The OECD Commentaries on the PPT are helpful re treaty-benefit situations that have economic substance

Comments on Art. 7 of the MLI (containing the principal purpose test) include:

  • The OECD Commentary (whose examples are based in large part on the facts of treaty abuse cases in various jurisdictions, whose results the Commentary may consider to be inapplicable under the PPT test) suggest that the PPT may apply mostly in situations where there is very little real economic substance to the transactions.
  • Because the PPT states that a benefit under a covered tax treaty (“CTA”) "shall not be granted” where the provision applies, the application of this provision could make taxpayers worse off than under a reasonable alternative transaction, e.g., a taxpayer who has sought to lower the dividend withholding tax rate from 10% to 5% could be subject to a 25% withholding rate under this complete-denial approach.
  • In interpreting a similar one-of-the-principal purposes test, UK courts have held that a principal purpose "has a connotation of importance” (Travel Document Services) and that a principal purpose of a transaction may be to obtain a tax advantage even if the transaction had a commercial objective at least as important as the tax advantage (Lloyds TSB Equipment Leasing). [See also the Groupe Honco line of cases.] Accordingly, the threshold for the PPT may be lower than in most domestic general anti-avoidance rules.
  • Since the PPT applies where it is "reasonable to conclude" that one of the principal purposes of an arrangement or transaction was to obtain a benefit under the CTA, it also imposes a relatively low burden on the tax authority, effectively requiring taxpayers to argue that it would be unreasonable to conclude that obtaining the benefit was a principal purpose of the arrangement or transaction.
  • The remedial benefits rule in Art. 7(4) has only been adopted by 28 jurisdictions (not including Canada) and is poorly drafted.

Neal Armstrong. Summaries of David G. Duff, “Tax Treaty Abuse and the Principal Purpose Test – Part 2,” Canadian Tax Journal, (2018) 66:4, 947-1011 under Treaties - MLI – Art. 7(1) and Art. 7(4).