Cora Final Submission

An analysis of rules for developing
countries to prevent treaty abuse
Adv LLM paper
submitted by
Cora Cheung
in fulfilment of the requirements of the
'Master of Advanced Studies in International Tax Law'
degree at the International Tax Center Leiden
(Leiden University)
supervised by
Prof. dr. Kees van Raad and
Monica Sada Garibay

Cora Cheung version 13 08 2014 II
PERSONAL STATEMENT
Regarding the Adv LLM Paper submitted to satisfy the requirements of the 'Master of Advanced Studies in
International Tax Law' degree:
1. I hereby certify (a) that this is an original work that has been entirely prepared and written by myself
without any assistance, (b) that this paper does not contain any materials from other sources unless these
sources have been clearly identified in footnotes, and (c) that all quotations and paraphrases have been
properly marked as such while full attribution has been made to the authors thereof. I accept that any
violation of this certification will result in my expulsion from the Adv LLM Program or in a revocation of my
Adv LLM degree. I also accept that in case of such a violation professional organizations in my home
country and in countries where I may work as a tax professional, are informed of this violation.
2. I hereby authorize the International Tax Center Leiden to place my paper, of which I retain the copyright,
in its library or other repository for the use of visitors to and/or staff of said library or other repository. Access
shall include, but not be limited to, the hard copy of the paper and its digital format.
3. In articles that I may publish on the basis of my Adv LLM Paper, I will include the following statement in
a footnote to the article’s title or to the author’s name:
“This article is based on the Adv LLM paper the author submitted in fulfilment of the requirements of the
'Master of Advanced Studies in International Tax Law' degree at the International Tax Center Leiden (Leiden
University).”
4. I hereby certify that any material in this paper which has been accepted for a degree or diploma by any
other university or institution is identified in the text. I accept that any violation of this certification will result
in my expulsion from the Adv LLM Program or in a revocation of my Adv LLM degree.
Signature:
Name: Cora Cheung
Date: 13 August 2014

Cora Cheung version 13 08 2014 III
Table of Contents
Table of Contents.........................................................................................III
List of Abbreviations used ......................................................................... VI
Executive Summary................................................................................... VII
Overview of Main Findings....................................................................... VIII
1. Introduction............................................................................................... 1
1.1. Scope, definitions and assumptions .................................................................. 1
1.1.1. Scope ............................................................................................................ 1
1.1.2. Definitions...................................................................................................... 1
1.1.2.1. Developing Vs. Developed Countries............................................................. 1
1.1.2.2. GAAR Vs. SAAR ............................................................................................ 1
1.1.3. Assumptions.................................................................................................. 2
1.2. Characteristics of Developing countries............................................................ 2
1.3. Importance of AAR for Developing Countries ................................................... 2
1.4. The Two-Fold of Challenges for Developing Countries.................................... 3
1.4.1. Capacity Deficiency....................................................................................... 3
1.4.2. Common types of Abuse............................................................................... 4
1.4.2.1. A description of the issues ............................................................................. 4
1.4.2.2. Capital gains taxable only in the conduit company’s state
– loss of taxing right........................................................................................ 4
1.4.2.3. Reducing WHT through conduit arrangement
– lose taxing right; enable round tripping ....................................................... 4
1.4.2.4. Interest deductions – reduce taxable base .................................................... 4
1.4.2.5. Switching character of income to alter source and taxability
– reduce taxable base .................................................................................... 4
1.4.2.6. Permanent Establishment loophole................................................................ 5
1.5. Objective................................................................................................................ 5
2. International AAR ..................................................................................... 5
2.1. UN & OECD on Anti Avoidance ........................................................................... 5
2.1.1. Model Convention and commentary ............................................................. 5
2.1.2. BEPS Action 6 suggests 3-pronged approach.............................................. 6
2.2. GAAR...................................................................................................................... 6
2.2.1. Main Purpose Test ........................................................................................ 6
2.2.2. Extension of MPT in distributive provisions: ................................................. 8
2.2.3. The Savings Clause ...................................................................................... 8
2.3. SAAR...................................................................................................................... 9
2.3.1. Two General Approaches to SAARs............................................................. 9
2.3.2. Limitation On Benefits................................................................................. 11
2.3.3. Denying Benefits to Conduit Entities........................................................... 12
2.3.3.1. Look-through provision................................................................................. 12
2.3.3.2. Beneficial Owner Concept............................................................................ 13
2.3.3.3. Deemed Conduit clause ............................................................................... 14
2.3.4. Denying Benefits to Conduit Arrangements................................................ 15
2.3.4.1. Remittance based taxation & Subject-to-tax provision :............................... 15
2.3.4.2. Channel Approach........................................................................................ 16
3. Domestic ................................................................................................. 17

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3.1. Introduction ......................................................................................................... 17
3.1.1. OECD and UN clarification on domestic AARs: no conflict ........................ 17
3.1.2. Pros and Cons of Domestic AAR................................................................ 17
3.2. GAAR.................................................................................................................... 18
3.2.1. Standard GAAR .......................................................................................... 18
3.2.2. Alternative Minimum Tax............................................................................. 19
3.2.3. Black List..................................................................................................... 19
3.3. Judicial Doctrines............................................................................................... 20
3.4. SAAR.................................................................................................................... 21
3.4.1. Introduction.................................................................................................. 21
3.4.2. Deeming Income & Capital Gains............................................................... 21
3.4.2.1. Benefits for this category of rules ................................................................. 21
3.4.2.2. Controlled Foreign Company ....................................................................... 21
3.4.2.3. Deemed Interest on Interest-Free Loans ..................................................... 22
3.4.2.4. Exit Tax ....................................................................................................... 22
3.4.2.5. Suggestions for this category of rules .......................................................... 23
3.4.3. Deduction restriction ................................................................................... 23
3.4.3.1. Benefits for this category of rules................................................................. 23
3.4.3.2. Interest Restriction/Thin Capitalisation Rule ................................................ 23
3.4.3.3. Leasing Expense Restriction........................................................................ 23
3.4.4. Income Recharacterising Rules .................................................................. 24
3.4.4.1. Benefits for this category of rules................................................................. 24
3.4.4.2. Interest Recharacterising Rule ..................................................................... 24
3.4.4.3. Substance over form approach .................................................................... 24
3.4.4.4. Anti-Dividend Stripping Rule ........................................................................ 25
3.4.4.5. Risks for this category of rules ..................................................................... 25
3.5. Safe Harbour Rules............................................................................................. 25
3.5.1. Introduction.................................................................................................. 25
3.5.2. Stock Exchange provision – Business Purpose.......................................... 26
3.5.3. Holding Period – Substance Requirement.................................................. 26
3.5.4. Proof of Approval/Acknowledgement from Other Contracting State
– Reciprocity ............................................................................................... 27
4. Case Studies: Myanmar and neighbouring countries......................... 27
4.1. Economic status ................................................................................................. 27
4.2. Attracting Foreign Investments - Incentives.................................................... 28
4.2.1. Improve Effectiveness of Incentives ........................................................... 28
4.2.2. Learn from Bhutan’s Mistakes..................................................................... 29
4.2.3. Considering Alternatives to Tax Sparing Relief .......................................... 29
4.3. Treaty partners.................................................................................................... 30
4.3.1. Myanmar’s Existing Treaty Network ........................................................... 30
4.3.2. Understand Why Cambodia Said No to Treaties........................................ 31
4.3.3. Recognise the Reason for Mongolia’s Termination of Treaties with the
Netherlands, Luxembourg, Kuwait and UAE .............................................. 31
4.3.4. Considerations for Myanmar in the Current State of Affairs ....................... 32
4.4. A Review of Existing Treaties............................................................................ 32
4.5. Domestic AAR ..................................................................................................... 33
4.5.1. Absence of Domestic AAR.......................................................................... 33
4.5.2. Avoid Nepal’s Overly Complex AARs ......................................................... 34

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4.6. Summary.............................................................................................................. 34
4.6.1. General rule: simple and targeted rules with clear implementation
procedure .................................................................................................... 34
4.6.2. Revaluate tax incentives, implement safeguards and conditions ............... 34
4.6.3. Review Existing Treaties and Conclude Treaties with Real Investor
Countries..................................................................................................... 35
4.6.4. AAR, definitions in treaty to allow Domestic AAR....................................... 35
4.6.5. Narrow GAAR ............................................................................................. 35
4.6.6. Progressive SAARs..................................................................................... 36
4.6.7. Plan phases of development....................................................................... 36
4.6.8. Resources should be spent on data collection and competency building .. 36
5. General Recommendations for Developing Countries ....................... 37
5.1. Achieving the objective...................................................................................... 37
5.2. General Principles .............................................................................................. 37
5.2.1. Keep it simple.............................................................................................. 37
5.2.2. Target majority ............................................................................................ 37
5.2.3. Conflict prevention and resolution............................................................... 38
5.2.4. Pro-business attitude .................................................................................. 38
5.2.5. Measurable policies .................................................................................... 38
5.3. Overall evaluation of AARs – Summary Table................................................. 38
5.4. Moving forward ................................................................................................... 40
Bibliography ................................................................................................41

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List of Abbreviations used
(alphabetical list of abbreviations used in the Paper)
AAR Anti-Avoidance Rule
AMT Alternative Minimum Tax
Art., Arts. Article, Articles
BEPS Base Erosion Profit Shifting
CCCTB Common Consolidated Corporate Tax Base
CFC Controlled Foreign Company
COR Certificate of Residence
e.g. Exempli gratia (for example)
Etc. Et cetera
FDI Foreign Direct Investment
FMV Fair Market Value
FRS Financial Reporting Standard
GAAR General Anti Avoidance Rule
GDP Gross Domestic Product
GNI Gross National Income
i.e. id est
IMF International Monetary Fund
LOB Limitation On Benefits
MNC Multi-National Company
MPT Main Purpose Test
OECD Organisation for Economic Cooperation and Development
OECD MC OECD Model Convention (2010)
Para. Paragraph
PE Permanent Establishment
SAAR Specific Anti Avoidance Rule
SPV Special Purpose Vehicle
TFEU Treaty on the Functioning of the European Union
TP Transfer Pricing
Treaty Double Tax Avoidance Agreement
UK United Kingdom
UN United Nation
UN MC United Nation Model Convention (2011)
US United States of America
VCLT Vienna Convention on the Law of Treaties
WHT Withholding Tax

Cora Cheung version 13 08 2014 VII
Executive Summary
This paper aims to provide developing countries with a starting point in designing a set of anti-avoidance
rules that is effective in protecting them against treaty abuse. The anti-avoidance topic has been in the
limelight in recent years and a lot of effort has been put into seeking solutions for treaty abuse, however,
few of these initiatives were made in the perspective of developing countries. Given that developing
countries are in a lesser position to safeguard their tax revenue but are in dire need of funds to operate,
they are in a more critical predicament than their developed treaty partners.
Developing countries have their unique characteristics and therefore have different challenges from
developed countries. Chapter 2 and 3 discuss selected AARs applicable in treaties and in domestic tax
law respectively. The rules are broadly categorised into GAARs and SAARs, and further streamed into
categories based on different approaches. Each of these rules is evaluated on its benefits and risks in the
perspective of developing countries, suggestions are then made based on the evaluation. These
suggestions often involve modifying existing rules or combining them to achieve the desired outcome.
However, it must be proclaimed that these suggestions are not tested and are purely deductions of the
author. The paper also contains new rules which are inspired by certain countries’ practices, discussions
with other professionals and the materials accredited in the bibliography. These new and possibly
controversial rules are proposed here as a hypothesis to general further discussions.
The case study of Myanmar is brought in to demonstrate the practical aspect of introducing AARs in a
developing country. A brief introduction of its economic status is included to provide a basic idea of
Myanmar’s current stage of development. The chapter goes on to discuss issues the country might or is
facing with tax incentives and treaties, and how AARs could address these issues, while drawing
examples from other developing countries. The author has concluded the case study with a set of 8
recommendation points for Myanmar’s consideration.
Finally, a summary table of the AARs evaluation is prepared based on the author’s perspective of the
suitability and priority for implementation in developing countries. The paper concludes with some
general recommendations for developing countries’ tax authorities in designing, maintaining and
progressing with their AARs.

Cora Cheung version 13 08 2014 VIII
Overview of Main Findings
The initial research brought up a key question not considered by the author previously: the effectiveness
of incentives and treaties in attracting FDI is not guaranteed but the loss of tax revenue is real and the
cost of administering both of these tax benefits is high. What make countries dive into them so
frivolously? Through further research on the case study, the author notices that tax competition amongst
peers and pressure from trading partners are the probable causes for entering into a treaty agreement
prematurely. In Myanmar’s case, surrounding countries are mostly ahead in their development and all of
them have tax incentive regimes. The list of top exporting countries is almost identical to the list of
countries that Myanmar has concluded or is negotiating treaties with.
The author believes that developing countries tend to let their treaty partners take the lead in negotiation,
as a result, their treaties have a tendency to vary widely in focus between different treaty partners. The
author also notices that AARs, if available, are often for the residence state’s benefits. Although
developing countries are perceived to have lower bargaining power (due to the need for FDI), they do
have do have leverage over developed countries (opportunities for above average return on
investments). Depending on the competency of the developing countries’ tax authorities, there are still
possibilities to negotiate favourable treaties. Therefore, competency building should be a priority for
developing countries. Further, section 5 suggests some general principles for developing countries to
follow, such as: keeping it (the rules) simple, targeting majority, manage conflict prevention and
resolution, maintain a pro-business attitude and use measureable policies.
In a developing country’s perspective, the motive for introducing treaty AARs is to limit access while
domestic AARs have more direct impact on tax revenue through restricting deductions or deeming
income. However, most developing countries have limited domestic AARs and are unprepared to
administer them. Thus, the author suggests to prioritise the SAARs which have direct measurable impact
on revenue collection.
Although GAAR is favoured by developing countries for its wider scope, SAARs are probably more
effective for them. SAARs do not require case by case investigation, it has direct impact and direct
results. GAAR, on the other hand, raises more uncertainty and is harder to administer. Thus, the
recommendations focuses on SAARs.
Developing countries need to understand that most Model Conventions are based on residence taxation
(an exception is the CARICOM treaty, which is unique and highly criticised), therefore, AARs are
necessary to balance the benefits of source state, especially if the contracting states are at different
stages of economic development.

Cora Cheung version 13 08 2014 1
1. Introduction
1.1. Scope, definitions and assumptions
1.1.1. Scope
It is not the objective of this paper to evaluate all AARs available, the AARs selected for
discussion on this paper aim to display the attributes that should be valued by developing countries.
Through evaluation of the suitability of these rules, it is intended to give developing countries an
understanding of the capacity requirement each type of rule demands.
While it is the intention to evaluate effectiveness based on hard statistics, the lack of reliable
data of developing countries and the wide range of non-tax variables made it difficult to have
conclusive recommendations. Therefore, estimates and inferences based on current conditions are
used in the paper. There are also pertinent issues which will have to be discussed another time, such
as:
TP and its role as an anti-abuse tool is not covered in this paper because it is a large topic on
its own and compared to other AARs, it is not as easy for developing countries with limited
administrative resources to apply.
Unitary taxation as a potential solution is probably a long term goal and more of a theory for
now. It will require consensus and collaboration from the international community for it to work. For
that reason, it is also impractical for developing countries to consider at this stage.
Effectiveness of treaties in attracting FDI is often questioned, many scholars consider
treaties a risky tool to incentivise FDI. In particular, Michael Lang believes that “Developing countries
that have very few or no treaties may in fact be doing the right thing.”1 Understandably there are also
non-tax reasons involved in concluding treaties, therefore it is not the interest of this paper to discuss
treaties’ effectiveness in attracting FDI.
1.1.2. Definitions
1.1.2.1. Developing Vs. Developed Countries
Developing countries are defined according to their GNI per capita per year. Countries with a
GNI of US$ 12,616 and less are defined as developing countries (based on the World Bank’s
classification in 20142
). The developing country category is further classified into upper middle, lower-
middle and low income groups. For the purpose of this paper, developing countries are referred to
lower-middle and low income groups.
The case study in Section 4 is based on Myanmar – a low income economy and the
comparisons are drawn from lower-middle and low income groups for consistency: Cambodia (low),
Bhutan (lower-middle), Nepal (low) and Mongolia (lower-middle).
1.1.2.2. GAAR Vs. SAAR
A GAAR3 prevents the entitlement to the treaty while a SAAR targets entities, receipts and
arrangements. There is an exception in the case of LOB, as it is generally categorised as a SAAR
although it is mostly a barrier to access treaty based on the UN MC Commentary.
1
Michael Lang et al, Tax Treaties: Building Bridges between Law and Economics (Amsterdam: International
Bureau of Fiscal Documentation, 2010), pp 455
2
http://data.worldbank.org/about/country-and-lending-groups (accessed on 2 July 2014)
3
Section 34 to 37 of UN Commentary on Art. 1

1.1.3. Assumptions
Treaty has a positive correlation with FDI - As mentioned above, there are arguments
which challenge4
this premise but for the purpose of this paper it is assumed that treaty serves as a
reduction of barrier to enter the markets, without going into statistics supporting or negating this
correlation.
Source state assumption - Developing countries will be assumed as the source state in the
context of this paper unless specifically stated otherwise.
1.2. Characteristics of Developing countries
Fundings required by developing countries are substantial and it is not sustainable to rely on
foreign assistance. In low income countries, the problem with revenue collection is evident: over 20
countries still have tax ratios (tax revenue relative to GDP) under 15% while average tax ratio is 30-
40%5.
Developing countries are generally more reliant on corporate tax revenues (on average close
to 20% of tax revenues, compared to 8-10% for developed countries)6 and this view is echoed by the
IMF in its Fiscal Monitor of October 2013: “Recognition that the international tax framework is broken
is long overdue. Though the amount is hard to quantify, significant revenue can also be gained from
reforming it. This is particularly important for developing countries, given their greater reliance on
corporate taxation, with revenue from this taxation often coming from a handful of multinationals.”7.
Reason for high reliance on corporate tax revenue is also due to weak personal tax system
as it rarely achieve progressivity in developing countries. Some deduced the reason behind that is
because top income earners are often in position of political influence in developing countries, thereby
preventing tax reforms which could result in higher tax rates for themselves.
It has been observed that WHT forms a significant part of developing countries’ tax collection
due to its advance collection nature and because it has fewer tax leakage opportunities. There is no
available data to support this claim, however, the author believes this is a logical inference especially
for developing countries with weak administration and enforcement.
A developing country’s economy is generally composed of a few large companies and a big
pool of small taxpayers (shadow economy), an average of 34.5% of GDP8
of these countries is
contributed by small/informal businesses. The cost to track and tax these enterprises is high while the
return is limited, thus developing countries are heavily dependent on a small group of big taxpayers.
Finally, many developing economies are heavily dependent on international trade and FDI as
it brings about direct tax revenue as well as non-income type taxes therefore they are reluctant to
impose strict anti-avoidance rules.
1.3. Importance of AAR for Developing Countries
According to OECD’s statistics, China, US, Russia and Japan are the largest sources of
outward FDI in 2013 and more than half of global FDI is received in developing countries9. Just to
have a keener sense of the impact of FDI in monetary terms, the OECD estimates the total world FDI
outflow in 2013 is approximately USD 1.3 trillion. This is what developing countries are competing for.
4
Katrin McGauran, Should the Netherlands sign tax treaties with developing countries? (Amsterdam: Stichting
Onderzoek Multinationale Ondermemingen), 2013, pp 19
5
International Monetary Fund, Revenue Mobilization in Developing Countries (Washington D.C: IMF, 2011)
6
Sol Picciotto, 'Base Erosion and Profit-Shifting (BEPS): Implications for Developing Countries' (United
Kingdom: Tax Justice Network, 2014)
7
International Monetary Fund. IMF Fiscal Monitor: Taxing Times. (Washington D.C.: IMF, October 2013)
8
F. Schneider, A. Buehn, and C.E. Montenegro, 'Shadow Economies All over the World: New Estimates for 162
Countries from 1999 to 2007', World Bank Policy Reseach Working Paper No. 5356 (2010), pp 4, 9, 38
9
Organisation for Economic Cooperation and Development. FDI in Figures. International investment stumbles
into 2014 after ending 2013 flat. (Paris: OECD, 2014)

However, how many of these investments generate actual tax revenue for the tax authorities?
The top investors in developing countries are not always the top global investors because they invest
through SPVs. These SPVs are generally established in jurisdictions with preferential tax regimes
and/or jurisdictions with wide treaty network. Developing countries are obliged to give away their
taxing rights on income, gains and profits under the treaties, which is likely more than what they
would if FDI flows in directly from the real investors.
Lack of effective legislation to prevent such abuses, or at least discourage them, leaves gaps
unguarded and provide opportunities for simple but potentially aggressive tax avoidance10. Worst
case scenario for a developing country will be arriving to a point where the economy is highly
dependent on FDI through conduit arrangement, the authority will have too much resistance to
enforce AARs and at the same time value is flowing out of the country tax free. India’s relationship
with Mauritius can be loosely described as such, to-date Mauritius is still the top foreign investor for
India11; there has been discussion to include an LOB clause in the India Mauritius treaty or even
cancel it altogether but nothing has been done since 1996 when the issue was first raised.
1.4. The Two-Fold of Challenges for Developing Countries
1.4.1. Capacity Deficiency
Most if not all developing countries experience the lack of skilled workforce in public and
private sector to enforce and comply with the rules, making it difficult even at the domestic level to
enforce taxation on enterprises. In the domestic context, active income is more difficult to tax than
passive income (withholding at source) as it requires computation, filing, and assessment and
therefore collection is not immediate. Due to low administrative capacity in enforcement, the cost of
relinquishing rights to tax passive income becomes even higher (in a treaty application situation).
The drafting of domestic tax law usually has room for improvement as it forms the basis of
taxation, without which there is no need for treaty because there is no taxation to be relieved.
Developing countries usually adopt the rules left with them by their previous occupiers which are
usually biased against the developing states and not adjusted to their needs. Thus, the domestic tax
act should be first reviewed in the perspective of the state’s benefit.
In an international perspective, developing countries suffer in treaty negotiation due to the
lack of technical expertise and/or bargaining power, resulting in a possibly over generous treaty which
is skewed to the benefit of more affluent treaty partners. This could be inevitable at times but
developing countries should be aware and give up taxing rights only for more important benefits/terms
in the process of treaty negotiation.
Post-treaty, they also face high administrative burden (and related costs) that treaties
imposed on participating states. Without guidance, they may not fulfil their obligations as a treaty
partner and the poor administration of treaty may backfire on the effort to attract FDI.
Due to limited resource, human and technology capacity, developing countries often
encounter difficulties in collecting statistics to make meaningful analysis. It is an issue that affects
their long term development because it would impinge on effective policy making. Local government
needs to be aware of the cost and benefit for each policy that it considers implementing and it needs
to track the effect of what has been implemented.
Thus, capacity building should always be prioritised in a developing country’s agenda.
10
Organisation for Economic Cooperation and Development. Special meeting of the OECD Task Force on Tax
and Development on BEPS and Developing countries and Summary of the BEPS Consultations.(Paris:
OECD, 2014)
11
Department of Industrial Policy & Promotion, Government of India. Fact Sheet on Foreign Direct Investment
(FDI) From April 2000 to May 2014. (India: Government of India, 2014)

1.4.2. Common types of Abuse1213
1.4.2.1. A description of the issues
Developing countries are usually the source state while most treaty models serve to allocate
taxing right between source and residence state by limiting source state taxation. Even the UN Model
Convention, which is known to be developing-country-friendly, is a residence based treaty model.
Thus, the reason for developing countries to enter into treaties is to attract FDI by giving up source
state taxing rights. AARs are therefore important to act as safeguard from loss of tax revenue through
improper use of the treaties. Following are some examples of common misuse of treaties:
1.4.2.2. Capital gains taxable only in the conduit company’s state – loss of taxing right
By interposing a holding company, established in one of the treaty partner states, between
the real investor and the target company (in source state), the source state could lose taxing rights on
capital gains. The capitals gains would then be remitted back to the real investor’s state absolutely tax
free.
This is a concern because exponential growth in asset value is expected in developing
countries yet the local tax authority is deprived of the taxing rights on such value due to abuse of
treaty.
1.4.2.3. Reducing WHT through conduit arrangement – lose taxing right; enable round tripping
Besides using conduit entities as described above, a conduit arrangement can be made to
benefit from treaties. A back-to-back loan is a good example for these types of arrangement, instead
of paying interest directly to the real lender, an intermediary company is interposed, established in a
treaty state, to benefit from the lower WHT rates. Interest is then paid by the intermediary company to
the real lender tax free.
1.4.2.4. Interest deductions – reduce taxable base
A change in the composition of FDI has been observed: reduction of equity type funding by
40% and increase of 20 folds in debt funding between 2012 and 201314
. It is an issue for FDI
receiving countries as debt-funding reduces the taxable base of the country. Excessive debt-funding
allows interest deduction against taxable income, effectively reducing the tax suffered in these
developing countries. The problem is aggravated by abuse of treaties as that allows further reduction
of tax on outflowing interests.
1.4.2.5. Switching character of income to alter source and taxability – reduce taxable base
Although treaties and commentary of the Model Conventions attempt to provide a definition of
different types of income, they still allow for interpretation by treaty partners therefore the differences
in domestic tax laws could give rise to the opportunity for arbitrage. Companies could make use of
legal arrangements to change the form of payments to benefit from preferential treaty rules while
maintaining the outcome of a transaction.
12
International Monetary Fund. Spillovers in International Corporate Taxation: Selected Key Issues for
Developing Countries (Washington, D.C.: IMF Policy Paper, 2014)
13
Philip Baker, 'Improper Use of Tax Treaties, Tax Avoidance and Tax Evasion', Papers on Selected Topics in
Administration of Tax Treaties for Developing Countries, (May 2013) , Tax Avoidance and Tax Evasion By
Philip Baker
14
See OECD, supra note 7

1.4.2.6. Permanent Establishment loophole
Restrictive PE definitions in treaties reduce the source state’s taxing rights; investors could
take advantage of these PE rules to limit tax exposure in source states. The OECD MC does not
provide for a “force of attraction” clause, which makes all businesses conducted in source state not
taxable if they are not effectively connected to a PE in that state. By setting up a conduit entity in a
treaty state (which exempts foreign income from tax) to conduct operations in developing countries
while circumventing from PE qualifications, foreign investor could earn tax free income from these
developing countries and enjoy tax deferral in the conduit entity’s state.
1.5. Objective
The aim of this paper is to analyse the applicability of existing AARs for developing countries,
taking into consideration their general economic structure and attributes, the challenges they face
regarding capacity deficiency and abuse of treaty. It should give a basic guidance to developing
countries’ governments in devising AARs to prevent treaty abuse. It also attempts to bring new ideas
for the existing rules to the table for further discussions and debate. Some hypothesis made in this
paper could be controversial and need to be considered with an open mind.
Section 2 and 3 discusses the AARs in treaties and domestic tax laws respectively. The rules
will be evaluated based on benefits and risks in a developing country’s perspective. Suggestions are
made on the suitability of these rules and how they should be applied. Bearing in mind that these
rules are not exhaustive, the evaluation and suggestions are based on available data, estimates,
inferences and experiences of other countries.
A case study is used to illustrate the concepts and application of AARs further. It aims to
provide a practical angle to this paper and at the same time expose the readers to trends and
challenges unique to developing countries. Myanmar was chosen for its eagerness to attract foreign
investment in a very early stage of economic development and its vulnerability as such.
2. International AAR
2.1. UN & OECD on Anti Avoidance
2.1.1. Model Convention and commentary
In seeking guidance on the effect on treaties and its application, the UN MC and OECD MC
are the basic documents relied upon. The UN MC Commentary on Article 1 and the OECD MC
Commentary on Article 1 are by and large identical in their content. The UN commentary often refers
to the OECD commentary and mirrors concepts discussed therein. They too share the same guiding
principle on anti-avoidance, which was added to the OECD commentary in 2003 (emphasis added):
“the benefits of a double taxation convention should not be available where a main purpose
for entering into these transactions or arrangements was to secure a more favourable tax position and
obtaining that more favourable treatment would be contrary to the object and purpose of the relevant
provisions”1516
This guiding principle will be referred to throughout this paper as it is the fundamental building
block of the anti-avoidance initiative. However, it is of interest to note that this insertion in 2003 did not
come without criticism. The UN Commentary highlighted the ambiguous term of “a main purpose” and
proposed to change it to “the main purpose” for more certainty. The drawback in doing so might be
the increased burden of proof in the standpoint of tax authorities. In the case of developing country, it
could indeed be an issue. Having said so, the reverse will increase the burden of proof in taxpayers’
15
Section 9.5 of OECD Comm. on Art. 1
16
Section 23 to 27 of UN Comm. on Art. 1

perspective which is not necessarily fair play either. In the midst of this zealous atmosphere towards
anti-abuse, it is important to bear in mind the primary objective of a treaty is to provide a level playing
field for taxpayers. Therefore the treaty countries “… should carefully observe the specific obligations
enshrined in treaties to relieve double taxation as long as there is no clear evidence that the treaties
are being abused”17(hereon referred to as the “relief until proven abuse rule”).
Another criticism for the OECD’s commentary is the lack of structure in its chapter dealing
with improper use of the Convention. Some AARs have been peppered into the Commentary over
time resulting in a patchwork of rules, it is disorganised and at times difficult to follow. There are also
areas of repetition of concepts under differently named AARs which have similar objectives and
perhaps slight differences in their approaches. On the other hand, the UN Commentary is better
organised but refrains from providing suggestions for wordings and it often refers to OECD
Commentary for basis.
Collectively, these two sets of internationally recognised Model Conventions and
Commentary point in the same direction and complements one another in addressing the problem of
treaty abuse.
2.1.2. BEPS Action 618
suggests 3-pronged approach
The OECD has issued a discussion draft for BEPS action 6 earlier this year which proposed
the following:
Firstly, to include in the title and preamble of treaties contracting states’ intention to prevent
tax avoidance, especially treaty shopping. Secondly, to include the LOB (Section 2.3.2 refers) article
in treaties, which contains a set of SAARs targeting some prevalent treaty abuse arrangements.
Finally, a GAAR is suggested to reinforce and cover situations not addressed by the LOB.
Taking a step back and looking at the framework as a whole, it makes sense. The contracting
states set the tone by voicing their shared intention of anti-avoidance on the outset, and then, they
take on the existing avoidance schemes directly with a full set of dedicated rules provided in LOB.
Finally, they may use the trump card (GAAR) provided for unforeseen abusive scenarios. It looks like
a full kit against treaty abuse.
However, the author finds quite a number of potential issues which needs to be ironed out in
steps two and three. Issues on LOB are discussed in the later section. As for the GAAR, the
discussion draft loosely refers to the guiding principle, MPT and judicial doctrines garnished with a
claim that there is no conflict between the Convention and domestic tax laws19 and that it echoes the
“relief until proven abuse rule”20. The following section will discuss the validity of these claims.
2.2. GAAR
2.2.1. Main Purpose Test
As part of the 3-pronged approach proposed by BEPS action 6, MPT forms an important
component of the GAAR which aims to cover treaty shopping scenarios not dealt with by the LOB.
This also means that even if taxpayers pass the LOB tests, they may still be caught by the MPT. The
recommended wordings for MPT is as follows:
“Notwithstanding the other provisions of this Convention, a benefit under this Convention shall
not be granted in respect of an item of income if it is reasonable to conclude, having regard to all
relevant facts and circumstances, that obtaining that benefit was one of the main purposes of any
arrangement or transaction that resulted directly or indirectly in that benefit, unless it is established
17
18
Organisation for Economic Cooperation and Development. Public Discussion Draft, BEPS Action 6:
Preventing the Granting of Treaty Benefits in Inappropriate Circumstances. (Paris: OECD, 2014)
19
20

that granting that benefit in these circumstances would be in accordance with the object and purpose
of the relevant provisions of this Convention.” 21 (Emphasis added)
This concurs with the guiding principle but took it a step further by giving more room for
subjectivity by including new wordings such as “reasonable to conclude”, “relevant (facts and
circumstances)” and “one of the main purposes”. Further, instead of following the “relief until proven
abuse rule”, the wordings seem to suggest that, notwithstanding the MPT, benefits will be granted
only if it is proven to be in accordance to the object and purpose of the Convention. It might be a
small difference but the burden of proof seems to be transferred to the taxpayer entirely and it seems
to contradict the “relief until proven abuse” principle. Understandably, these issues are still in a fervent
debate, as the international community is concerned about the increased uncertainties and onus for
taxpayers.
Benefits
The MPT provides a direct tool for developing countries to retract treaty benefits in potentially
tax-avoidance situations should they lack the specific domestic laws to do so. It closes the loopholes
and narrows the effect of knowledge gap between tax authorities and international tax advisors, as it
gives tax authorities more power to challenge complex schemes designed by experienced tax
advisors
Risks
This test may be overly onerous and unreasonably arduous for law abiding taxpayers to
justify their transactions or corporate structuring. Further, it is fundamentally contradicting since
treaties are meant to provide tax benefits and many developing countries offer tax incentives in their
domestic laws. According to this rule, if the company considers such tax benefits as one of the
reasons to invest in the developing country (which is the original intention of the government), the
company could be penalised under the MPT for having “tax benefits” as one of the main purposes.
The same argument has been put forth by various parties in the Comments received by the
OECD on the BEPS Action 6 Public Discussion Draft22.
Suggestions
Although it is suggested in the Discussion Draft for MPT to form part of the LOB clause
(typically a SAAR) it is still technically a GAAR. GAARs are like trump cards for tax authorities and
understandably most favoured by developing countries as it saves them the drafting hassle and
provides the overriding right to deny treaty benefits. However, it is a double edged sword: without the
required competency within the tax authorities, it is a nightmare to administer such a provision.
Developed countries often find difficulties in striking the balance and had to rely on case laws in other
countries as reference for their judgements. Developing countries will be in a lesser position to
administer such a provision with limited human capital. Further, developing countries’ key objective in
concluding treaties is primarily to attract FDI, this should not be overshadowed by the paranoia of
treaty shopping. As such, developing countries should refrain from implementing such overly wide-
reaching GAAR.
Instead of adopting a highly criticised provision in their treaties, developing countries could
consider incorporating the “general bona fide provision”23, which is also recommended in the OECD
Commentary, into their GAAR. The said provision is generally accepted by international community
and the suggested wordings could be modified as such: "The foregoing provisions benefits of the
Convention shall not apply be denied where the company resident establishes that the principal
purpose of the company resident, the conduct of its business and the acquisition or maintenance by it
of the shareholding or other property from which the income in question is derived, are motivated by
21
22
Organisation for Economic Cooperation and Development. Comments received on Public Discussion Draft
BEPS Action 6: Preventing the Granting of Treaty Benefits in Inappropriate Circumstances. (Paris: OECD,
2014)
23
Section 19 of OECD Comm. on Art. 1

sound business reasons and do not have as primary purpose the obtaining of any benefits under this
Convention." This is reflective of the “Business Purpose” doctrine.
2.2.2. Extension of MPT in distributive provisions:
OECD MC suggests to add the following to each distributive rule:
"The provisions of this Article shall not apply if it was the main purpose or one of the main
purposes of any person concerned with the creation or assignment of the [Article 10: "shares or other
rights"; Article 11: "debt-claim"; Articles 12 and 21: "rights"] in respect of which the [Article 10:
"dividend"; Article 11: "interest"; Articles 12 "royalties" and Article 21: "income"] is paid to take
advantage of this Article by means of that creation or assignment." 24
(Emphasis added)
The same wordings, “…main purpose or one of the main purposes…” were mentioned in the
preceding section 2.2.1. This Commentary was added in the 2003 OECD Commentary along with
Commentary 9.5 – “guiding principle”, preceding the BEPS discussion.
Benefits
This proposed provision reaffirms the applicability of the MPT on each type of income. An
additional benefit would be the added flexibility in implementing the MPT. Albeit the wide reaching
wordings - as mentioned previously, it is specifically stated in the respective distributive provision of
the treaty. This means that the same condition can be waived in certain distributive clause, which
provides a developing country with the tool to target income which is more prone to abuse than others
while relieving taxpayers from unnecessarily onerous provisions for other types of payments.
Risks
Application of these additional clauses in distributive rules has the same effect as a GAAR in
fuelling uncertainties in treaty application. If an aggressive position is taken by the tax authorities,
such additions to the treaties will reduce the beneficial effects of treaties severely.
The terms “creation or assignment” could possibly give rise to uncertainty in interpretation.
Perhaps more familiar terms should be used such as “arising” or “paid” to avoid the complication. If
the intention is to prevent assignment of income rights to a third state, this can be covered by SAARs
(discussed in section 2.3).
Finally, a similar problem exists as per the general MPT clause, such additions to the treaties
leave developing countries’ tax authorities and tax courts with too much power but no capacity to
handle ambiguous situations.
Suggestions
In order to tackle the conflict of tax incentives, the wordings can be adjust to “the main
purpose” only, this way, legitimate investors with bona fide reasons would be excluded from this AAR.
Further, it seems rather redundant for such a general rule to be put into every distributive provision,
unless the state wants to use it for specific distributive rules, which are vulnerable to abuse. It could
be a less intrusive approach compared to the application suggested in BEPS action 6 and perhaps a
more balanced approach for developing countries’ consideration. For instance, it can be used in
article 11 as a safeguard for interest payments if there is no SAARs targeting interest deduction (e.g.
Thin Capitalisation rules) in their domestic tax laws and the treaty provides attractive WHT reductions.
Lastly, to avoid overwhelming the tax courts and tax administration, the tax authorities may
consider issuing soft rules and guidelines for taxpayers. These soft rules may indicate the evaluation
methodology set forth by the tax authorities, example of scenarios where these clauses are applicable
and clear exceptions where the AAR is not applicable.
2.2.3. The Savings Clause
The Savings clause is a US concept which is included in its treaties to allow contracting
states to tax residents based on their domestic tax rules notwithstanding the provisions that restricts
24

source taxation in the treaty. In addressing the issue of treaty overriding domestic AARs, the BEPS
Action 6 suggested the inclusion of this clause to Article one: “3. This Convention shall not affect the
taxation, by a Contracting State, of its residents except with respect to the benefits granted under
paragraph 3 of Article 7, paragraph 2 of Article 9 and Articles 19, 20, 23, 24 and 25 and 28.”25
The exceptions mainly covers rules which are applicable to resident recipients in residence
states, which means that the general rule applies to most distributive rules. This general rule is not
contingent to only abusive scenarios but it is a general statement. It could in effect erase benefits a
treaty provides in its distributive provisions or at the very least make these benefits very uncertain.
Benefits
It allows states to implement their AARs without restriction from the treaties. However,
developing countries may find this clause redundant as it is drafted in the residence state’s
perspective. A savings clause will not help to effect a source state’s domestic AARs and they could
still be overridden by treaties.
Risks
In exchange for tax sovereignty, developing countries could be paying a high price for it. First
of all, the addition of a savings clause could diminish the applicability and attractiveness of a treaty
severely in the investors’ perspective. Developing countries are not just competing for FDI through
treaties, they are also using treaties to make investments through legitimate locations more attractive
compared to investment via tax haven countries. Without a reliable treaty, investors may revert to
investing through tax haven countries as the tax exposure could be the same (given the uncertainty)
and it is more cost effective to set up in tax havens.
Secondly, it allows taxation by a contracting state of its residents. As a source state,
developing countries do not get much benefit from this rule.
Suggestions
There is still value in a savings clause if the scope is limited to abusive situation and not just
for residence state. For example: “3. This Convention shall not affect the taxation or denial of benefits,
by a Contracting States, in a tax avoidance situations of its residents except with respect to the
benefits granted under paragraph 3 of Article 7, paragraph 2 of Article 9 and Articles 19, 20, 23, 24
and 25 and 28.”26 In fact, this could be combined with a GAAR for better outcome. However, the term
tax avoidance needs to be defined clearly to limit its application. The definition of tax avoidance in
domestic law should also be included and match the definition in treaty to avoid discrepancy in
applying the AARs.
2.3. SAAR
2.3.1. Two General Approaches to SAARs
The OECD has categorised SAARs in two types of approach27: an entity exclusion approach
or an income denial approach (referred to as safeguarding clause in the Commentary) as a counter
treaty shopping measure. The entity exclusion approach will exclude companies which pay low or no
tax (thanks to tax privileges) from treaty benefits. The intention is to prevent harmful tax competition
from countries that couple preferential tax regimes with treaty benefits to drastically reduce effective
tax rates on investment returns. The income denial approach targets income, which is exempt or
suffers minimal tax, instead of the company. This seems to be a more moderate and reasonable way
to address abusive situation without making it too onerous for taxpayers. Most of the SAARs
discussed below will fall into either categories.
Benefits
25
26
27
Section 21 to 21.3 of OECD Comm. on Art. 1

The entity exclusion type rules target conduit entities while the income denial rules target
conduit arrangements. By excluding these entities and income streams from benefiting from the
treaties, the benefits of setting up conduit companies in treaty partners’ states are effectively nullified.
These are particularly handy provisions for developing countries to include in treaties with popular
conduit jurisdictions with preferential tax regimes such as the Netherlands, Belgium, Luxembourg,
Malta, Singapore, etc.
Risks
Entity exclusion rules may require constant updating on the developing countries’ part.
Depending on the drafting, if the treaties include a closed list of entities which are excluded from
benefiting from the treaties, this list will need to be constantly reviewed and updated mostly by the
developing country since it is to its benefit to do so. If it is an open list of entities which have certain
qualities, it is harder to implement. Tax authorities of developing countries will have to first evaluate
the status of an entity at each point of the transaction to determine the applicability of the treaty.
Status of the companies may change year-on-year, which translates to perpetual administrative
burden on the developing countries.
Income denial rules are rules like “subject to tax clause” (ref. Sec. 2.3.4.1), targeting exempt
or lowly taxed income stream instead of the entity itself. It is perhaps a less restricting and fairer
treatment towards taxpayers as their non-exempt income could still benefit from the treaties. In the
tax authorities’ perspective, it remains burdensome as it still requires them to closely monitor their
treaty partners’ domestic tax law changes. For this rule to work for a source state, developing
countries need to establish that the income will be subject to tax (or be subject to acceptable tax
rates) in the residence state, i.e. they are required to foresee the tax treatment post
payment/remittance. One option is to require the taxpayer to submit a proof of tax payment in the
residence state subsequently or the source state may withhold full amount and provide a refund upon
receipt of the mentioned proof of payment in the residence state. Either ways, it requires the tax
administration to constantly review, assess and follow up with taxpayers on most cross-border
payments which might not be feasible.
Another issue with drafting will be to define “low tax”. Whether it is a set rate; or a percentage
of source state’s headline tax rate compared against the headline tax rate of the treaty partner; or the
effective tax rate, these need to be justified with rationale and need to be regularly reviewed. Further,
considering the reverse scenario whereby source state entity is granted tax incentives and income
was not subject to tax, these entities or income could be caught by this clause and thus unable to
enjoy the treaty protection in the residence state, nullifying all incentives given by the developing
countries as income will be fully taxable in the residence state. The effect is equivalent to the lack of
tax sparing relief clause in the treaty.
Suggestions
Developing countries need to modify standard SAARs to suit their needs and be aware of the
following issues. Firstly, some SAARs can be technically difficult to draft. The developing country risks
making them too restrictive which would deter investments while having a narrow scope would make
them too easy to circumvent. Secondly, they can be administratively demanding. The treaty may
require constant updating (even if it is just for the annexes) and it could strain the enforcement
department unnecessarily if it requires case by case assessment of claims and refunds. Lastly, these
rules could potentially wipe out the tax advantages the developing country’s domestic tax law or the
treaty is granting. This brings us back to square one, no FDI and no tax revenue.

2.3.2. Limitation On Benefits
It is modelled after the LOB article in the US Model treaty, included in both the UN28 and the
OECD29 Commentary and a modified version is recommended in the BEPS action 6. The LOB
article30 is a combination of SAARs put into one Article. Key concepts are embedded in each
paragraph, in Para. 1: introduction of the “Qualified Person” concept as additional criteria for treaty
access which is similar to the effect of adding Beneficial Owner concept to the OECD MC distributive
rules; Para. 2: definition of “Qualified Person”, which encompasses detailed shareholding tests, stock
exchange provision31, management and control test32, physical presence test33 and channel
provision34; Para 3 provides an exception for active businesses, which is similar to the “activity
provision”35; Para 4 gives the competent authority power to grant access to the Convention, part of
the wordings resemble the MPT and the guiding principle.
The LOB provision is proposed as a separate article to the treaty and effectively as an
additional condition to access the treaty on top of the existing Articles 1, 3 and 4 of the OECD MC.
Benefits
Deploying the LOB article would cover a lot of the treaty abuse issues like conduit companies,
stepping-stone arrangement, residency manipulation and artificial arrangement without economic
substance. Moreover, it contains safeguards like the active business exclusion and stock exchange
provision for legitimate businesses, a tangible set of criteria and thresholds for entities to be regarded
as a qualified person.
To wrap it all up, there is even a GAAR-like provision (Para. 4) thrown in for contracting states
to exercise discretion. It does seem to have the characteristics of a magic pill for all abusive ailments.
Risks
The downfall of the LOB article is also the attribute that made it attractive. Having all the rules
packaged into one has its benefits as well as risks. By putting them all into one article, they become
less flexible and may not make sense for all kinds of payments. The problem with such redundancy is
the equivalent risk of it being an obstacle for application of the treaty. For example, it might not be
logical to apply the channel approach within the “qualified person” concept36 to dividend payments but
the rule is non-discriminatory towards all distributive rules, so if the entity does not qualify under the
other provisions to access the treaty, it might be prohibited from benefiting from the treaty due to an
unintended limitation rule.
One may notice within the LOB article that new terms are introduced and defined and the
definitions are further defined to the point of which paragraph 5 is dedicated to define all the new
terms within the article. Problem with this is that it is a vicious cycle, if contracting states wish to drill
into the wordings of such a complex article, they may end up drafting another treaty within the treaty.
Practically, this will not be feasible for developing countries.
Moreover, there is the question of effectiveness of the article, the author agrees that it adds a
layer of protection against the abuse of the treaty; however, it does not seem too difficult to
circumvent it either. In addition, not all countries or potential treaty partners of the developing
countries are willing to include the LOB in their treaties since it is not yet a prevalent article. The
absence of the same in some treaties may be interpreted as having a higher tolerance for tax
avoidance arrangements.
28
Section 20 of UN Comm. on Art. 1
29
30
31
Organisation for Economic Cooperation and Development. Public Discussion Draft, BEPS Action 6:
Preventing the Granting of Treaty Benefits in Inappropriate Circumstances. (Paris: OECD, 2014), LOB Article
paragraph 2(c)(i)
32
Ibid paragraph 2(c)(i)(B)
33
Ibid paragraph 2(e)(i)
34
Ibid paragraph 2(e)(ii)
35
Section 19(b) of OECD Comm. on Art. 1
36

The elephant in the room once again is the feasibility of implementation, is it worth the while
for developing countries to devote their limited resources to administer such an article along with
other obligations as treaty partners?
Suggestions
When adopting the LOB article, developing countries can pick and choose concepts from it
and embed them into the applicable distributive rules or they can specify within the LOB article which
types of income, gains or profits these concepts would be relevant for.
A simplified version of the LOB needs to be developed for treaties with developing countries.
The consideration and technical skill required for having such an article challenges even the very
developed countries. The OECD has not prepared Commentary or made any reference to the US
MC’s technical explanation thus far and it is probably not the best idea to rush into it until it has
developed the simplified version of LOB article. It might also better to have a separate GAAR than to
have a watered down GAAR tucked into a set of SAARs as it dilutes the effect of a GAAR but adds to
the formidability of the LOB.
2.3.3. Denying Benefits to Conduit Entities
2.3.3.1. Look-through provision
The look-through provision suggested by the OECD targets the conduit entities by
disregarding them (along with the treaty benefits), which is similar to the Beneficial Owner concept
below. The following wordings were added to the OECD Commentary in 1992: "A company that is a
resident of a Contracting State shall not be entitled to relief from taxation under this Convention with
respect to any item of income, gains or profits if it is owned or controlled directly or through one or
more companies, wherever resident, by persons who are not residents of a Contracting State." 37
The OECD prompted it is necessary, in the adoption of such a provision in a treaty, to
determine the criteria according to which a company would be considered as owned or controlled by
non-residents. This also coincides with the “substantial interest” concept highlighted in the “subject-to-
tax” approach and the “qualified persons” concept in the LOB.
Benefits
The look-through provision is can be more effective than the remittance based provision in
countering “stepping-stone” arrangement. This rule targets the entities with conduit attributes and
disregard their existence thus exclude the resident conduit entity from treaty benefits thereby
addressing the problem head on.
It also seems like a more reasonable rule than, for example, the typical CFC rule, as the look-
through provision would still allow application of treaty between the source state and ultimate
resident’s state, even if the income, gains or profits is not “paid to” the ultimate resident directly (no
“paid to” requirement in this provision).
Risks
Once again the effectiveness of the rule stems on the definition of the term “owned or
controlled”. Generally, the “ownership and control” needs to be defined both quantitatively (e.g.:
percentage requirement) and qualitatively (e.g.: types of rights attach to shares). In a dividend
distribution, percentage of ownership and voting rights threshold are often used as a quantitative
measure while corporate rights attached to the shares are stipulated as qualitative criteria to prevent
the split of legal and economic ownership – a common trick used by tax advisors. The quantitative
threshold may correspond to the ownership requirement agreed in treaties; however, the qualitative
criteria will need to be listed in details. In drafting the list of rights that should be attached to the
shares, developing countries may need to review the type of shares available in the contracting
state’s domestic corporate law to ensure there are no loopholes for abuse.
37

Secondly, the repercussion of a look-through provision needs to be considered - should the
income retain its character or should it be deemed a dividend? This could affect the domestic WHT
rate applicable or the treaty distributive rule if another treaty is applicable, the contracting states
needs to agree on the course of action for these repercussions.
Thirdly, there might be an issue of double source taxation when the conduit entity distribute
the income, gains or profits to its shareholder. If the state where the conduit entity is tax resident (it
might be considered conduit in one state but not in others) may exercise its source taxation rights, the
same income might be double taxed. This dual source issue, as stated in article 23 of the OECD
Commentary paragraph 11, has to be dealt with by the Mutual Agreement Procedure.
Suggestions
Needless to say, developing countries will require technical assistance while drafting as well
as during the regular review of this provision. As highlighted above, there is no illusion that this
provision requires bilateral agreement, careful drafting and sophisticated implementation to meet its
objective and avoid causing double taxation.
If the developing country decides to adopt this provision, to ensure the applicability of third
state’s treaty, the “alternative relief provision” may be included: "In cases where an anti-abuse clause
refers to non-residents of a Contracting State, it could be provided that the term "shall not be deemed
to include residents of third States that have income tax Conventions in force with the Contracting
State from which relief from taxation is claimed and such Conventions provide relief from taxation not
less than the relief from taxation claimed under this Convention".38
2.3.3.2. Beneficial Owner Concept
The OECD introduced the Beneficial Owner concept in the distributive provisions in 1977.
The intention was to address abusive situations arising from the literal interpretation of “paid”.
Taxpayers were taking advantage of that loophole to obtain treaty benefits making “payments” to
conduit/nominee entities in treaty countries. Although the term was inserted into the OECD MC, it was
not defined within the treaties. In the Beneficial Owner discussion draft39, the OECD proposed that the
recipient of payment is considered the Beneficial Owner if he has the full right to use and enjoy the
payment unconstrained by a contractual or legal obligation to pass the payment received to another
person. However, the OECD remains ambiguous towards the reliance on domestic definitions of the
term “Beneficial Owner” in the absence of treaty definition, in accordance to Article 3(2) of the OECD
MC.
Benefits
Beneficial Owner is a familiar concept internationally defined after all the debates through the
years and it widens the reach of the distributive provisions in the protection against conduit entities
and arrangements.
Risks
One of the risks are the conflicting position of contracting states in interpreting this term within
the treaties and possible differences in their domestic definition. There is also no discussion in the
OECD Commentary about the course of action upon denying treaty benefit when payment was not
made directly to the Beneficial Owner but the Beneficial Owner is resident of a contracting state in
another treaty. Is the payment a criteria to treaty access? The indirect payment arrangement could be
purely for bona fide reasons for example to reduce currency risk or centralise treasury.
Suggestions
Since newly concluded treaties will have the term “Beneficial Owner” in place, developing
countries should include the definition in the treaty and adopt the same definition in their domestic tax
legislation for clarity.
38
Section 19(e) of OECD Comm. on Art. 1
39
Organisation for Economic Cooperation and Development. Discussion Draft: Clarification of the meaning of
“Beneificial Owner” in the OECD Model Tax Convention.(Paris: OECD, 2014)

Contracting states may consider adopting the “alternative relief provision” (Section 2.3.3.1
refers) and agree on the applicability of “payment” as a condition for granting relief in cases where the
Beneficial Owner is resident of another contracting state. Contracting parties should also provide a
recourse on potential double taxation issues.
2.3.3.3. Deemed Conduit clause
The deemed conduit clause is a SAAR not considered by the OECD so far. Below is an
excerpt from the India-Singapore treaty:
“3. A resident of a Contracting State is deemed not to be a shell/conduit company if its total annual
expenditure on operations in that Contracting State is less than S$200,000 or Indian Rs 50,00,000 in
the respective Contracting State as the case may be, in the immediately preceding period of 24
months from the date the gains arise.
4. A resident of a Contracting State is deemed not to be a shell/conduit company if:
a) it is listed on a recognised stock exchange of the Contracting State; or
b) its total annual expenditure on operations in that Contracting State is equal to or more than
S$200,000 or Indian Rs 50,00,000 in the respective Contracting State as the case may be, in the
immediately preceding period of 24 months from the date the gains arise.
(Explanation: The cases of legal entities not having bona fide business activities shall be
covered by Article 3.1 of this Protocol.)”40
The above is the first of its kind that the author has seen, it is a reverse safe harbour type clause and
akin to a simplified “qualified person” definition.
Benefits
The rule is simple and direct in targeting conduit entities by increasing the cost of conduit
entity establishment. By using a purely quantitative rule, it also allows simple application versus a
qualitative approach. This is also the kind of AAR where result is measurable and could be
anticipated. If the developing countries have statistics on the average expenditure of an operating
entity in the contracting state, they will be able to see the number of entities disqualified by the
threshold; projecting that to volume of relevant cross border payments, the “additional tax revenue”
from denying WHT reduction can be estimated. This gives contracting states valuable control over the
cost and benefit of this AAR.
Risks
The statistics of the contracting state may not be readily available and to set a single
threshold across all industry may not be fair. Further, such a rule may discriminate against legitimate
small foreign investors.
The economic landscape tends to change rapidly in developing countries, this might call for
regular revaluation of the threshold for it to remain relevant. Moreover, expenditure can be made to
related parties of the conduit entity to meet the threshold.
There is also a danger in the reciprocity of the clause as developing countries may not have
the capacity and knowledge to evaluate the adequacy of the threshold proposed by the other
contracting state. For instance, Singapore could have proposed the S$200,000 minimum expenditure
which could be the bare minimum expenditure of a Singapore company and almost all Singapore
entities would qualify, whereas Rs. 5,000,000 is the real average expenditure of an operating Indian
entity and only 50% of the entities would be eligible. This could tilt the obligations of the contracting
states drastically.
Suggestions
This is an entry level clause which developing countries could benefit from. Although there
could be difficulties in setting and reviewing the thresholds. It gives developing countries the rare
40
Agreement Between The Government of The Republic of Singapore and The Government of The Republic of
India for The Avoidance of Double Taxation and The Prevention of Fiscal Evasion with Respect to Taxes on
Income- ANNEX B Article 3

chance to estimate the effectiveness of an AAR with tangible figures. It might also incentivise
companies to meet a certain level of local expenditure which is always good for the economy.
Expenditure requirement should exclude related party payments to prevent avoidance.
Finally, to prevent the exclusion of the smaller enterprise, an exception can be added in the
clause for companies with annual turnover below a certain amount. The rule should be included in the
Annex or protocol to allow easy amendment. As the developing countries progress, this may not be
necessary and more refined provisions may replace this one.
2.3.4. Denying Benefits to Conduit Arrangements
2.3.4.1. Remittance based taxation & Subject-to-tax provision41
:
The intention of the remittance based provision is to prevent non-taxation in situation whereby
the resident state taxes only on remittance basis. The rationale is that relief should not be granted as
there is no double taxation. The following paragraph is suggested by the OECD in its Commentary:
"Where under any provision of this Convention income arising in a Contracting State is relieved in
whole or in part from tax in that State and under the law in force in the other Contracting State a
person, in respect of the said income, is subject to tax by reference to the amount thereof which is
remitted to or received in that other State and not by reference to the full amount thereof, then any
relief provided by the provisions of this Convention shall apply only to so much of the income as is
taxed in the other Contracting State." 42
An addition to the above, a time limit for remittance is also suggested for administrative clarity
considering the possible time difference in claiming for benefits and the actual cash remittance, i.e. if
remittance is not made within the time limit, benefits of the treaty will not be granted. In the OECD
Commentary, under Article 10, 11 and 12, abuse through the use of PE was mentioned and a subject
to tax provision was suggested under Article 24 - “… an enterprise can claim the benefits of the
Convention only if the income obtained by the PE situated in the other State is taxed normally in the
State of PE (in 3rd state)” 43
Curiously, the OECD Commentary also mentioned the subject to tax approach and illustrated
the effectiveness of the clause, it even recommended to add a bona fide provision for flexibility. The
difference between these two provisions is minor, subject to tax clause has a wider scope and could
cover the remittance based taxation provision and there is no clarification on the reason for having
separate provisions in the Commentary.
Benefits
These clauses keep the treaty close to its primary objective of eliminating double taxation and
prevent abusive situations such as arbitrage of domestic law differences to achieve non-taxation of
income. This is particularly prevalent with treaty partners adopting remittance based taxation. It
relieves developing countries from their obligation to reduce WHT based on the treaty thus protecting
its tax base.
Risks
Besides the timing issue highlighted in the OECD Commentary44mentioned above, there is
also an issue of defining the term subject to tax. It could be understood as being qualified as a
taxpayer (as per “liable to tax” criteria of Article 4 of the OECD MC) or it can literally mean suffering
tax liability in the other contracting state. It is important to define this term because some countries
may regard a taxpayer earning exempt income to have been subject to tax and the taxpayer may
benefit from the treaty; while in other countries, the benefit does not apply if the income is not subject
to tax in the other contracting state.
41
Section 15-17 of OECD Comm. on Art. 1
42
43
44
Section 26.1 of OECD Comm. on Art.

This clause could wipe out all treaty benefits for contracting states which embrace a territorial
tax system if not drafted properly. It can be argued that this result is still in line with the purpose of the
treaties (since no taxation in contracting state there is no need for relief). However, it is unfair towards
countries practicing territorial taxation as they will not benefit from the treaty as much as the other
contracting state.
Further, developing countries have to consider implementation issues. This rule requires the
tax authorities to not only track the outward remittance but also to foresee the taxability of income
upon remittance into the residence state. Putting the rule into context of dividend distribution, it would
be easier to imagine the magnitude of the required effort, bearing in mind that each resident company
may have multiple shareholders with various tax personalities (natural persons, partnerships,
collective investment vehicles, trusts, cooperation, etc.), subject to different tax regimes across
multiple jurisdictions. Although one may argue that it is not anymore tedious than the regular
distributive rules, the additional requirement has a multiplying effect. Therefore the cost of
implementing such a system could outweigh the benefits of safeguarding the developing state’s
taxing rights.
Suggestions
In all, it does not seem effective for developing countries to enact such a clause, considering
the challenge in agreeing to a definition for “subject-to-tax”. Also, it is easy to side-step this clause
through a “stepping-stone” arrangement or making use of a preferential tax regime where income is
minimally taxed as described in Section 2.3.4. Although safeguards could be used to supplement this
clause in preventing the “stepping-stone” arrangement, developing countries run the risk of making
the treaties unnecessarily complex.
2.3.4.2. Channel Approach
The Channel Approach targets income streams instead of entities, which can be more
effective in tackling “stepping-stone” arrangements than targeting conduit entities. The OECD
provides an example: "Where income arising in a Contracting State is received by a company
resident of the other Contracting State and one or more persons not resident in that other Contracting
State have directly or indirectly or through one or more companies, wherever resident, a substantial
interest in such company, in the form of a participation or otherwise, or exercise directly or indirectly,
alone or together, the management or control of such company, any provision of this Convention
conferring an exemption from, or a reduction of, tax shall not apply if more than 50 per cent of such
income is used to satisfy claims by such persons (including interest, royalties, development,
advertising, initial and travel expenses, and depreciation of any kind of business assets including
those on immaterial goods and processes)." 45 (emphasis added)
The condition that helps target conduit arrangement is in the underlined wordings of the
insertion. This requires tax to be paid on a substantial portion of the remitted income before the tax
benefit would apply, which reduces the likelihood of a conduit arrangement.
Benefits
This approach addresses the issue of conduit arrangements directly. Back-to-back licensing
or financing arrangement will not work under such a provision as the intermediate entity will not be
granted reduced WHT which will result in the same tax liability as the direct borrowing or licensing.
Risks
Inadvertently, this provision may implicate regular taxpayers working on low profit margins.
Since the rule is not industry specific, it would be difficult to set a percentage threshold that is
reasonable across board. Therefore contracting states should evaluate if there is a good rationale for
50% expenditure, if the states’ goal is to secure a minimum effective tax rate, then perhaps the
expenditure threshold should be decided based on the targeted minimum effective tax rate.
45

Further, the conditions for expenditure seems too strict, items like travel expenses and
depreciation of business assets (included in the suggested wordings above) actually indicate real
business activities which reduces the possibility that the entity is a conduit. Finally, administratively it
can be demanding as the developing country will need to collect detailed information on the residence
of the other contracting state, and evaluate the profit and loss statement to verify the applicability of
this rule.
Suggestions
Developing countries worried about conduit arrangements can consider modifying this clause
to include a bona fide provision and limit the expenditure type to high risk payments to non-residence
of the contracting state.
If developing countries find the clause too onerous, a watered down version of the condition
such as “... Convention conferring an exemption from, or reduction of, tax shall may not apply if...”.
This will provide the developing country an avenue to pursue this approach at a later stage when it is
better able to address the issue. Such conduit arrangements can also be dealt with by TP regulations
which are a more sophisticated tool that demands strong technical knowledge of the tax
administration.
3. Domestic
3.1. Introduction
3.1.1. OECD and UN clarification on domestic AARs: no conflict
One obvious obstacle for domestic AARs is the potential conflict with treaties. States following
a dualistic legal system may encounter more of such situations. However, both the OECD and UN
MCs have clarified, in abusive situations, there will be no conflict in applying domestic AARs as tax
avoidance is undoubtedly against the object and purpose of treaties anyway. Theoretically, that
makes perfect sense but practical difficulties arises when deciding if it is indeed an abusive situation.
Treaties are mostly bilateral agreements, and “Even if an ambulatory interpretation applies for
treaty purposes, there must be some threshold beyond which the unilateral amendment of a country’s
domestic law constitutes a breach of its treaty obligations.”46 In such situations, guidance shall be
seek from the VCLT. In particular, Articles 31 to 33 of the VCLT are often referred to, as they provide
the rules for interpretation of terms undefined in the treaty. The essence of these paragraphs could be
summarised simply in lay man’s term: as long as interpretation is made in line with the purpose of the
treaty, logically and in good faith, it is not in breach of the VCLT.
Thus, if developing countries are able to justify the enactment of domestic AARs with the
purpose of countering treaty abuse, these rules will not infringe VCLT and it cannot be a point of
accuse for treaty partners. It does not, however, stop the treaty partners from cancelling the treaty.
3.1.2. Pros and Cons of Domestic AAR
Domestic AARs are more flexible than treaty rules by nature because they can be modified
unilaterally whereas treaty rules require consent from treaty partners. As a result, domestic AARs can
be closely tailored to the needs of developing countries as they evolve, has a shorter reaction time
between identification of abusive arrangements and enacting countering rules and be administered at
the level that is compatible to the capacity of the government. There are also possibilities to set a time
period for the rules which would not be possible with treaty AARs and the legislator does not need to
be concerned about reciprocal effects of these rules.
46
Jinyan Li and Daniel Sandler, 'The Relationship Between Domestic Anti-Avoidance Legislation and Tax
Treaties', Canadian Tax Journal(1997)

Downside can be, besides conflicting with treaties, community laws (European Union Law) or
other public laws. There is the possibility of going overboard with AARs and driving FDI away with it.
All the efforts with tax incentives and giving away taxing rights through treaties will be futile if the
domestic AARs are too rigorous and onerous for taxpayers. There is also a risk of them causing
unintended effects when interacting with treaties. Thus, in deploying domestic AARs, all facets of its
effects should be evaluated, including other domestic laws, international laws and the treaties
concluded thus far.
3.2. GAAR
3.2.1. Standard GAAR
Unlike treaty GAAR, domestic GAAR can be very elaborate (e.g. UK) and have a much wider
scope that covers beyond income and capital gains tax. Wordings for a GAAR varies widely but the
general effect of GAAR would empower tax authorities to disregard, for income tax purposes, any
artificial arrangements and transactions with the purpose of obtaining tax benefits that are not
intended by the relevant provision. The terms “artificial arrangements” and “tax benefits” are usually
further defined within the legislation. For the purpose of our discussion, GAAR with the above
elements will be referred to as “Standard GAAR”.
Germany goes further to explain that the GAAR “is applicable if an inappropriate legal
structure is chosen that leads to a tax advantage for which the taxpayer cannot provide significant
non-tax reasons.”47, while Spain goes in a different direction by adopting the substance over form
doctrine in its legislation48 as a GAAR, providing the right to tax transactions based on substance.
Benefits
Just as discussed, GAAR serves as a fall back for tax authorities, it covers the gaps that
SAARs leave. It also gives legislators a break from drafting a never ending list of SAARs, avoiding
over complicating the tax acts.
Risks
Uncertainty is the biggest issue with GAARs, in both taxpayer and tax authorities perspective.
The burden is passed on to the court which, in a developing country, might not have the capacity to
handle tax cases. Many countries do not have a tax court and likelihood of wrongful application of
such rules can be high. Therefore, ambiguous wordings should be avoided, an example of such could
be the Canadian GAAR: “Where a transaction is an avoidance transaction, the tax consequences to a
person shall be determined as is reasonable in the circumstances in order to deny a tax benefit that,
but for this section, would result, directly or indirectly, from that transaction or from a series of
transactions that includes that transaction.”49. Without a full understanding of the Canadian tax
system or tax act, just based on the wordings above, if there is no definition of “avoidance
transaction” the scope seems unnervingly wide, the use of “reasonable” sounds very subjective and
“directly or indirectly….transaction or from a serious of transactions…” gives the impression that the
legislator wishes for the GAAR to reach above and beyond what the tax administration can recognise.
There is also a chance whereby domestic GAAR is overridden by a treaty if the treaty does
not provide a gate way for AARs in abusive situations
Suggestions
Germany’s approach could be useful for developing countries, placing the onus on the
taxpayer to provide significant non-tax reason for an arrangement or transaction. This could
supplement a Standard GAAR to provide a clearer indication of taxpayer’s responsibility. The GAAR
should also have a limited scope to avoid interfering with other tax legislations unintentionally. The
definition of key terms should be concise and unambiguous to allow easy application.
47
German legislation: Section 42 of the Abgabenordnung (General Tax Code)
48
Spanish legislation: Article 16 of the Ley General Tributaria (General Tax Law), Spain
49
Canadian legislation: Section 245(2) of Canadian Income Tax Act

Further, to ensure the applicability of domestic GAAR, first step of the BEPS Action 6 should
be adopted, i.e. including the intention to counter avoidance and evasion in the preamble of treaties.
A judicial doctrine (Section 3.3 refers) could be included in the GAAR to provide more grounds for
judgement when the GAAR is invoked.
3.2.2. Alternative Minimum Tax
Many countries choose to have an AMT rule to supplement their tax code. The format and
wordings varies widely, the US has detailed rules on how to calculate the AMT amount while Labuan
allows the taxpayer to elect from the outset to calculate its tax liability based on a tax rate or just pay
a flat tax. The former is more common but the calculation and parameter used still differs. In
application of AMT, the US and India attempt to spell out the separate set of calculation for AMT
which requires taxpayers to set up another computation and adjust the income figures before applying
the AMT rate; while Cambodia takes on a much simpler approach, i.e. 1% of total turnover.
This can be perceived as a GAAR as no specific income type or entity is targeted, it is a rule
that serves the sole purpose of tax revenue protection. It is an easy option for countries to elect since
it is difficult to anticipate the combined effect of tax incentives, treaty benefits and other short or long
term economic stimulating measures may have on tax revenue.
Benefits
Main feature of the AMT is to secure minimum revenue collection which is better for
budgeting. It also discourages aggressive tax planning since there is a limit to tax savings. In the tax
authority’s perspective, it reduces the need for tax audit and investigation.
Risks
It is definitely going to increase the compliance cost for legitimate businesses depending on
the complexity of AMT calculation. Similarly, tax authorities would need to verify two sets of
calculation for tax assessment. Further, the drafting of AMT rule can be difficult as it requires detail
examination of issues cross disciplines, i.e. accounting, law and economics, something developing
countries may not have the capacity for.
The effectiveness of this rule on conduit arrangements is also doubtful as outward payments
are generally not affected by the general AMT calculations. Just like the subject-to-tax provision, it
doesn’t address stepping-stone arrangements.
On the other hand, if turnover is used as the basis for AMT calculations (tax liability cannot be
reduced through expenditures), it might discourage businesses which works on slim profit margins,
limiting the progression of economic structure for developing countries.
Suggestions
I believe the benefits of this rule outweighs the risks for developing countries. An AMT with
simplified calculation is recommendable. For instance, AMT can be applied on the gross profit based
on the developing countries’ domestic financial reporting standards, keeping the compliance
requirement for taxpayers to minimal. By using gross profits as a basis instead of turnover, the issue
with differing profit margins is reduced. This way, developing countries may secure their tax revenue
without imposing too much burden on taxpayer. Conduit arrangements can be separately addressed
by SAARs.
3.2.3. Black List
Quite a number of countries uses a black list to refuse any form of tax benefits or apply a
higher tax rate to transactions with the listed countries. For example, Brazil imposes a higher tax rate
on outbound remittance of capital gains and service fees to black listed countries50. It is unlikely that
treaty partners end up on the blacklist but such situation does exist.
50
Secretariat of the Federal Revenue of Brazil. List of Favored Taxation and Privileged Fiscal Regimes
Countries and Dependencies.

Kazakhstan, for example, maintains a list of countries with preferential tax regimes and
secrecy laws - the list includes Singapore, China (regarding the administrative territory of Hong Kong)
and some US territories, with whom Kazakhstan has concluded treaties with. Although it has no direct
effect on residents of the treaty partners, i.e. their profit is taxed in accordance with the relevant
treaty, the residents of Kazakhstan who have transactions with the residents of these countries are
subject to limitations on the deduction of interest and must include the profit of their subsidiaries in
their aggregated annual income as mentioned above51.
Benefits
Exclude all black listed countries from any tax benefits and possibly impose disincentive
measures on these countries to discourage investment through them.
Risks
It may not be easy to set the criteria in building such a list. The tax authority will need to look
into each domestic law with sufficient depth to determine the qualification for the criteria. Some
countries ring-fence special tax regimes for investment vehicles under a separate incentive act,
making it difficult to identify these regimes within their tax legislation.
Further, the black listed countries may protest or have implement counter measures against
the developing country which can be detrimental to economic progress.
Suggestions
Developing countries may consider taking a less aggressive approach to black listed
countries by increasing compliance requirements for transactions or structures involving them. More
onerous disincentives can be used for payments which are more susceptible to abuse. This could
also help to hold off the need to conclude information exchange agreements with tax haven countries
- the British Virgin Islands is still in the top 10 list of global investors52, which will relieve developing
countries from the immediate pressure on their tax administrations.
3.3. Judicial Doctrines
Judicial doctrines are the expressed interpretations of tax laws by local courts. Therefore they
also serve as guiding lights for taxpayers to understand the parameters for tax planning. Most of the
judicial doctrines have the same root as the guiding principle advocated by the OECD. Broadly
speaking53, “Economic substance”, “Substance over form” and “Business purpose” concepts aims to
exclude tax motivated arrangements without bona fide commercial reasons, which correspond to the
first condition of the guiding principle; “abuse of law” and “Frau Legis” targets plans which contradicts
the spirit of tax provisions – second condition of the guiding principle.
Most of the AARs are designed around these principles, in treaties and domestic tax laws. It
has been argued that judicial doctrines are more suitable for common law countries but the author
believes that these principles are universal and should be explicitly stated in the legislation for clearer
guidance.
Benefits
The doctrines provide wider scope for application and they allow tax authorities to address
issues based closely on the object and purpose of the convention.
Risks
It has the same problem as GAAR. Judicial doctrine is hard to implement as it is arbitrary and
uncertain. Usually courts rely on them when there is no clear legislation that may address the specific
circumstances in a case, but without a qualified judge, application may not coincide with the judicial
doctrine’s intentions.
51
A. Shaidildinova et al., Kazakhstan, 'Corporate Taxation' , Country Analyses IBFD(accessed on 17 July 2014),
at sec. 10.
52
United Nations Conference on Trade and Development. World Investment Report 2013 (New York and
Geneva: UNCTAD, 2013)
53
Section 28 to 30 of UN Comm. on Art. 1

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