One of the issues left outstanding in relation to the question of treaty abuse within the Base Erosion and Profit Shifting (BEPS) discussion is the scope of the principal purpose test (PPT) test in relation to the use of intermediaries. Simon Clark, Singapore Tax Partner, shares his observations on this issue.
What is the PPT?
This might sound like a trite question but it’s important to remember that it’s a principal purpose test and not a substance test. It only requires that the tax outcome be one of the principal purposes and, it may not be possible to 'correct' a decision made for a 'bad' purpose by adding substance now.
Can the PPT have any impact where there is no net benefit?
Again this might sound like an obvious question but the PPT should not operate in these circumstances. However, it might still be relevant to use the intermediary for these transactions as it might assist in forming a view that the intermediary was not created for a tax purpose. Equally, excluding such transactions might create a negative presumption.
PPT in the fund context
What is the position where a fund is established by a manager and offered to various investors? Which purpose(s) is/are relevant when applying the PPT to that entity? It’s an objective facts and circumstances test, but is it the manager, the investors, both the manager and the investors? What happens if the investors change and one of the new investors clearly benefits from the way the fund was established? We are not sure that there is a clear answer to this at present but fund formation and secondary trading must now be carefully considered.
What is ’substance’?
Allowing for the comment above that the PPT is not a substance test, substance is still going to be relevant. It seems that substance revolves around having the intermediary involved in the decision making process (with appropriately qualified in-country directors and front-office staff) and otherwise having a business structure (including in-country staff and service providers) that is commensurate with the activity being undertaken.
Availability of transitional/grandfathering relief
There is nothing in the commentary on this issue and it seems that this is a decision to be made by individual countries.
This deals with what happens if you fail the PPT. This is best understood by way of an example. If you invest from State A via an intermediary into State B and the intermediary fails the PPT do you apply State A domestic withholding tax outcomes or the outcome under the treaty between State A and State B. Whilst there is sympathy for the latter outcome, it is far from a concluded position and it may be that this too resolves itself to a choice to be made by individual countries.