LOB and PPT rules to prevent tax treaty abuse

Reglas LOB y PPT contra el abuso de tratados fiscales
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23 de Oct, 2017

The BEPS Project, whose main goal is essentially to protect the countries’ tax revenues by fighting against tax avoidance or tax evasion practices seeking base erosion and profit shifting to reduce or eliminate the payment of taxes, in its Action 6, pursuing the prevention of treaty abuse, provides several mechanisms to stop tax treaties from being misused for obtaining tax benefits in circumstances in which these shouldn’t be applicable, or in which the treaty did not intend to grant them; particularly lookingh to eradicate the abuse committed through the practice known as treaty shopping, which represents itself one of the main concerns that the Project BEPS intends to resolve.

Treaty shopping, in simple words, consists in the execution of strategies aimed at obtaining a tax benefit granted by a tax treaty applicable to a country in which the person or entity pursuing such benefit is not resident. Such is the case of many multinational companies that, in order to have access to any benefit that could mean a reduction to their tax load, set up entities or agreements in countries that have nothing to do with their company nor with their business or operations, with the sole purpose of fulfilling the requirement of being a resident of that third country, so they can be consequently entitled to receive such benefit.

Among the various measures provided by BEPS Project’s Action 6 for the prevention of treaty abuse, the implementation of LOB rule (limitation-on-benefits rule) and PPT rule (principal purposes test) is particularly relevant.

Limitation on benefits rule– LOB Rule

In general terms, the LOB rule is a specific measure designed to prevent the inappropriate granting of tax treaty benefits, specially the one resulting from treaty shopping, by practicing an analysis over the substance and connection of the taxpayer’s activity in its country of residence.

By means of this rule, the granting of benefits will be limited to those taxpayers who, besides being resident of one of the treaty’s contracting countries, comply with the specific conditions required to be considered as a “qualified person” for the reception of the respective benefits, as well as the additional requirements established for that purpose. These conditions may variate among the different countries and treaties, they won’t always be the same, however, they will be essentially addressed to verify the existence of a sufficient link between the taxpayer and its country of residence, paying special attention to what is the legal nature of the taxpayer, who has the ownership of its shares and in what percentage, as well as to which kind of business or activities are conducted in said country, among other elements.


Principal Purposes Test – PPT Rule

The PPT rule is a measure a lot more general and subjective, since it consists in denying the granting of tax treaty benefits, when it is reasonable to conclude, having regard to all relevant facts and circumstances, that obtaining the respective benefit was one of the principal purposes of the relevant transaction, unless it is established that granting said benefit in these circumstances would be in accordance with the object and purpose of the applicable provisions of the treaty.


One the one hand, this rule has stand out for its high efficiency when it comes to addressing cases of treaty shopping and other abusive practices that remain uncovered by the other filters set by the LOB rule; on the other, it has been very criticized for being extremely subjective, considering that it leads to countless possibilities under which the tax authorities could claim that the principal purpose of a given transaction was to obtain the respective tax benefit, besides carrying the conflict of determining whether such a conclusion is reasonable or not, which clearly produces uncertainty for tax payers.

By virtue of the above, the Project BEPS’s multilateral instrument for the implementation of treaty related measures (MLI), has provided certain flexibility in the application of these rules, giving countries the option of complying the minimum standards for the prevention of treaty abuse through the combination of LOB and PPT rules, the sole implementation of PPT rule, or, the application of the LOB rule in combination with other mechanisms preventing the treaty abuse cases not addressed by the conditions of said rule; besides committing to their duty of implementing additional measures to prevent other forms of tax treaty abuse.


BCC Asesores – Tax Department


Contact info@bccasesores.com


October 23, 2017.

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