplified Limitation on Benefits (LOB) clause
• The Detailed LOB (DLOB) without the PPT (available only for treaties between US-style LOB jurisdictions)

Most jurisdictions chose the PPT alone or PPT plus simplified LOB. The US, which already had detailed LOB provisions in most of its existing treaties, did not sign the MLI and instead retained its bilateral treaty network with detailed LOB provisions negotiated individually.

The Simplified LOB

The simplified LOB provides a "safe harbour" list of entities that automatically qualify for treaty benefits:

• Individuals
• Governments and government entities
• Listed companies and their subsidiaries
• Pension funds and charitable organisations
• Active business entities (where the treaty benefits relate to the active trade or business)
• Companies with 50%+ ownership by qualifying persons

An entity that satisfies any of these conditions is treated as a "qualified person" and is not subject to the PPT for treaty benefits that a qualified person would receive.

A holding company that is a wholly-owned subsidiary of a listed parent company is a qualified person under the simplified LOB — it automatically passes the test.

Which Treaties Are Now Effectively PPT-Protected

The MLI, which entered into force on 1 July 2018, has been ratified by over 100 jurisdictions and has modified over 1,700 bilateral tax treaties. Most major economies' treaty networks are now covered:

• UK: Signed the MLI; PPT applies to most UK treaties
• Germany: Signed the MLI; PPT applies
• France: Signed the MLI; PPT applies
• Netherlands: Signed the MLI; PPT applies
• Singapore: Signed the MLI; PPT applies
• UAE: Signed the MLI in limited form; PPT does not apply universally to UAE treaties
• Cyprus: Signed the MLI; PPT applies to Cyprus treaties modified by the MLI
• Switzerland: Signed the MLI; PPT applies to Swiss treaties modified by the MLI

The United States has not signed the MLI. US treaties continue to use the bilateral US-style detailed LOB without a PPT.

Remaining Planning Opportunities in Genuine Substance Structures

The post-BEPS treaty landscape has not eliminated legitimate international tax structuring. What it has eliminated is the use of letterbox entities with no substance to access treaty rates. Where genuine substance exists, treaty benefits remain available.

What "Genuine Substance" Means Post-BEPS

For a holding company to access treaty benefits in the post-BEPS environment, it needs:

1. Legal and beneficial ownership of the shares it holds — not a nominee arrangement
2. Decision-making in the treaty jurisdiction — board meetings attended by resident directors, decisions made in-country
3. Qualified local directors — not merely nominee directors who rubber-stamp parent company decisions
4. Some economic activity — managing the investment portfolio, overseeing subsidiaries, managing group treasury or risk functions

A Cyprus holding company with a Cypriot resident director who genuinely manages the investment portfolio, attends quarterly board meetings in Cyprus, and makes investment decisions from Cyprus — supported by local legal and accounting advisers — will withstand PPT scrutiny. A Cyprus holding company with nominee directors appointed by a formation agent, with no presence in Cyprus and all decisions made by the beneficial owner abroad, will not.

The "Object and Purpose" Escape Hatch

Even where the PPT test is facially met, a taxpayer can still access treaty benefits if they can demonstrate that granting the benefit "would be in accordance with the object and purpose of the relevant provisions." This requires showing that the structure aligns with the underlying policy rationale of the treaty provision in question.

For example, a holding company that was established in the Netherlands five years before the relevant transaction, that employs Dutch staff, and that has been actively managing investments since its establishment, can argue that the treaty dividend benefit it claims is not an abuse of the treaty — even if a tax benefit is also a consequence.

Scenario	PPT Risk Assessment
Letterbox conduit with no substance, established to access treaty rate	High risk — PPT likely applies
Holding company with resident directors and genuine activity, tax benefit incidental	Low risk — PPT unlikely to apply
Holding company established primarily for treaty access, with some substance added after the fact	Medium risk — depends on timing and quality of substance
Structure using simplified LOB qualified person (listed parent subsidiary)	No PPT issue — automatically qualified

HPT Group designs post-BEPS compliant international structures for clients who require holding company, royalty, or treasury arrangements in treaty jurisdictions. The difference between a compliant structure and a challenged one lies entirely in the quality and genuineness of the substance — and in understanding what each treaty's PPT language requires. Contact our corporate tax advisory team or explore our services to discuss your international holding structure.