August 2017 - China Signs the Multilateral Instrument, Important Step for the Implementation of BEPS Action Plans

On 7 June 2017, the State Administration of Taxation (‘SAT”) signed the Multilateral Instrument (hereinafter called “MLI”) together with representatives from 67 jurisdictions. The MLI aims to swiftly modify bilateral tax treaties to implement the tax treaty-related Base Erosion and Project Shifting (“BEPS”) recommendations. This signifies another important step forward in implementing the BEPS Actions Plans recommended by the OECD. It should be noted that China also signed on behalf of Hong Kong in participating the MLI. Please refer to our Hong Kong Tax News on Hong Kong’s position.
Both foreign and Chinese companies with cross-border investments and transactions should assess the impact of the MLI on their existing or potential business structures.


The recommended measures in the BEPS Action Plans would be implemented using three approaches: amendment of each participating country’s domestic tax laws, amendment to the OECD Transfer Pricing Guidelines and amendment of existing tax treaties. In relation to amending existing tax treaties, it would not be practical to make amendments on a treaty-by-treaty basis. BEPS Action Plan 15 explored the feasibility of developing a Multilateral Convention to implement Tax Treaty Related Measures. After rounds of negotiations, the MLI was finally concluded at the end of 2016.
The signatories from the participating countries indicate each country’s commitment to implementing the BEPS Action Plan’s recommended measures that are treaty-related. After the signing, the “MLI position” for each country and jurisdiction is deposited with the OECD, and all positions, including those of China and Hong Kong, are published on the OECD website.
It should be noted that these positions are only provisional and may still be subject to change before ratification.
China has basically opted into the provisions of the MLI that represent the minimum standards and are mandatory, while opting out of some of the provisions that are not mandatory.

How Does the MLI Work?

The MLI does not substitute existing tax treaties. Rather, it supplements and modifies the tax treaties with a series of BEPS-related provisions. It is designed as a modular with alternatives, allowing participating countries may opt in and out of the MLI’s different provisions. Nevertheless, it is expected that the minimum standards would be opted in by most, if not all, participating countries and jurisdictions.
Compatibility provisions are provided for each rule, addressing how the rule interacts with provisions in the existing tax treaties that the MLI will modify.
Because of the opting in and opting out mechanism, it is expected that the application of the MLI will be highly complex. For example, in some cases, a country would opt into an option on the condition that its relevant tax treaty partner would make the same decision, and yet in other cases, the opting into a certain provision can be asymmetrical. Therefore, it is important to know the other country’s position in analyzing the application of the MLI to a particular cross-border transaction involving the other country.

BEPS Measures Covered in the MLI

The MLI includes four tax-related BEPS Action Plans as summarized below:

- Hybrid mismatches (Action 2):
This provision deals with the optional treaty provisions that relate to transparent entities, dual resident entities and the application of exemption method to eliminate double taxation. For example, one of the mismatches is an arrangement whereby a payment would be treated as interest in the paying jurisdiction, thus deductible for tax purposes, but as dividends in the receiving jurisdiction, thus not taxable under the exemption method. This measure is optional and each jurisdiction can opt out of the measure;

- Treaty Abuse (Action 6):
This provision of the MLI would require the adoption of anti-abuse rules to effectively address treaty shopping. OECD’s recommendations include the adoption of a preamble text to prevent double non-taxation by utilizing the tax treaties, and the adoption of either the Principal Purpose Test (“PPT”) or the simplified Limitation on Benefits (“LOB”) test. The adoption of the preamble text and the PPT is mandatory, while the adoption of the LOB and other requirements are optional;

- Permanent Establishment (Action 7):
This provision provides stricter rules for determining a Permanent Establishment (“PE”) by addressing commissionaire arrangements and similar strategies, modifying the specific activity exemptions, and introducing anti-splitting rules.
The adoption of this measure is optional;

- Improving Dispute Resolution (Action 14):
This provision requires the full implementation of Mutual Agreement Procedures (“MAP”) in tax treaties in good faith and sets a new standard for mandatory binding arbitration in MAP process. Improving MAP is mandatory, but each jurisdiction can opt out of the mandatory binding arbitration.

China’s MLI Position  

China’s position can be summarized as follows:

- Covered Tax Agreement:
China put all of its existing tax treaties into the covered tax agreement, except for the one with Chile and the one with India. This is because the newly signed China-Chile tax treaty has already adopted BEPS recommendations in many aspects. For India, it is expected that the bilateral tax treaty should be in place in the near future, incorporating the minimum standards.
It should be noted that the tax agreements with Hong Kong, Macao and Taiwan (not yet effective) are not included in the covered tax agreements. It is expected that the relevant competent authorities will make relevant changes to their respective tax agreements.

- Treaty Abuse (Action 6):
China’s MLI position in relation to treaty abuse generally follows its current position in negotiating and re-negotiating tax treaties.
Basically, China has extended or is applying the PPT to the application of all tax treaties. Consequently, China has opted for PPT provision in the application of the MLI. It has not opted for the simplified LOB clause, which, as noted above, is not mandatory.
In addition, China has opted for the 365-day minimum threshold for enjoying a reduced withholding tax rate on dividends. This is in line with the existing local practice based on its domestic interpretation rules.
With respect to the minimum requirement of 365-day look back for capital gain exemption, China has not opted for the minimum requirement relating to property-rich companies, because the threshold period for enjoying treaty benefit under its domestic rule is three years, much longer than the threshold period provided in the MLI.

- Avoidance of Permanent Establishment (Action 7):
China has opted out of all the MLI provisions relating to the avoidance of PE. Consequently, there is no immediate impact on foreign companies’ PE positions in China.
With respect to PE, foreign companies with transactions in China should review their positions based on the Circular Guoshuifa (2010) No. 75. This circular has already provided similar provisions to address the BEPS concerns, including agency PE, preparatory and auxiliary services.

- Mutual Agreement Procedures (“MAP”):
As expected, China has chosen to opt out of the arbitration clause. In addition, China has not adopted the provision in the MLI that permits a taxpayer to present his/her case for MAP to the competent authority of either country.
Other than the above, China has adopted the provisions (Article 16 and 17 of MLI), including the extension of the period during which a taxpayer is required to present his/her case to the relevant competent authority to 3 years.

- Effective Date:
The MLI needs to go through the legal ratification process in a jurisdiction domestically, which will then notify the OECD, in order for the MLI on the covered tax agreements to become effective. It is expected that the MLI with respect to China will be effective in early 2018.

Our Observation

China has opted out of many of the provisions that are not required under minimum standard, especially the recommendation relating to PE. As noted above, the SAT has the view that the Circular Guoshuifa (2010) No. 75 has already provided similar provisions, as recommended by the OECD under Action 7. Consequently, it may not be necessary to implement the MLI provisions relating to PE.
The MLI is the third multilateral tax cooperation agreement signed by China, apart from the Multilateral Agreement on Mutual Administrative Assistance and the Implementation on Common Reporting Standards. Together with the Country-by-country Reporting under OECD’s BEPS Action 13, it will reshape China’s international taxation rules in the median- to long-term.
Multinational enterprises with cross-border investments and transactions would need to keep the MLI in mind together with the relevant tax treaties. This will mitigate cross-border tax risks and enhance tax compliance.