In this article we will discuss about:- 1. Introduction to Anti-Treaty Shopping 2. Impact 3. OECD Model Treaty and Commentaries 4. Beneficial Ownership Requirement 5. Various Countries 6. Comments.


  1. Introduction to Anti-Treaty Shopping
  2. Impact of Treaty Shopping
  3. Treaty Shopping under the OECD Model Treaty and Commentaries
  4. Beneficial Ownership Requirement
  5. Anti-Treaty Shopping in Various Countries
  6. Comments on Anti-Treaty Shopping

1. Introduction to Anti-Treaty Shopping:

The UN Ad Hoc Group of Experts defined the term “abuse of tax treaties” as the use of tax treaties by persons the treaties were not designed to benefit, in order to derive benefits that the treaty were not designed to give them. Treaty shopping has come under greater scrutiny in recent years.


It is defined as the routing of income arising in one country to a person in another country through an intermediary country to obtain an unintended tax advantage of tax treaties. It occurs when a taxpayer, residing in a third country, takes advantage of the benefits of a treaty that would not normally be available to the taxpayer.

Treaty shopping usually involves the “flow-through” of income through conduit or base companies in low-taxed treaty jurisdictions. Other examples include triangular structures where a low or nil taxed branch of a company in a treaty country receives income from a third country.

A third example of treaty shopping may involve the use of hybrid entities that are characterized differently in two Contracting States. Individuals can also “treaty shop” by transferring their tax residence to another treaty country.

Treaty shopping can be achieved either as a direct conduit or as a stepping stone conduit. In the former, the taxpayer interposes an intermediary entity with a favourable tax treaty usually to reduce the tax rate in the source State.


It generally involves an intermediate step of no commercial significance, coupled with a series of preordained transactions, resulting in a tax advantage. The latter method uses counterbalancing expense (i.e. an offsetting deduction) in the conduit company to reduce its tax base.

The income is fully taxable but the tax is levied on a margin or spread only. In both cases, normally the corporate tax on the income and the withholding tax on the outgoing payment in the intermediary country are either very low or exempt.

Several countries actively encourage the use of their jurisdiction by third-country residents for treaty shopping as special concession havens. Some examples include United Kingdom, Netherlands, Luxembourg, Ireland, Switzerland, Denmark, Belgium, Austria and Spain in Europe and Singapore and Malaysia in Asia.

In addition, several smaller traditional financial centres are active in treaty shopping (Examples: Barbados, Cyprus, Malta, Mauritius, Labuan (Malaysia), Madeira (Portugal), Netherlands Antilles and Seychelles). Treaty shopping as a commercial activity is also actively promoted in several transitional economies in Eastern Europe.


2. Impact of Treaty Shopping:

Treaty shopping primarily affects source States and intermediary or conduit jurisdictions that provide the location as a treaty haven.It enables nonresident taxpayers to avoid or reduce source country taxes through a third-country treaty. It is widely practised by both residence and source countries today.

As mentioned, the national policies of several countries favour treaty shopping. Source countries may encourage it (or not discourage it) when reduced source tax is in their overall economic interest and it does not materially affect their own tax base.

Many source States use conduit structures to access capital or technology. Residence States may permit (or even encourage) treaty shopping to develop their overseas markets or improve their competitiveness, as well as limit source taxation.


Several countries actively support treaty shopping to attract holding and headquarters companies of multinational enterprises, even if these centres are mere conduits, as treaty havens. Moreover, treaty shopping is encouraged in the European Union if it helps to break down national boundaries and create a single market.

Generally, developing countries favour tax treaty measures that assist them in promoting their political, social and economic goals. They usually have a wider policy objective besides fiscal goals when applying direct tax measures (e.g. investment promotion, employment generation, etc.).

For them, treaty shopping is like a tax incentive. The loss of their source tax through treaty shopping may be a small price to pay for non-fiscal benefits. These countries tacitly (or actively) approve treaty shopping provided it is beneficial (fiscally or otherwise) but may disapprove it when it is disadvantageous to them.

However, there are some countries, particularly those either adversely affected by certain treaty shopping transactions or unable to benefit economically from such preferential tax regimes that regard it as unacceptable and improper as a principle.


To them, treaty shopping is harmful tax competition. They either have specific anti-treaty shopping provisions under their domestic law, and/or under bilaterally negotiated tax treaties. These measures under the domestic law may be either judicial or legislative provisions.

While the judicial measures rely primarily on “substance over form” doctrine, the legislative measures involve specific anti-avoidance rules under the domestic tax law or tax treaties.

There are four main categories of anti-treaty shopping measures, currently in use, namely:

(i) Neutral measures that seek to prevent treaty shopping by combining domestic and tax treaty provisions (Example: non-domiciled residents in the United Kingdom may be entitled to treaty benefits on foreign income only when remitted).


(ii) Specific measures that deny benefits to entities, which are not subject to tax in their State of residence.

(iii) Purpose-based measures that deny certain tax treaty benefits to entities set up only for claiming such benefits (Example: No tax refunds are given under the Netherlands treaty with the United Kingdom in such cases).

(iv) Comprehensive measures imposed under the domestic legislation or treaties (Examples: The 1962 Swiss Abuse Decree; Article 22 of the 1996 US Model treaty on the Limitation on Benefits).

Thus, treaty shopping may be attractive in economic terms to the taxpayer and to source countries where it is intended. However, it may be deemed as fiscally objectionable in certain countries when the use is unintended or against their fiscal policy.


For them, bilateral tax treaties are primarily meant for sharing taxing rights and for avoidance of double taxation, based on mutual negotiations. Treaty shopping affects the underlying principles of reciprocity and the balanced revenue sacrifices by each Contracting State.

The source country loses tax revenues due to either reduced withholding taxes or an unintended erosion of its tax base through a conduit entity. The residence country may also have a tax “deferral” problem due to the accumulation of profits in an intermediary treaty haven in a base company.

These countries dislike treaty shopping as an abuse of rights. In their view, treaty shoppers observe the letter of the law, but not the intention of the Contracting States. They diminish the bargaining power in treaty negotiations.

Treaty shopping makes the bilateral treaty function largely as a “treaty with the world” and reduces the incentive to sign treaties with third countries since the intermediary treaty provides similar tax benefits.

It encourages intermediary transactions with little or no economic substance. Finally, third-country residents escape the scrutiny by the source State under the exchange of information and mutual agreement provisions in tax treaties.

Like other international taxation issues, the attitude to treaty shopping depends on the relative benefits and disadvantages to a country. While treaty shopping is generally disliked when it is unintended, many countries do not object to it, and even encourage it if in their overall self-interest. Therefore, it cannot be regarded as per se abusive.


It often depends on the relative benefits and disadvantages and their impact on the national tax and treaty policies. Currently, few countries insist on general anti-conduit measures in their tax treaties, although several have included specific or purpose-based measures in their treaties.

3. Treaty Shopping under the OECD Model Treaty and Commentaries:

The OECD Committee on Fiscal Affairs disapproves of treaty shopping as a principle. Prior to 2003, the OECD Model Convention expressed concern over treaty shopping but provided only a rudimentary solution to the problem. It contained few anti-avoidance provisions in the treaty itself.

For example:

(a) A treaty shopper must qualify as a resident under Article 4(1) MC, i.e. he must be liable to comprehensive taxation (full liability to tax on world income) under the domestic law. Therefore, the treaty benefits are denied if a person is not liable to worldwide tax in his country of residence. The Commentary specifically refers to the exclusion of conduit companies in treaty havens that tax-exempt offshore income of residents.

(b) Art. 10 (dividends), 11 (interest) and 12 (royalties) mention that only a “beneficial owner” is entitled to treaty benefits. The legal owner cannot benefit as an intermediary with very narrow powers, such as a nominee or agent or a conduit company, unless the beneficial Owner is also a resident of that State. The Model treaty suggests an economic relationship (not just legal) to prove beneficial ownership. (See below)

The OECD Committee on Fiscal Affairs has modified its recommendations on anti- avoidance measures over the years, as follows:

(a) OECD Report on the Use of Conduit Companies:

The 1987 OECD Report held that treaty shopping was undesirable since it frustrated the spirit of the treaty, if not the provisions. The Report commented on the following four approaches employed by countries to prevent treaty shopping.

According to the Report:

(i) Look through approach permitted the tax authorities to “pierce the veil” and to examine the underlying beneficial ownership or the use of funds. This approach was incompatible with the regard for the legal status of companies, and tended to be complicated and burdensome. It was suitable only for treaties with countries with no taxes, or low taxes or where there was little substantive business activity.

(ii) Exclusion approach excluded exempt or near-exempt companies or incomes from the treaty benefits. This approach was simple to apply but tended to be limited in scope. It resembles the abstinence approach.

(iii) Subject to tax approach excluded taxpayers, who did not pay any tax in either the country of residence or source. It discourages double non-taxation. However, this approach adversely affected tax-exempt entities like charities, pension funds, etc., and other entities that were granted tax holiday benefits in the source country.

(iv) Channel approach denied the treaty benefits if the tax base was substantially eroded through payments to nonresident related entities. This approach was administratively difficult to apply since it required the exchange of tax information. However, it was the only effective measure against stepping-stone conduits.

The 1987 OECD Report recommended “bona fide” provisions to ensure that the treaty benefits were not refused on genuine business activities.

These bona fide provisions included exemptions for:

i. Tax structures based on sound business reasons (“the general business provision”),

ii. Entities with substantive business activities (“the activity provision”),

iii. Companies that are directly or indirectly quoted on a stock exchange (“stock exchange provision”),

iv. Situations where the tax benefit claimed in the source State was equal or less than the tax actually imposed by the conduit State (“amount of tax provision”), and

v. Circumstances where equal or greater “derivative benefits” were available to third country residents under their own treaty with the source country compared to the conduit structure (“alternative relief provision”).

The OECD Report concluded that anti-treaty shopping provisions under the domestic law should not override treaty provisions. The purpose of the tax treaty was limited to eliminate double taxation and not to help tax avoidance or evasion. Therefore, anti-avoidance was not one of the objectives of a tax treaty.

It mentioned in paragraph 43 of the Report that “treaty benefits must be granted under the principle of pacta sunt servanda (i.e. good faith”) even if considered improper”.

Every treaty in force was binding on the Contracting States and must be performed by them in good faith under public international law (Article 26 of the Vienna Convention). Thus, treaty benefits should be granted to those taxpayers who could prove that they were entitled to them.

The Report did not compel the countries to take action to prohibit treaty shopping under their treaties. If considered improper, it suggested that the treaties should be renegotiated to avoid a treaty override.

As treaties generally supersede domestic law, general or specific anti-avoidance provisions under the domestic law do not normally apply in the context of a treaty. Any such attempt would lead to a treaty override.

(b) Harmful Tax Competition:

The 1998 OECD Report refers to treaty shopping and mentions that it encourages harmful tax competition among intermediary jurisdictions. It, therefore, advocates more extensive use of tax treaties to counter such competition. In particular, it recommends the entitlement of treaty benefits to residents of third countries should be restricted.

In 2002, the OECD Committee on Fiscal Affairs issued its Report “Restricting the Entitlement to Treaty Benefits” in response to its 1998 Report. The Report recommended that the Commentary on Article 1 be amended to suggest specific provisions in tax treaties to counter treaty shopping.

Besides treaty shopping, the Report also made suggestions on a range of specific anti- avoidance measures on harmful tax practices. They refer to preferential tax regimes that are either restricted to entities owned by nonresidents or are low or no tax regimes not requiring substantial presence in the country.

Examples include conduit entities such as holding companies, headquarters companies and coordination centres involving banking, shipping, financing or insurance or electronic commerce and others that give rise to passive income. These recommendations were included in the OECD Commentary Update 2003 under “Improper Use of the Convention” in Article 1.

(c) OECD Commentary Update 2003:

The Commentary amendments in 2003 have fundamentally changed the relationship between tax treaties and domestic anti-avoidance rules. Under the 1963 Draft Model and until 2003, the OECD Commentaries just mentioned that treaties should not help tax avoidance or evasion and through Article 26 it provided for exchange of tax information.

The main purpose was double tax avoidance and the prevention of tax avoidance or evasion was ancillary to that purpose.

Paragraph 7 of Article 1 of the Commentary now specifically mentions that, besides preventing judicial double tax, tax treaties are meant to prevent tax avoidance and evasion.

Tax treaties do not restrict the application of domestic anti-avoidance (both judicial and legislative) rules. Therefore, it may no longer be necessary for domestic anti-avoidance rules (general or specific) to be included in the treaty text for them to be applicable as anti-treaty abuse provisions.

Paragraph 9 defines the use of treaties as improper if “a person (whether or not resident of a Contracting State) acts through a legal entity created in a State essentially to obtain treaty benefits that would not be available directly”.

The Commentary concludes that “a proper construction of tax conventions allows them to disregard abusive transactions”, such as treaty shopping. In its view, this conclusion is based on the interpretation of the object and purpose of treaties as well as the obligation to interpret them in good faith under the Vienna Convention.

Paragraph 9.5 mentions that treaty benefits should not be granted, “where a main purpose for entering into certain transactions or arrangements was to secure a more favourable tax position and obtaining that more favourable treatment in these circumstances would be contrary to the object and purpose of the relevant provisions”.

Therefore, “states do not have to grant benefits of a double taxation convention where arrangements that constitute an abuse of the provisions of the convention have been entered into”.

The OECD recommendations under the Commentary Update 2003 are currently contained in its later Commentaries. They disapprove of treaty shopping, except for bona fide business transactions or activities (see 1987 Report above), as tax avoidance and conclude that tax treaties cannot override domestic anti-avoidance rules.

The Commentary also suggests the use of specific provisions in the tax treaties to prevent particular forms of tax avoidance. Unlike the 1987 OECD Report, there is no mention of treaty renegotiation to avoid treaty overrides.

Under the 2003 Commentary, the OECD Committee on Fiscal Affairs appears to have adopted a stringent policy on treaty shopping (like the United States).

However, it does not recommend a single method for dealing with treaty shopping and relies on the suggested measures mentioned in the 1987 OECD Report on Conduit Companies. The Commentary also includes a detailed example of a comprehensive Limitation of Benefits Article, similar to US MC Article 22.

4. Beneficial Ownership Requirement:

There are very few anti-abuse provisions in the OECD Model. The most important is probably the concept of “beneficial owner” to counter treaty shopping. OECD MC refers to beneficial ownership in the Articles relating to dividends (Article 10), interest (Article 11) and royalties (Article 12) as an anti-treaty shopping measure.

The Model treaty restricts the treaty benefit to the beneficial owner if resident in the other State and excludes the concessional withholding tax benefit from the legal owner if he is not the beneficial owner and the beneficial owner is not a resident in the same Contracting State.

The term “beneficial ownership” implies a division between the legal rights and the rights of enjoyment over the economic benefits, as recognized by law. According to Vogel, it should be interpreted with reference to the context in the treaty and not the domestic law of various states. For him, the issue of control is the most important factor.

He defines a beneficial owner as a person who is free to decide:

(i) Whether or not the capital or other assets should be used or made available for use by others (i.e. the right over capital), or

(ii) On how the yields from them should be used (i.e. the right over income), or

(iii) Both. The OECD Commentary excludes an intermediary, such as an agent or nominee as a beneficial owner.

The 1987 OECD Report mentioned that a conduit company acting as a mere fiduciary or an administrator for its shareholders with very narrow powers was similar to an agent or nominee.

However, it also clarified that a conduit company, which holds assets or rights, was not necessarily a mere intermediary for tax purposes. A legal entity was sometimes created in an intermediary country for other than tax purposes (e.g. access to capital markets, currency regulations, political situations, etc.).

The 2003 Commentary Update extended the meaning of the term “beneficial owner” in the Model treaty text as an anti-avoidance measure. Besides agents and nominees, it now excludes payments to persons (other than agents and nominees) acting as a conduit for someone else.

Thus, a taxpayer with very narrow powers, which make him a mere fiduciary or administrator acting for interested parties in third countries, is unlikely to be a beneficial owner. It would, therefore, exclude an agent or nominee when the income or asset beneficially belongs to the principal.

It would also exclude situations like short periods of ownership, remittance just after receipt on back-to-back transactions, small intervention spread with little or no operational substance, etc.

A conduit company would not usually qualify as a beneficial owner. The Commentary also indicates that the mere fact that the recipient was a conduit does not necessarily mean that it is not the beneficial owner.

Therefore, it may be difficult for the source State to identify the beneficial owner in the other Contracting State before it grants treaty benefits, without disclosures by the taxpayer or through the exchange of information between the tax authorities. The restriction on the treaty benefit given by the source State does not apply if the beneficial owner is also a resident of the other State.

The term “beneficial owner” is not defined in the treaty. It is essentially a concept that originated through the law of equity in England during the middle Ages, and is not recognized in the domestic law of several civil law countries.

Under the common law in England, ownership was indivisible but the law of equity permitted an application to the Court of the Lord Chancellor to provide for a notional division of ownership between a legal and beneficial (or equitable) owner.

Unfortunately, no country has provided so far a precise definition under its domestic law and its meaning varies widely.The 2003 Commentary Update now specifically mentions that the term “beneficial owner” should not be used in a narrow technical sense.

It should be understood “in its context and in light of the object and purposes of the Convention, including avoiding double taxation and the prevention of fiscal evasion and avoidance”.

As an undefined concept under the OECD MC or its Commentaries, countries follow their own definition of beneficial ownership.

The following conclusions on beneficial ownership may be derived from various case law decisions:

i. Mere legal title without any rights (e.g. copyright, patent and trademark) does not constitute beneficial ownership.

ii. The right of beneficial ownership must be recognized by law, and must be enforceable by the Courts.

iii. Beneficial ownership does not include ownership with the obligation to transfer it to others.

iv. There can only be one beneficial owner in respect of a thing at a specific point of time.

A discussion panel in the 1999 IFA Congress suggested three possible meanings for the term “beneficial owner”:

(i) The domestic law meaning in common law countries;

(ii) A definition excluding agents and nominees; or

(iii) The person to whom the income is attributable for tax purposes under the law of the Residence State or the source State.

In their view, the definition should be wider than the domestic meaning to provide a treaty meaning to the term. The 1999 OECD Partnerships Report considered a beneficial owner as the person to whom the income was allocated for tax purposes by his Residence State.

The US Model Convention 1996 regarded a person as a beneficial owner in a State if the income is attributable to him as a resident under its tax laws. The term “beneficial owner” means a person ultimately entitled to control the income.

A nominee or any other person acting in a similar capacity is not the beneficial owner. Therefore, the US tax rules may still exclude a person if he receives the income but does not in substance have control or the rights over it.

In the United Kingdom, the Courts have held that a person is an equitable or beneficial owner if he can demand the specific performance of a contract and the right to deal with the property as his own. In Canada, the “beneficial owner” is the person who can ultimately exercise the rights of ownership in the property.

German domestic law does not define the term and only a few German tax treaties include it. For example, under the Germany-Italy treaty a person is a beneficial owner if he owns the asset and the rights over them, and the related income is attributed to him.In Switzerland, the 1962Abuse Decree excludes fiduciary or collecting agents of nonresident principals from treaty benefits.

Belgium and France take the term “beneficial ownership” to exclude only agents and nominees. In the Netherlands, a person who is contractually bound to pay to a third party most of the dividends, interest or royalties received by him is not regarded as a beneficial owner.

In his book, du Toit defines a “beneficial owner as the person whose ownership attributes outweighs that of any other person”. This view, which is held in many common law countries, requires that the beneficial owner has the ultimate right to enjoy the benefits.

According to another commentator, the correct definition should follow the contextual meaning (e.g. object and purpose) under the Vienna Convention (VCLT Art. 31(1)). The primary purpose of the concept of “beneficial owner” when introduced in the 1977 OECD MC was to prevent treaty shopping.

Therefore, what is relevant is not the person who benefits but the person who effectively controls the allocation of income derived from the source State. Thus the beneficial owner is “the person who legally, economically or factually has the power to control the attribution of income”.

A recent panel discussion in the United States of international tax specialists referred to the 2006 Indofood decision in the United Kingdom.The UK Court had held that the term “beneficial owner” should be given an international fiscal meaning not derived from the domestic laws of the States involved.

This view differs from the Treasury Technical Explanation of the recent US Model Convention. 2006. It mentions that the beneficial owner is the person to which the income is attributable under the domestic law of the country imposing the tax, e.g. the source State.

These conflicting approaches have created further uncertainty. The panel concluded that to avoid treaty issues on beneficial ownership, the intermediary should preferably have substance in the intermediary State.

Some of the relevant factors include an office, employees, assumption of risk, local directors knowledgeable in the business, local bookkeeping, local filing of returns and adequate capital or equity to carry out the business.

5. Anti-Treaty Shopping in Various Countries:


Under its present legislation, Australia does not encourage treaty shopping. It has several treaties with special anti-treaty shopping provisions.


Austria regards treaty shopping (and international tax planning) as acceptable under domestic law. The tax authorities cannot challenge it even if the sole purpose is tax avoidance, provided it is lawful. The denial of treaty benefits if it violates domestic law is not an infringement of the treaty. However, the tax authorities must clearly prove such violation (in practice difficult).


Anti-treaty shopping rules apply if the intention is primarily to claim treaty benefits, and the use of the treaty is not motivated by a business purpose or bona fide structure. Therefore, the application is dependent subjectively on the motive and the facts and circumstances. Belgian treaties exclude certain tax-privileged companies in Luxembourg, Canada, Malta and Cyprus from treaty benefits.


Canada does not have a comprehensive approach to inbound treaty shopping since it is more focused on outbound investments by Canadian corporations. The Canadian Tax Court held in 2006 that domestic anti-abuse rules must be specifically included in a treaty to be effective.

Several Canadian tax treaties, however, deal with treaty shopping issues.For example, Canada denies treaty benefits to certain tax-exempt or low-tax offshore companies in tax havens (Examples: Barbados IBC, Cyprus offshore company, Luxembourg 1929 company).

The Limitation on Benefits Article also applies to resident taxpayers in certain countries (Examples: Cyprus, Malaysia, United Kingdom) when foreign income is taxed on a remittance basis.

The beneficial ownership is questioned if the payee is known to act, even occasionally, as an agent or nominee, or if the payee is reported as “in care of another person or in trusts”, or if the mailing address is different from the registered address of the owner.

The Income Tax Conventions Interpretation Act, 1985 contains provisions that specifically override the tax treaty provisions in certain circumstances. To overcome the decision in the Melford case, the Act provides that the undefined terms in the treaty have the meaning under the domestic law at the time when the treaty is applied and not when the treaty was entered into.

The Canadian Courts must, therefore, give regard to the legislative intent even under the tax treaties.


France includes treaty shopping under its “abus de droit” doctrine, in cases where the motive or intent to avoid tax is accompanied by the artificiality or abnormality of the legal form.

They include situations where:

(a) The income is not actually taxed in the State of residence,

(b) The beneficial ownership of the income or control over the beneficial owner is held by a third country resident, or

(c) One of the main purposes (not necessarily principal) is to benefit from the tax treaty. Thus, an interposition of a person is deemed as abusive if tax driven (e.g. simulation).

Generally, France does not appear too concerned with treaty shopping due to practical considerations or the low revenue loss. However, many French treaties do exclude companies that are not liable to taxation in a treaty country.

For example, several treaties include an “actual taxation test” in the country of residence (Examples: Italy, Malaysia, and Switzerland). The business motive test is applied in the UK and US treaties. Anti-treaty shopping provisions specifically exclude certain individuals and companies, e.g. Luxembourg 1929 company.


In the past, the German Federal Tax Court (“Bundesfinanzhof’) allowed treaty shopping to nonresidents using German tax treaties. The German Tax Court also appears to adopt a dual policy, depending on the residence of the beneficiary under a treaty.

For example, in the so-called “Monaco-case” in 1981 the German tax Court held that the German anti- abuse rules under Section 42 of the German Tax Code did not apply to foreign corporations, in which German residents did not hold a share interest.

In a 1986 case, it applied the same Section 42 to two German taxpayers, who owned all the shares of a Swiss investment company. The Court denied them a repayment under the Germany-Switzerland treaty.

Germany has enacted a special provision in Section 50d of the German Income Tax Act under the Anti-abuse and Technical Amendment Act (1994) to curb treaty (and EU Directive) shopping by third country residents.

Domestic withholding taxes are levied irrespective of treaty restrictions and the nonresident taxpayer must apply for reimbursement. No reimbursement is given under the treaty and EU Directive benefits to entities that are set up as conduit companies, primarily to take advantage of treaty benefits not otherwise available to their shareholders.

Under the above amendment, holding companies do not qualify for treaty benefits unless they exercise some management and control over its subsidiaries through own employees and premises. No advance rulings are given on such structures.

In 2005, the German tax law (Section 50d93) of the EStG was amended from 2007 to counter the Federal Tax Court decisions in Hilversum cases.

An intermediary foreign company is denied the reduction in withholding tax in Germany under the treaty if one of the following three requirements is not met:

(a) The interposition of the foreign company is supported by economic motives or other significant reasons;

(b) The foreign company generates more than 10% of the total gross earnings of the relevant business year from its own commercial activities; and

(c) The foreign company participates in the general trade with a business with adequate business equipment.

The above conditions do not apply if the foreign company is listed on a recognized stock exchange and its shares are regularly traded.


The 2003 decision of the Indian Supreme Court in the Azadi Bachao Andolan case held that there was no inherent anti-abuse rule in Indian tax treaties and hence it required a specific Limitation on Benefits clause in the treaty itself for the denial of treaty rights. Treaty shopping is not illegal.

The Court further observed “Overall, countries need to take, and do take, a holistic view. The developing countries allow treaty shopping to encourage capital and technology inflows, which developed countries are keen to provide to them. The loss of tax revenues could be insignificant compared to the other non-tax benefits to their economy. Many of them do not appear to be too concerned unless the revenue losses are significant compared to the other tax and non-tax benefits from the treaty, or the treaty shopping leads to other tax abuses. Whether it should continue, and, if so, for how long, is a matter which is best left to the discretion of the executive as it is dependent upon several economic and political considerations”.

After the Supreme Court decision, India has included Limitation on Benefits provisions in some of its recent treaties. In each case, the LOB provision is based on its national treaty policy and influenced by non-fiscal factors. (Examples: Armenia, Singapore, United Arab Emirates).

While the treaty with Armenia contains a comprehensive LOB Article (similar to US MC Article 22), the Singapore treaty denies the treaty benefits relating to capital gains exemption only to certain shell or conduit companies. A more general provision on “Limitation of Benefits” has been added in the treaty protocol signed with the United Arab Emirates by India in 2007.


In 2006, the Indonesian tax authorities clarified the term “beneficial owner” for tax treaty purposes under a ruling letter (S-95/PJ.342/2006). The ruling letter mentions that a foreign company claiming treaty benefits must provide a certificate of beneficial ownership besides a certificate of residence.

To qualify as a beneficial owner, the foreign company must either:

(a) Have income subject to tax or an active business in its country of residence;

(b) Have full power or control over the income to use in its operations; or

(c) Its shares must be traded on a recognized stock exchange.


There are no specific anti-treaty shopping measures. New tax treaties with the US and the UK include comprehensive Limitation of Benefits clauses.


The Netherlands does not favour comprehensive anti-treaty shopping provisions since it supports a free international flow of capital and promotes conduit structures using holding and headquarter companies.

Nevertheless, the Netherlands has accepted the 1992 treaty (as modified in 2004) with the United States that includes a very extensive Limitation on Benefits Article at US insistence. Moreover, some Dutch tax treaties include specific anti- abuse provisions (e.g. Kuwait, Mexico, Singapore, and United Kingdom).

The Dutch advance ruling practice has also changed in recent years on conduit tax structures. In order to prevent the abuse of the Dutch tax system, there must be real substance, local management and control, and a physical presence in the Netherlands.


Singapore does not discourage treaty shopping by nonresidents for offshore activities and actively promotes itself as a tax planning intermediary destination. However, some of its treaties include limited provisions at the insistence of the other Contracting State.

For example, certain treaties contain a “Limitation of Relief” provision on remittance- based taxation (Examples: United Kingdom, Latvia).Tax-sparing provisions are subject to LOB provisions in the Singapore-New Zealand treaty. Generally, domestic rules are applied in cases of treaty abuse.


In Spain, domestic anti-abuse clauses are applicable to counter treaty shopping.

However, as the treaty generally overrides domestic law, these anti-abuse provisions apply only if:

(a) The transaction is artificial, and

(b) It seeks to obtain a tax advantage only or is simulated (e.g. sham).

The tax authorities have the burden to prove either abuse or simulation. There are several Spanish treaties with Limitation on Benefits (LOB) clauses (Examples: Bolivia, Colombia, Cuba, Ireland, Israel, Luxembourg, Portugal, Russia, and United States). Some recent treaties exclude Spanish ETVEs from the LOB clause.


The 1962 Abuse Decree (Federal Decree on Measures Against the Improper Use of Tax Treaties enacted on 14 December, 1962) primarily affects the withholding tax on dividends, interest and royalties, but may also include other types of income if there is treaty relief for the tax withheld at source. It does not affect other treaty provisions.

The Decree deals with Switzerland as an intermediary residence State where its residents take advantage of a treaty in the source State.

The following conditions must be satisfied by a Swiss tax resident to take advantage of the reduced withholding in the other Contracting State under a treaty:

(i) Appropriate profit distributions (foreign controlled companies only):

a. A minimum of 25% of the gross amount of the treaty-favoured profits must be distributed as dividends every year (and, therefore, subject to Swiss withholding tax). The compulsory dividend distribution may be waived only where the company has incurred “commercially justified” losses (“25% distribution test”). (No longer applicable – See below)

b. The financing or debt-equity ratio should not be more than 6:1 at the tax year-end. Moreover, the interest paid on loans from nonresidents must not exceed the official fair market interest rate. (Modified – See below)

(ii) Payment to non-qualifying persons (all companies):

Not more than 50% of the gross treaty-favoured income may be transferred, directly or indirectly, as flow-through income or tax-deductible payments (other than as dividends) to persons who would not be eligible for treaty benefits if it were paid directly to them (“50% base erosion test”).

The Decree also applies to partnerships that are not actively engaged in business in Switzerland and to foreign-controlled family foundations. In their case, the treaty relief on withholding taxes is denied if more than 50% of the treaty-favoured income is for the benefit of unentitled persons.

As from 1999 under a circular of 17th December 1998:

(a) The Decree no longer applies to

(i) Pure holding companies in Switzerland,

(ii) Certain companies engaged in an active business in Switzerland, and

(iii) Companies or direct subsidiaries of companies listed on a recognized Swiss or foreign stock exchange.

The majority of its shares must be either quoted on a recognized Swiss or foreign stock exchange, or owned by a quoted company. However, the deductible payments must be commercially justifiable.

(b) Mixed holding companies continue to be subject to the 50% limitation on expenses paid to non-qualifying persons, but are exempt from the 25% profit distribution requirements. The debt-equity ratio has been modified to equity financing (including non-interest-bearing loans) of at least 30%.

Over the years, the Decree has been significantly relaxed. In December 2001, the exemption from 25% annual dividend distribution requirement was extended to all companies.

There is now a distribution requirement only if:

(i) More than 80% of the Swiss equity is directly or indirectly held by nonresidents;

(ii) Most of the assets are located abroad and most of the claims relate to non-Swiss creditors; and

(iii) The annual dividends are less than 6% of the total net income. The financing and interest rate requirements still apply.

The Decree rules may be modified under the treaty provisions. Several tax treaties (Examples: Belgium, France, Germany, Italy) deny the treaty benefits unless the Swiss company pays full cantonal taxes.

The Swiss treaties with the US and the Netherlands contain specific provisions against treaty abuse. The extensive Limitation on Benefits provision under the Swiss-United States treaty overrides the Decree in relation to the United States.

In case of treaty abuse, the Swiss tax authorities may:

(i) Refuse application made for the reduction of withholding taxes; or

(ii) Recover any withholding taxes reduced by treaty provisions; or

(iii) Inform the other Contracting State of the existence of such an abuse.

Under the Decree, cantonal and federal tax authorities keep one another informed of suspected cases of abuse.

United Kingdom:

The United Kingdom has no general anti-treaty shopping rules since it is primarily interested in unrestricted inbound and outbound investment flow. Besides the use of its tax treaties, the United Kingdom provides several tax incentives to promote itself as an intermediary jurisdiction for conduit holding and headquarter companies of multinationals.

It largely relies on the “beneficial ownership” limitation in its treaties to counter inbound treaty abuse. There are also specific provisions in its treaties with Belgium, Cyprus and the Netherlands to prevent tax refunds and “subject to tax” clauses in certain treaties (e.g. the UK- Singapore treaty).

Recent treaties also include a “main purpose” test to disallow treaty benefits where the main or one of the main purposes was solely to benefit from the treaty. The domestic law includes provisions to prevent dual resident companies that are treaty resident abroad from benefiting under the tax provisions.

In a recent decision, the UK High Court was required to judge on the likely decision of the Indonesian Courts on treaty shopping, based on the definition of “beneficial ownership” under its treaties.

The Indonesian tax authorities had issued a Circular clarifying that the term refers to the actual owner, who has the “full privilege” to directly benefit from the income and that a conduit company or a nominee would not be regarded as the actual owner. The Court applied a test of “reasonable certainty” and held that treaty benefits cannot be denied in such case, unless it was specifically mentioned in the treaty text.

It held that if a particular country disapproves of treaty shopping “their remedy is, either to negotiate a variation of its terms to exclude the perceived abuse or to revoke the treaty”. This decision was subsequently reversed by the UK Appeal Court, which took a probabilistic view of the outcome in the other country.

United States:

The United States authorities believe that only “legitimate” residents should benefit from its tax treaties, and that the treaties should contain specific provisions to prevent their use by residents of third countries.

For example, Sec. 342 of the Tax Equity and Fiscal Responsibility Act of 1982 (TEFRA) requires the IRS to establish procedures to grant the reduced withholding rates under tax treaties solely to those persons legitimately entitled to such benefits.

Many US treaties now contain a Limitation on Benefits Article to exclude certain residents from treaty benefits. The new Article 22 on the Limitation on Benefits under the 1996 US Model treaty is substantially more detailed than the 1981 US Model Article 16.

It includes various restrictive clauses but it also provides objective “safe harbour” provisions in cases of bona fide business activities. Despite the detailed provisions and explanations, it contains several subjective rules that may be difficult to apply.

Moreover, the mere foreign share-ownership or the “use of income” to make payments to foreigners may create a presumption of treaty shopping. It also shifts the burden of proof to the recipients of the treaty benefits.

The United States also has specific anti-conduit regulations in its domestic law if the intermediary lacks sufficient business purpose. It can disregard back-to-back loans and collateralised loans from stepping-stone conduits, and re-characterize the structure as a direct loan.

IRC Section 7701(1) enacted in 1993 gives the IRS further authority to treat any multi-party transaction under conduit financing arrangements as a direct transaction, and determine its true nature as interest, dividend or royalty.

The United States does not object to outbound treaty shopping by US entities. Subject to certain anti-abuse rules and rules applicable to certain “stapled entities”, there is no provision that prevents a US resident from using a corporation or other entity formed in the other treaty country for tax purposes.

The United States also does not disapprove of the use of US conduit structures by nonresidents provided it does not affect its domestic tax base.

6. Comments on Anti-Treaty Shopping:

Stef van Weeghal in his book “The Improper Use of Tax Treaties” mentions that there is no clear answer to the question what constitutes improper use or abuse of a treaty.

According to him, a treaty may be termed as abusive if:

(a) The sole intention of its use was to avoid the tax of either or both of the Contracting States, and

(b) It defeats the fundamental and enduring expectations and policy objectives shared by both States.

Both conditions must be met before improper use can be deemed present. The different perceptions and attitudes in different countries underscore the importance of the second part of the rule.

Any use of an intermediary treaty country as a conduit is strictly treaty shopping. It is often referred to as “treaty abuse” or “tax avoidance” in several countries, but it is also regarded as a lawful instrument of international tax planning under the domestic law in many other countries.

With few exceptions, taxpayers should be free to structure their economic actions so long as they do not go beyond a tolerable point. However, at what point tax planning ends and tax avoidance or abuse begins is debatable. Therefore, what may be considered as “abusive” by one set of persons may well be considered as legal tax planning by another set of persons?

Like all tax rules, treaty shopping can be abused but it cannot be deemed as per se abusive. The attitude towards treaty shopping varies. For example, many source countries (largely developing countries) do not object to loss of tax revenues if treaty shopping serves its wider non-fiscal policy objectives.

In such cases, treaty shopping is usually intended and acceptable. Several other countries regard it as abusive only when it materially affects their tax base as a source state, and then they either revoke the treaty or renegotiate it.

Generally, some business purpose is required and pure conduits or “brass place” companies are considered abusive. Many countries also encourage treaty shopping for financial gain and allow conduit tax structures that use their treaties.

Very few countries regard treaty shopping as a treaty abuse as a principle. An example is the United States. Since 1981, it has inserted a comprehensive Limitation on Benefits (LOB) Article in every newly negotiated or renegotiated US tax treaty to prevent source tax erosion.

Generally, countries do not disapprove of treaty shopping when it favours them, but object (include them in the treaty) when it harms their domestic tax base. This approach to treaty shopping is one-sided and not principled. Moreover, as anti-treaty shopping measures are protectionist in nature they increase tax costs when a treaty is meant to be relieving in nature.

Overall, countries take a holistic and pragmatic view. Many of them do not appear to be too concerned unless the revenue losses are significant compared to the other tax and non-tax benefits from the treaty, or the treaty shopping leads to other tax abuses. Treaties are negotiated for both fiscal and non-fiscal considerations by countries based on self- interest.

It may be intended under the tax treaty policy of a country. Even if unintended, it may be specifically allowed by them in their wider national interests. If it is not desired, the treaty is renegotiated. Since such situations are country and situation specific, a broad denial based on just fiscal considerations is unjustified.

Many commentators believe that the use of tax treaties by third country residents to obtain treaty benefits not available directly to them should be lawful, as long as it is not specifically prohibited by treaty provisions or general international law. Every treaty is binding upon the parties to it and must be performed in good faith under the principle of “pacta sunt servanda” (VCLT Article 26).

VCLT Article 27 requires that a country may not invoke its domestic law as a justification for its failure to perform a treaty. It would therefore be improper to regard treaty shopping as abusive unless specifically disallowed under a bilaterally negotiated treaty.

As mentioned in the UN Manual:

“Every country should develop anti-treaty-shopping provisions and encourage other countries to adopt similar provisions that limit the benefits of the treaty to bona fide residents of the treaty partner. These provisions cannot be uniform, as each country has its own characteristics that make it more or less inviting to treaty shopping in particular ways. Consequently, each provision must to some extent be tailored to fit the facts and circumstances of the treaty partners’ internal laws and practices. Moreover, the provisions need to strike a balance that avoids interfering with legitimate and desirable economic activity”.