The multilateral instrument to modify tax treaties

Out-Law Legal Update | 14 Jun 2017 | 5:12 pm | 4 min. read

LEGAL UPDATE:  68 countries have signed up to a multilateral instrument (MLI) which will change the interpretation of over 1000 double tax treaties to counter international tax avoidance and to improve the resolution of international tax disputes. The signatories include almost all EU countries, as well as Russia, China, Hong Kong, India, South Africa, Australia, Turkey, Switzerland and Singapore, but not the US.

The Multilateral Convention to Implement Tax Treaty Related Measures to Prevent Base Erosion and Profit Shifting, otherwise known as the Multilateral Instrument (MLI) was signed by representatives of 68 jurisdictions on 7 June 2017, with further countries expected to sign up in the future.

The signatories included the UK and almost all other EU countries, as well as Russia, China, Hong Kong, India, South Africa, Australia, Turkey, Switzerland and Singapore. The US did not sign.

It will enable over a thousand double tax treaties to be interpreted in a way that implements the Organisation for Economic Cooperation & Development's (OECD's) recommendations relating to hybrid mismatches, treaty abuse, artificial avoidance of permanent establishments and improving dispute resolution. This is part of its base erosion and profit shifting (BEPS) project to prevent international tax avoidance by multinational companies.

How does it work?

Some of the OECD recommendations which the MLI implements are minimum standards which means all OECD states must sign up to them. Others are recommendations so countries can opt out of applying them or make 'reservations' on certain aspects, so that not all signatories will be signed up to everything. The reservations and notifications provided by each jurisdiction at the time of signing (which may not necessarily be the final position) have been published by the OECD.

Each signatory country will set out the treaties to which it wants the MLI to apply. The MLI will apply to treaties between countries which have both chosen to apply the MLI to the relevant treaty and where any options they have chosen are compatible.

The convention will not actually amend the text of double tax treaties but will have to be considered when applying them. Interpreting treaties will therefore be a complex process unless and until revised versions of the treaties incorporating the impact of the MLI are published. The UK government has said it will do this for UK treaties.

Each of the signatories needs to now ratify the MLI in accordance with their domestic law. It will only come into force in relation to a particular treaty three months after both contracting states have ratified the MLI and chosen to apply its provisions to the relevant treaty. The provisions will then take effect from the beginning of the next calendar year or fiscal period. The OECD expects the first modifications to treaties to enter into effect in early 2018.

Preventing treaty abuse

In signing up to the MLI, countries agree to include anti-abuse provisions in their tax treaties.  There is a range of permitted options for achieving this. These are a principal purpose test (the option preferred by EU countries, Australia, China, Singapore, Turkey and South Africa), a US-style detailed limitation of benefit provision or a combination of a principal purpose test and a simplified limitation of benefits test.

Permanent establishment

The MLI also contains provisions to make it more difficult to avoid having a 'permanent establishment' (PE). These are designed to catch commissionaire arrangements, to narrow exemptions for preparatory or auxiliary activities, to prevent the fragmentation of activities and prevent the artificial splitting of long construction contracts. The PE changes are not minimum standards so the approach to adoption varies considerably. For instance, France has adopted all the changes but the UK has only adopted the anti fragmentation rule.


It is likely that there will be an increase in international tax disputes as a result of the implementation of the measures recommended by the OECD, as countries will be implementing the recommendations in slightly different ways and at different speeds. Some of the most important provisions in the MLI are those that aim to improve the dispute resolution process.

The changes include incorporating revised mutual agreement procedure (MAP) wording in treaties. This requires the tax authorities of the two treaty states to engage with each other when a taxpayer claims that it is not being taxed in accordance with the treaty. All states have to sign up to the MAP provisions, which are designed to make it easier for taxpayers to invoke the procedure. The changes include allowing taxpayers to present their case to activate the MAP to either state, rather than just the state where they are resident.

One of the most promising initiatives in the MLI for resolving disputes is the ability for states to sign up for mandatory binding arbitration. This is optional and only 25 countries have signed up so far. They are: Andorra, Australia, Austria, Belgium, Canada, Fiji, Finland, France, Germany, Greece, Ireland, Italy, Japan, Liechtenstein, Luxembourg, Malta, Netherlands, New Zealand, Portugal, Singapore, Slovenia, Spain, Sweden, Switzerland and UK.

However, with the exception of the US, these countries include the states which had the most outstanding MAP disputes at the end of 2015 in figures published by the OECD. The top ten offenders being Germany (1147 cases), US (998), Belgium (632), France (566), Switzerland (328), Italy (319), Canada (272), Netherlands (259), UK (229) and Sweden (192).

States applying the arbitration provisions to their treaties can chose final offer or independent opinion arbitration. Most states have chosen final offer arbitration, sometimes called 'baseball arbitration'.

The changes to MAP and the introduction of the framework for mandatory binding arbitration are welcome.  Businesses and countries will be waiting to see how the changes work in practice. If mandatory binding arbitration is seen as being successful, we may see more countries signing up to it in the future.

It is to be hoped that the OECD will continue to work on processes to prevent disputes arising in the first place and, when they do, to resolve them more quickly. MAP and arbitration are very much a last resort. Businesses need to be confident that the international tax system will not expose them to double taxation and that any disputes can be resolved quickly and effectively. The MLI is definitely a step in the right direction, but it will not be an immediate solution to all the problems in all jurisdictions. 

Heather Self and Ian Hyde are tax dispute experts at Pinsent Masons, the law firm behind