Since the inception of the Base Erosion and Profit Shifting (BEPS) initiative, the Organisation for Economic Co-operation and Development has sought a means of implementing and enforcing their recommendations in member states. The OECD lacks treaties that stipulate a common set of rules or a method of resolving disputes between members. Without these treaties, the OECD must rely on legislators in each country to translate the BEPS recommendations into law. However, this practice gives legislators considerable liberty over how or if the recommendations are written into laws.

In general, each country legislating its own version of the rules is not a problem, but when countries have different definitions for similar concepts, the recommendations can be applied inconsistently across countries. These inconsistencies create situations where the same income is taxed by two countries. In addition, the inconsistencies create opportunities to avoid taxes by designing a business’s legal structures around these differences. In both cases, the asymmetric taxes can damage economic growth as well as reduce tax revenues.

Moreover, when inconsistencies are identified, tax authorities and taxpayers alike have little recourse other than bilateral bargaining. Taxpayers are particularly vulnerable when two countries attempt to tax the same income. Without a formal set of rules to resolve disputes, taxpayers must appeal to each country for relief. Even if both countries agree to accept the taxpayer’s appeal, the bilateral bargaining to determine which country has the right to claim the income may drag on indefinitely.

To address these issues, the BEPS project included the Multilateral Instrument (MLI) as Action 15 of the discussion items. The MLI lays out a set of multilateral treaties that set default legal definitions, limit acceptable remedies, and create a process for adjudicating disputes between signatory countries over tax issues. These treaties effectively streamline the process of developing and amending bilateral tax treaties as well as implementing a process for ironing out details as problems arise.

Recommendations for the MLI were initially reported in September 2014 and refined in the October 2015 final report. In November 2016 an ad hoc group concluded negotiations and produced a model treaty for the MLI. As of December 31, 2016, a convention was open to all countries and jurisdictions, and support for the treaty gained momentum in the spring of 2017. This culminated in 68 countries agreeing to the MLI in a signing ceremony on June 7, 2017.

The MLI treaty contains 39 articles addressing issues common in tax treaties as well as specifying the rules of the treaty convention. The articles are split into seven major sections: hybrid mismatches, treaty abuse, avoidance of permanent establishment, improved dispute resolution, arbitration and two administrative sections. These sections represent common disputes between countries over tax policy.

Articles 3 and 4 introduce rules for hybrid mismatches. Hybrid mismatches are situations where one country classifies taxable income as occurring from one source, e.g., income from a corporation, while another country considers the same income as from another source, e.g., income from a partnership. In these cases, the income may never be taxed, because each country is expecting the other country to tax the income, due to different definitions of income. The MLI sets rules to resolve this problem by requiring tax authorities to agree upon the definition of the income. Moreover, if there is no consensus, then the taxpayer is required to pay the taxes on the same income in both countries.

Article 5 establishes acceptable methods for eliminating double taxation, particularly with respect to foreign source income. Income tax paid in one country can be deducted from the tax base, exempted from income, or be claimed as a tax credit in another country.

Articles 6 and 7 set grounds for denying a treaty’s benefits to an individual or business. The MLI treaty includes model language for adding a purpose to a tax treaty. If the purpose of the tax treaty is not met by the action of an individual or business, then the tax authority of a country can deny the individual or business the benefits of the treaty. It also defines a process for adjudicating the denial of treaty benefits.

Articles 8 and 9 put limits on passing dividends and ownership of assets between related entities to avoid treaty abuse. Article 8 sets a minimal time between receiving and paying dividends between related parties. Article 9 defines when capital gains can be assessed on the sale of assets, particularly when assets are held for a short period or on transactions involving real estate.

Articles 10 to15 set additional requirements for permanent establishment. In order to tax business income, a tax authority must prove that the business has a substantial economic presence in the country, which is known as permanent establishment. Article 10 strengthens the test for permanent establishment by assigning permanent establishment to any “habitual” activity conducted by a business in a country. Article 14 requires split contracts to be summed over the entire year as part of the permanent establishment test. Article 15 establishes that agents who do not garner at least 50 percent of the profit from a transaction are not considered independent. Moreover, the articles restrict treaties from exempting or redefining permanent establishment.

Articles 10-15 also restrict permanent establishment when a third-party country is involved. Assume a business is a resident of country A, has a permanent establishment in country B, and has sales from country B to country C in which the business does not have permanent establishment. Country C can claim the income from sales if the taxes paid on the income in country B is less than 60 percent of the taxes it would have paid if the income was attributed to country A. This provision is intended to reduce income shifting from high-tax countries to low-tax countries.

To enforce these rules, articles 16 to 26 establish procedures for resolving conflict that may arise, particularly when third parties are involved. An individual or business has three years to dispute a tax claim. The tax dispute can be logged in either of the countries under a tax treaty or in the country in which the individual or business is a resident.

The countries have two years to resolve the dispute among themselves. If the dispute is not resolved, then the two tax authorities are required to undergo arbitration. Arbitration consists of a council of three tax experts: one from each country and a chair from an unrelated country. The council’s decision is final and binding.

Articles 27 to 39 define how the treaty is administered and conditions for entering and exiting the convention. Article 28 stipulates that signatory countries have the right to reject portions of the MLI but enumerates the articles that cannot be rejected. None of the articles related to binding arbitration are included in the list of mandatory articles. The MLI also included the option to withdraw from the convention in Article 37.

The MLI tackles many of the common problems in developing and amending tax treaties, but the benefits of the MLI are only realized when the rules are consistently applied across many countries. The MLI provides a framework for signatory countries to develop bilateral tax treaties with each other. The framework facilitates the bargaining process by starting with a common set of rules, which reduces confusion and saves time. However, if countries apply the framework differently, negotiators are likely to spend just as much time reconciling the frameworks as they would have spent bargaining without a framework.

Unfortunately, most signatory countries have chosen to reject at least one article within the MLI. In some cases, several articles from each section were rejected. For example, India rejected seven of the 39 articles. This has created a patchwork of default rules, which is likely to negate the intended benefits of the MLI.

The parts of the MLI involving dispute resolution are particularly vulnerable to a lack of consensus. The mandatory binding arbitration is one of the most controversial articles in the MLI. Of the 68 countries that signed the MLI treaty, only 26 countries opted into the article involving binding arbitration. As such, one of the key provisions of the MLI may not have the critical mass needed to ensure arbitration decisions will be enforced.

Only two OECD countries chose to abstain from the MLI: Estonia and the United States. The United States participated in the BEPS report and was part of the negotiations of the MLI treaty. However, the U.S. Treasury has already implemented many of the anti-treaty-shopping and base erosion rules present in the MLI. Henry Louie, deputy international tax counsel at the U.S. Department of Treasury, stated that the “multilateral instrument is consistent with U.S. tax treaty policy that the Treasury Department has followed for decades.” Louie’s position was supported by Pascal Saint-Amans, director of the Centre for Tax Policy and Administration at the OECD, who argued that U.S. tax treaties currently have sufficient measures to guard against base erosion and profit shifting.

In addition, the United States already has dispute resolutions agreements with other countries. Eight of the 26 countries that signed the binding arbitration portion of the MLI are part of a similar treaty with the United States. “That is a pretty big chunk of the willing countries,” Louie argued. “Even with respect to arbitration, the Treasury Department concluded that the potential benefits to the U.S. would be incremental.”

Louie also realized the political realities on the ground. The U.S. Treasury requires approval from the U.S. Senate to sign treaties like the MLI. The process would have generated additional debate and bargaining in which senators would have necessitated some assurances that the MLI would not change existing treaties.

Unlike the United States, Estonia has promised to review and sign the MLI in the future. Its caution may ultimately pay off, particularly if there are problems with integrating the MLI into existing treaties. The wait-and-see tactic is advantageous because it shifts the cost of hammering out the details onto the signatory countries. This may have been the original intention of the United States as well. The U.S. Treasury has not ruled out reopening MLI negotiation in the future.

With so many countries deciding to opt out over many of the MLI’s articles, it is uncertain whether the MLI can deliver the promised benefits of a streamlined tax treaty process. In fact, the patchwork of agreed-upon articles is likely to frustrate the process of negotiating future treaties. There also remains the question of how the MLI will affect existing tax treaties and to what extent it will affect non-signatory countries. Overall, it remains to be seen whether the OECD’s efforts will have the intended impact on the international tax system.