Upcoming amendments to double taxation agreements

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With a bill, the Council of Ministers proposed to the National Assembly to vote on the ratification of the Multilateral Convention to Implement Tax Treaty Related Measures to Prevent Base Erosion and Profit Shifting (“the Convention”).  According to the Petitioners, by ratifying the Convention, Bulgaria will take steps towards initiating a process to prepare for the country’s membership in the Organisation for Economic Co-operation and Development (“OECD”).

It is important to note that the Convention has been in force since 1 July 2018, and as of 31 March 2022, ninety-nine countries have acceded to it and seventy-one have ratified or endorsed it.

The decision to establish the Convention is directly related to Measure 15 of the OECD’s Base Erosion and Profit Shifting (“BEPS”) Plan. The Convention was adopted as a tool to prevent the circumvention of tax treaties. It is, by its very nature, an international treaty whose main purpose is to amend more than 2,800 double tax treaties (“DTTs”) concluded worldwide. Its working mechanism is to replace the need for bilateral renegotiation between states that are parties to existing DTТs and to provide the possibility, through accession, to modify, replace or add provisions to DTTs falling within its scope.In other words, the Convention serves as a common framework, as a basis for modifying thousands of  DTTs in a cost-effective manner by achieving a degree of universalization. Through this method of action, the effective implementation of the BEPS Plan measures among the signatory states is accelerated and ensured.

As it affects an extremely large number of agreements, the Convention provides for a degree of freedom of negotiation. This is expressed in the settlement of possibilities for: 1. Selection of tax agreements to which the Convention is to be applied; 2. Choice of options and 3. Ability to express reservations. In particular:

  1. States and jurisdictions ratifying or approving the above mentioned Convention shall prepare lists of DTTs to which it will apply. In other words, the states choose which agreements that they have signed will potentially be amended by the Convention. Bulgaria’s list, included in the Bill under consideration, contains 64 agreements. It excludes only those double tax agreements with states with which the Republic of Bulgaria has reached a consensus to conclude new bilateral agreements that would incorporate the provisions of the Convention. In particular, the agreements with Malta, Finland, Germany, Switzerland and Uzbekistan are not listed. Also two Agreements in which the provisions of the above mentioned Convention chosen by Bulgaria are already enshrined are not included. These are the Agreements with the Kingdom of the Netherlands and with the Islamic Republic of Pakistan.
  2. Choice of options – this is the regulated option of the States that are parties to the Convention to choose a specific provision when alternative means of solving the same problem related to shrinkage of tax base or profit shifting are regulated. The Bill includes two choices of options, in Articles 5 and 13 of the Convention respectively. In Article 5 , entitled “Application of double taxation avoidance methods”, the Republic of Bulgaria chooses to apply the tax credit as a method. In Article 13, related to artificial avoidance of a permanent establishment, Bulgaria chooses to apply option A, which describes that the maintenance of a permanent establishment when it is of a preparatory or ancillary nature does not fall within the term permanent establishment.
  3. The Convention enshrines the legal possibility for States to formulate reservations in certain cases. The consequence of this is the non-application of the norm of the Convention to which a reservation is made for both States under the double tax treaty. According to the draft law, the Republic of Bulgaria has repeatedly made use of this possibility. In particular, Bulgaria has chosen not to apply the following provisions of the Convention:
  4. Article 3 – (“Transparent entities”)
  5. Article 4(“Dual resident entities”)
  6. Article 6 par. 1 (“Purpose of the covered tax agreements”) – the reservation regards to tax treaties that already contain provision in the preamble declaring the intention to avoid double taxation but without possibilities to circumvent the tax legislation.
  7. Article 8(“Dividend transfer transactions”)
  8. Article 10(“Anti-abuse rule for permanent establishments situated in third Jurisdictions”)
  9. Article 11(“Application of tax agreements to restrict a party’s right to tax its own residents”)
  10. Article 13, par. 4 (“Artificial avoidance of permanent establishment status through the specific activity exemptions”)
  11. Article 14 – (“ Splitting-up of contracts”)
  12. Article 35, par. 4 – reservation concerning the time of entry into force of the Article 16 procedure (“Mutual Agreement Procedure”)

There is, however, a so-called from OECD “minimum standard”. These are fundamental norms that are binding on all States and jurisdictions party to the Convention.

It is important to mention the specific effect of the Convention on DTTs, which are included in the final lists of countries. First of all, when a provision of the Convention is adopted, it amends all the DTTs included in the lists in the same way. This is undoubtedly a prerequisite for formulating multiple reserves. It is also worth noting the rule laid down in the Convention that when the text of a provision is duly amended, the rule shall remain so even though one or both Contracting States may withdraw from the Convention.

However, like any international treaty, the adoption of the Convention goes through several stages. Signing is an indispensable step and, as stipulated in the Convention, it is at this stage that it is necessary to submit a preliminary list of reservations and notifications to the Convention itself, which should be drawn up according to a model established by the OECD. The final list of reservations and notifications should be submitted when the instrument of ratification is deposited (which is the moment of acceptance in the international law).

According to the final list of reservations and notifications, the Republic of Bulgaria chooses to apply the following clauses of the Convention:

  1. Provision on the application of double taxation avoidance methods – in line with its recent treaty practice, the Republic of Bulgaria chooses to apply the “tax credit” method for the listed DTTs. The application of the chosen method listed above will be applicable if one of two conditions is met- either the other country of the double tax treaty has allowed the application of the option chosen by Bulgaria or has chosen the same option.
  2. Provision on the purpose of tax treaties – in accordance with Article 6 of the Convention, the DTTs on the final lists will undergo a change and should incorporate the current preamble of the OECD Model DTT, 2017 edition. This preamble sets out the general point of the treaties – to introduce anti-avoidance tools that have been developed as part of the BEPS list of measures. The Organisation for Economic Co-operation and Development considers the introduction of this preamble as a minimum standard relating to measure 6 of the BEPS plan.
  3. Provision against the abuse of agreements – this provision is also part of the minimum standard under measure 6 of the BEPS plan. The intent of the clause is to curb the misuse of tax benefits under double tax treaties. In other words, each transaction is assessed by the competent authorities of the State Party to the specific DTT as to its primary purpose. If during the course of this examination it is concluded that the sole purpose of the transaction is to obtain a tax benefit, the latter may be restricted.
  4. Provision relating to profits from the transfer of shares or interests in entities which derive their value principally from immovable property – this updates the rule that tax is due in the source State on profits from the transfer of shares or comparable rights where a proportion of their value is attributable to immovable property situated in that State. The purpose of the rule is to limit the possibilities for abuse. It is regulated that the taxation takes place when the above mentioned factual situation is realised, at any time during the 365 days prior to the transfer.
  5. Provisions designed to prevent abusive avoidance of place of business establishment. They are intended to prevent the artificial avoidance of the place of business establishment through legal deals concluded for that very purpose.
  6. Provision on the mutual agreement procedure – relates to the minimum standard requirements under measure 14 “Establish a more effective mechanism for dispute resolution” of the BEPS plan. The mutual agreement procedure is an administrative procedure aimed at resolving problems related to the interpretation, application and elimination of taxation inconsistent with the double taxation treaties concluded by Bulgaria or the Convention on the Elimination of Double Taxation in Connection with the Adjustment of Profits of Connected Enterprises 90/436/EEC (the Arbitration Convention). The procedure is carried out between the competent authorities of the Contracting States and the debtor does not take a direct part in the procedure but is informed in due time of its progress and outcome.
  7. Provision concerning corresponding corrections. In this way, the corresponding adjustment of the profits of related companies is settled. In short, a profit realized in one country under the DTT is deducted from the tax obligations of the other country under the DTT.

There is also a procedure for resolving disputes between the States Parties to the Convention when mutual agreement cannot be reached. The option provided is for the dispute to be examined at a second stage by an arbitration commission.

Under the Convention, in the absence of an specific reference to an elective clause in the List of Reservations and Notifications, it means that the clause has not been chosen by the State concerned  and will not apply to treaties concluded by that State. However, the Republic of Bulgaria has not chosen in its List of Reservations and Notifications to apply the provisions relating to arbitration. They are therefore inapplicable to the agreements concluded by the Republic of Bulgaria.

The Bill also specifies the time when the Convention will enter into force if duly ratified. Its legal effect will take place for the Republic of Bulgaria on the first day of the month following the expiration of a period of three calendar months counted from the date of deposit of the instrument of ratification with the Secretary-General of the OECD. The Convention will apply to a double tax agreement after both parties to the agreement have ratified, accepted or approved the Convention and after a certain period of time has elapsed for reasons of legal certainty. It remains to be seen whether the National Assembly will pass a law ratifying the Convention.

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