On May 3 the Conference of the Parties (COP) to the Multilateral Convention to Implement Tax Treaty Related Measures to Prevent Base Erosion and Profit Shifting approved an opinion titled "Interpretation and Implementation Questions," which was published on May 20.1 Article 32(2) of the multilateral instrument provides that "any question arising as to the interpretation or implementation of this Convention may be addressed by a Conference of the Parties convened in accordance with paragraph 3 of Article 31." The opinion was issued to address the questions that had arisen in the interpretation and application of the MLI after its conclusion on June 7, 2017.

This article provides an in-depth analysis of the capital gains article of the MLI in light of the updated information in the COP opinion. It starts with the exception relating to the interaction between the notification clause and the compatibility clause, which is also the focus of this analysis. By examining the language pattern used in the compatibility and notification clauses, the author derives the general conception from the specifics and then applies those concepts to the cases that illustrate how the MLI provisions modify the covered tax agreements (CTAs) concluded by some selected countries in the Asia-Pacific region.

Conference of the Parties

The COP categorized its May 3 opinion into six guiding principles, which provide the theoretical and technical tools in the interpretation and implementation of the MLI.

The third guiding principle introduces the later-in-time rule. It states that the application of the MLI to CTAs follows the general principle that when two rules apply to the same subject matter, the later-in-time rule prevails (lex posterior derogat legi priori), to the extent they are incompatible.

The COP in its May 3 opinion endorses the term "MLI positions" under the fourth guiding principle, which was first used in a note issued by the OECD Directorate for Legal Affairs.2 This principle provides that the MLI should be interpreted in light of the consent given by each contracting jurisdiction to modify their CTAs, as expressed in their MLI positions, and with the consequences set out in the relevant MLI provisions. The MLI, while respecting countries' sovereignty and the bilateral nature of the CTAs, allows for flexibility through a system of reservations and notifications of choices of alternative provisions and optional provisions. The lists of CTAs, reservations, and notifications are submitted in the form of so-called MLI positions that represent the boundaries of each party's consent to its CTA modifications.

In the fifth guiding principle, the opinion provides that the compatibility clauses set out whether, and to what extent, provisions in the MLI interact with existing provisions of CTAs. When a substantive MLI provision conflicts with specific CTA provisions covering the same subject matter, it is addressed through a description in the compatibility clause of the existing provisions that the MLI is intended to modify.

The sixth guiding principle provides that the notification clauses ensure clarity and transparency about existing CTA provisions that are modified by the MLI. While the notifications sometimes trigger the application of the MLI, in other cases, they do not.

The Application of the MLI to CTAs

As explained by the May 3 opinion, the compatibility clause, which is the cornerstone for MLI implementation, objectively defines the relationship between MLI and CTA provisions, in relation to its interactive relationships with the operative and notification clauses.

Mechanisms on MLI Application to CTAs

The MLI modifies CTA application in four different ways using specified language. The MLI provision:

  • applies "in place of" an existing provision (case a);
  • "applies to" or "modifies" an existing provision (case b);
  • applies "in the absence of" an existing provision (case c); or
  • applies "in place of or in the absence of" an existing provision (case d).

The operation of the MLI provision requires notification by both CTA contracting jurisdictions of the existence (cases a and b) or the absence (case c) of an existing provision. In case d, the MLI provision will apply in all cases, regardless of whether the notification has been given by the parties.

Notification clauses serve two purposes in the operation of the MLI. First, when an MLI provision modifies specific types of existing provisions described in compatibility clauses, parties to the MLI are generally required to make a notification to identify which existing provisions of CTAs are within the scope of compatibility clauses. Second, notifications made under the MLI sometimes have the effect of triggering the application of the MLI.

The May 3 opinion states that there are exceptions in the notification mechanism to achieve those purposes. For the first purpose, the parties to a CTA are also required to notify a list of CTAs that do not contain a provision described in a compatibility clause. Take article 6(3) for example, which provides that:

A Party may also choose to include the following preamble text with respect to its covered tax agreements that do not contain preamble language referring to a desire to develop an economic relationship or to enhance co-operation in tax matters: "Desiring to further develop their economic relationship and to enhance their co-operation in tax matters . . . ."

The quoted sentence is added to the preamble language paragraph if it does not exist in the CTA. For the second purpose, a party is obligated to give notification so that the compatibility clause takes effect. The COP also opined that:

Article 8 of the MLI (dividend transfer transactions), which contains a compatibility clause in its article 8(2) referring to "in place of or in the absence of," does not operate in the same manner. Rather, article 8(2) of the MLI describes the interaction between its article 8(1) and existing provisions of Covered Tax Agreements only with respect to minimum holding periods. In this case, notifications made under article 8(4) of the MLI have the effect of triggering the application of article 8(1) of the MLI. This is also true for article 9(2) of the MLI, which cannot apply without an existing provision described in article 9(1) of the MLI.3

A summary of the notification rule for the purpose of giving legal effect to the operative clause is set out in Table 1.

Table 1. Summary of Different Uses of the Notification Rules

Specified Phrases for Cases a Through d Notification Required to Take Legal Effect? Notes
a) applies in place of Yes
b) applies to or modifies Yes
c) applies in the absence of No It is also used to notify a list of CTAs that do not contain the provision described in the compatibility clause.
d) applies in place of or in the absence of No, the compatibility clause will apply in all cases regardless of whether notification is given. Except for paragraph 4 of article 8 (dividend transfer transactions) and paragraph 7 of article 9 (capital gain).


To facilitate further analysis, the legal text of article 9 (capital gains from alienation of shares or interests of entities deriving their values principally from immovable property) is reproduced in Table 2.

Table 2. Full Text of Article 9

Main Provisions Alternative Provisions
3. A Party may also choose to apply paragraph 4 with respect to its Covered Tax Agreements.

1. Provisions of a Covered Tax Agreement providing that gains derived by a resident of a Contracting Jurisdiction from the alienation of shares or other rights of participation in an entity may be taxed in the other Contracting Jurisdiction provided that these shares or rights derived more than a certain part of their value from immovable property (real property) situated in that other Contracting Jurisdiction (or provided that more than a certain part of the property of the entity consists of such immovable property (real property)):

  1. shall apply if the relevant value threshold is met at any time during the 365 days preceding the alienation; and
  2. shall apply to shares or comparable interests, such as interests in a partnership or trust (to the extent that such shares or interests are not already covered) in addition to any shares or rights already covered by the provisions.
 4. For purposes of a Covered Tax Agreement, gains derived by a resident of a Contracting Jurisdiction from the alienation of shares or comparable interests, such as interests in a partnership or trust, may be taxed in the other Contracting Jurisdiction if, at any time during the 365 days preceding the alienation, these shares or comparable interests derived more than 50 per cent of their value directly or indirectly from immovable property (real property) situated in that other Contracting Jurisdiction.
2. The period provided in subparagraph a) of paragraph 1 shall apply in place of or in the absence of a time period for determining whether the relevant value threshold in provisions of a Covered Tax Agreement described in paragraph 1 was met. 5. Paragraph 4 shall apply in place of or in the absence of provisions of a Covered Tax Agreement providing that gains derived by a resident of a Contracting Jurisdiction from the alienation of shares or other rights of participation in an entity may be taxed in the other Contracting Jurisdiction provided that these shares or rights derived more than a certain part of their value from immovable property (real property) situated in that other Contracting Jurisdiction, or provided that more than a certain part of the property of the entity consists of such immovable property (real property).
6. A Party may reserve the right:
  1. for paragraph 1 not to apply to its Covered Tax Agreements;
  2. for subparagraph a) of paragraph 1 not to apply to its Covered Tax Agreements;
  3. for subparagraph b) of paragraph 1 not to apply to its Covered Tax Agreements;
  4. for subparagraph a) of paragraph 1 not to apply to its Covered Tax Agreements that already contain a provision of the type described in paragraph 1 that includes a period for determining whether the relevant value threshold was met;
  5. for subparagraph b) of paragraph 1 not to apply to its Covered Tax Agreements that already contain a provision of the type described in paragraph 1 that applies to the alienation of interests other than shares;
  1. for paragraph 4 not to apply to its Covered Tax Agreements that already contain the provisions described in paragraph 5.
7. Each Party that has not made the reservation described in subparagraph a) of paragraph 6 shall notify the Depositary of whether each of its Covered Tax Agreements contains a provision described in paragraph 1, and if so, the article and paragraph number of each such provision. Paragraph 1 shall apply with respect to a provision of a Covered Tax Agreement only where all Contracting Jurisdictions have made a notification with respect to that provision. 8. Each Party that chooses to apply paragraph 4 shall notify the Depositary of its choice. Paragraph 4 shall apply to a Covered Tax Agreement only where all Contracting Jurisdictions have made such a notification. In such case, paragraph 1 shall not apply with respect to that Covered Tax Agreement. In the case of a Party that has not made the reservation described in subparagraph f) of paragraph 6 and has made the reservation described in subparagraph a) of paragraph 6, such notification shall also include the list of its Covered Tax Agreements which contain a provision described in paragraph 5, as well as the article and paragraph number of each such provision. Where all Contracting Jurisdictions have made a notification with respect to a provision of a Covered Tax Agreement under this paragraph or paragraph 7, that provision shall be replaced by the provisions of paragraph 4. In other cases, paragraph 4 shall supersede the provisions of the Covered Tax Agreement only to the extent that those provisions are incompatible with paragraph 4.


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Footnotes

1. OECD, "Multilateral Convention to Implement Tax Treaty Related Measures to Prevent Base Erosion and Profit Shifting (MLI): Interpretation and Implementation Questions" (May 3, 2021).

2. See OECD Directorate for Legal Affairs, "Multilateral Convention to Implement Tax Treaty Related Measures to Prevent Base Erosion and Profit Shifting: Functioning Under Public International Law," at para. 21.

3. See the explanation in footnotes 23 and 26 in the opinion of the COP issued on May 3, 2021.

Originally published by Tax Notes International, November 29, 2021, p. 1023.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.