The End of Treaty Abuse and a Fresh Start of Tax Treaty Use – the Multilateral Instrument (MLI)


The popularity of the Multilateral Instrument Convention (MLI) is on the rise but few have understood and even less have seen its effect which has been argued to be a milestone in the history of international taxation.

For instance, how would the MLI affect Cyprus? Cyprus – a country which has benefited from its corporate tax system and its extensive Double Tax Treaty network – has ratified the MLI in January earlier this year. Below we look at the general concept of the MLI as well as how it affects Cyprus.

What is the MLI?

The MLI introduces tax treaty-related measures of the BEPS project (the MLI is one of the 15 BEPS Actions) into the existing tax treaties of the jurisdictions which have signed the MLI in a consistent and efficient manner, thus eliminating the need to renegotiate each bilateral tax treaty separately, for the purpose of:

  • preventing treaty abuse;
  • improving dispute resolution;
  • preventing artificial avoidance of Permanent Establishment status; and
  • neutralising the effects of hybrid mismatch arrangements.

From now on, when considering a future or existing transaction between two jurisdictions, not only should the applicable bilateral tax treaty be consulted but equally – if not more importantly – the MLI Instrument and specifically how each signatory has chosen to position itself.

Minimum Standards

The MLI is comprised of 39 articles. Each signatory has chosen which Double Tax Treaties to be included in the Instrument and submitted its MLI positions with respect to the different options provided for in the MLI.
The signatories can choose to opt out on certain provisions but they have to position themselves with regards the minimum standards as expressed in Articles 6 and 7 on prevention of treaty abuse which are to be overviewed below as well as Article 16 on improving dispute resolution:
Going back to basics, Article 6 introduces a text to all tax treaties which have been listed by both jurisdictions, stating what should have never been challenged; that the purpose of the Double Tax Treaty is to eliminate double taxation and not to be exploited for tax avoidance and evasion through treaty shopping for the indirect benefit of a third jurisdiction.
Most importantly, under Article 7 on preventing Treaty Abuse, the concept of the Principal Purpose Test has been introduced. The test – which Cyprus has applied – provides that:

A benefit of a treaty – either by granting exemption from or deduction of withholding taxes- shall not be granted in respect of an item of income or capital if it is reasonable to conclude that obtaining that benefit was one of the principal purposes of any arrangement or transaction unless it is established that granting that benefit would be in accordance with the purpose and provisions of the treaty.

In simple terms, the test checks whether there are only tax reasons for setting up a structure in place and no business or commercial reason(s) to support it and if the result is affirmative then any tax treaty benefit will be denied and normal taxes will be paid.

What is the Cyprus’s position to the MLI?

Cyprus has listed all 59 Double Tax Treaties in the MLI “the Covered Tax Agreements” and adopted only the minimum standards provisions.
The effective date for withholding tax rates is the 1st of January 2021 and for other taxes the 1st of January 2022.

What is the solution?

Countries – especially smaller size countries like Cyprus – are called to take immediate measures if they wish to remain in the international arena and participate through Holding or Financing companies of multinational enterprises. The sooner this is understood and actions are taken towards this, the better it is for countries which for years have had their treaties abused to remain competitive with other EU member states who nonetheless have to also play by the same new rules.

Each Cyprus company needs to have an undisputable purpose of existence and have its share in the generation of profit within a structure; after all, this is the purpose of incorporating any company -to make money and add value.

It is important to note that random acts (such as signing an employment contract and/or a rental agreement in Cyprus) may add substance fees but not real substance and will not save the beneficiary when treaty benefits are questioned by foreign authorities.

The Eurofast approach

We believe there are more than a few sophisticated solutions which international structures can seek depending on the nature and specifications of each case. Implementing such tailor-made solutions can guarantee no challenges by the tax authorities.
If you are interested in taking real actions and following the new international tax rules, we can provide efficient solutions through our local and international network, whilst ensuring your business in Cyprus will continue to enjoy all double tax treaty benefits.