This article examines the diverted profits tax (DPT) introduced by the United Kingdom to counter aggressive tax planning adopted by many multinational enterprises so as to transfer profits from its jurisdiction, and the main controversies surrounding the compatibility of the DPT with tax treaties.

1. 399© IBFD BULLETIN FOR INTERNATIONAL TAXATION JULY 2016
The United Kingdom’ s Diverted Profits Tax and
Tax Treaties: An Evaluation
This article examines the diverted profits tax
(DPT) introduced by the United Kingdom to
counter aggressive tax planning adopted by
many multinational enterprises so as to transfer
profits from its jurisdiction, and the main
controversies surrounding the compatibility of
the DPT with tax treaties.
1. Introduction
InApril2015,theUnitedKingdomintroducedthediverted
profits tax (DPT) into its domestic law. The DPT has the
declared objective of countering aggressive tax planning
as used by many multinational enterprises (MNEs) to
transfer profits from the United Kingdom’ s jurisdiction
by way of business structures that prevent the charac-
terization of a permanent establishment (PE) within the
United Kingdom, either by the use artificial transactions
or of entities without economic substance.
This article deals specifically with the DPT levied when
a foreign company carries on activities in the United
Kingdom by means of a structure that is designed to avoid
the creation of a PE, i.e. a taxable presence, in the United
Kingdom. In such circumstances, the DPT targets situ-
ations where a non-resident company provides goods, ser-
vices or other properties in the United Kingdom through
a business model that avoids the characterization of a PE.1
The DPT is levied at a rate of 25%, which is higher than the
current standard corporation tax rate of 20% levied in the
United Kingdom. The tax base corresponds to the profits
that would have been attributed to the PE if its presence
had not been prevented by the taxpayer. The profits to be
subject to the DPT are calculated using the same domestic
taxrulesthatgoverntheallocationofprofitstoPEslocated
in the United Kingdom.
TheDPTmaybeconsideredthegreatestproofofinconsist-
ency in the attitude of certain European countries regard-
ing the debate on the allocation of taxing rights between
the source state and the residence state. In the recent past,
the main argument used by developed countries against
the taxation at source of technical services and adminis-
trative assistance was the absence of a PE in the source
* MasterofLaws(LL.M.)ininternationaltaxation,ViennaWirtschafts-
universität Wien (University of Economics and Business, WU) and
Master of Laws candidate in tax law, University of São Paulo (USP),
Member of the Scientific Committee, postgraduate course in interna-
tionaltaxlawoftheBrazilianInstituteofTaxLaw(IBDT)andVisiting
Professor,postgraduatecoursesinBrazil,andTaxAssociate,Marizde
Oliveira e Siqueira Campos Advogados. The author can be contacted
at rts@marizsiqueira.com.br
1. UK: Finance Act 2015, sec. 86.
state, thereby being able to demonstrate the existence of
an effective connection with its jurisdiction. However, as
soon as some US MNEs started to sell their products in the
UK consumer market without paying a supposedly “fair
share of tax”, the United Kingdom quickly introduced the
DPT into its national tax system to ensure the taxation of a
portion of the profit derived by such MNEs in its territory.
Despiteallreasonablejustificationsfortheadoptionofthis
unilateral tax measure, which departs from the proposals
presented by the OECD Base Erosion and Profit Shifting
(BEPS) initiative,2
the compatibility of the DPT with tax
treaties is very questionable.
2. The DPT and the Material Scope of Tax
Treaties
As reported, the UK government decided to implement
a new tax levied on diverted profits with the deliberate
intentionofexcludingthetaxfromthematerialscopeofits
tax treaties. However, regardless of the unilateral position
adopted by the UK government, the DPT should be exam-
ined carefully to verify whether it falls within tax treaties
based on the OECD Model.3
In this context, it should be noted that article 2 of the
OECD Model, which deals with the taxes covered by a
tax treaty, reads as follows:
1. This convention shall apply to taxes on income
and on capital imposed on behalf of a Contract-
ing State or of its political subdivisions or local
authorities, irrespective of the manner in which
they are levied.
2. There shall be regarded as taxes on income and
on capital all taxes imposed on total income, on
totalcapital,oronelementsofincomeorofcapital,
including taxed on gains from the alienation of
movableorimmovableproperty,taxedonthetotal
amounts of wages or salaries paid by enterprises,
as well as taxes on capital appreciation.
(...)
4. TheConventionshallapplyalsotoanyidenticalor
substantially similar taxes that are imposed after
the date of signature of the Convention in addi-
tion to, or in place of, the existing taxes. The com-
petent authorities of the Contracting States shall
2. See, for example, OECD, Addressing Base Erosion and Profit Shifting
(OECD 2013), International Organizations’ Documentation IBFD and
OECD, Action Plan on Base Erosion and Profit Shifting (OECD 2013), In-
ternational Organizations’ Documentation IBFD.
3. Most recently, OECD Model Tax Convention on Income and on Capital (26
July 2014), Models IBFD.
Ramon Tomazela Santos*International/United Kingdom
Exported / Printed on 20 July 2016 by biblio2@ibdt.org.br.

2. 400 BULLETIN FOR INTERNATIONAL TAXATION JULY 2016 © IBFD
Ramon Tomazela Santos
notify each other of any significant changes that
have been made in their taxation laws.
As can be seen, article 2 of the OECD Model covers any
taxes levied on total income or on specific types of income
earned by taxpayers, regardless of the political subdivision
in state and the method of collection, for example, income
tax withheld at source or income tax levied on the basis
of a tax return.
In addition, identical or substantially similar taxes
imposed after the date of the signature of the tax treaty are
also covered in article 2(4) of the OECD Model. Indeed,
this provision contains an extension clause, which encom-
passes taxes introduced after the conclusion of a tax treaty
if they are identical or substantially similar to the taxes
originally covered. Such an extension clause preserves
the application of a tax treaty over the time, as it avoids
the fact that amendments to domestic laws make a tax
treaty inoperative. It also relieves the contracting states
from the obligation of renegotiating a tax treaty on each
modification of their domestic laws. Consequently, if the
new taxes imposed are identical or substantially similar
to those covered by the tax treaty, the levying of such tax
should comply with the treaty provisions agreed by the
contracting states.4
In general, the term “tax” means any charge levied by an
authority of a sovereign state on a person or property
underitsjurisdictiontoobtainfinancialresourcestocover
general public expenditure.5
As a result, the term “tax” has
a broad and generic meaning that encompasses almost all
amounts levied by a state based on its sovereignty, with a
few exceptions, such as the charges relating to administra-
tive policing powers, which are often referred to as “fees”.
All others forms of taxation, such as duties, excises and
socialcontributions,maybeincludedinthebroadconcept
of “tax”. Specifically with regard to the income tax, article
2(2) of the OECD Model adopts a very broad wording,
which covers not only a comprehensive income tax levied
on the total income earned by a taxpayer, but also specific
taxes that are levied on particular types of income.6
Appar-
ently, this broad definition could apply to the DPT levied
ontheprofitsdivertedfromtheUnitedKingdom’ smarket.
In contrast, it could be argued that the DPT is not sub-
stantially similar to income tax, as it has a specific scope
that encompasses a narrow number of taxpayers, as well
as a different tax rate. However, article 2(2) of the OECD
Model also covers tax levied on elements of income, such
as in a schedular income tax system, in which separate
taxes are imposed on different categories of income. In
addition, the applicable tax rate is not a decisive element
in defining whether a new tax is covered by article 2 of the
OECD Model, as it only quantifies the amount to be paid
to the government treasury, without determining the legal
nature of the tax due.
4. M.Lang,Introduction to the Law of Double Taxation Conventions,2ndedn.,
sec. 8. (IBFD/Linde 2013), Online Books IBFD.
5. A. Sampaio de Moraes Godoy, Direito Tributário International Contextu-
alizado pp. 28-119 (Quartier Latin 2009).
6. J. Hortalá i Vallvé, Comentarios a la Red Española de Convenios de Doble
Imposición pp. 65-66 (Thomson/Aranzadi 2007).
Further, the definition of PE is directly connected with
article 7 of tax treaties, which is the allocation rule applied
to business profits. As a consequence, if a country creates
a new type of tax that is levied on PEs, or on MNEs that
avoided the creation of a PE, on diverted profits, such a tax
would clearly fall within the material scope of tax treaties.
In the case under consideration, even the name of the new
tax indicates that it is levied on profits.
Strictly, the DPT is substantially similar to an income tax,
as its tax base corresponds exactly to the profits that would
havebeenattributedtoaPEhadataxpayerhadnotavoided
such a characterization in the United Kingdom. The tax
base is usually considered to be the most important factor
in identifying the similarities between new taxes and taxes
covered by article 2 of tax treaties. As a result, given the
similarities in the computation rules, it would appear that
the differences between the DPT and the regular income
tax levied on a PE in the United Kingdom are not so great
as to prevent the DPT from being regarded as a tax sub-
stantially similar to the income tax. It follows that, despite
themanoeuvreusedbytheUnitedKingdomtoimplement
a new tax, the DPT is covered by the material scope of its
tax treaties.
3. The DPT and the Equivalent of Article 7 of the
OECD Model in Tax Treaties
Assuming that the DPT is a substantially similar tax, the
question to be answered concerns its compatibility with
article 7 of tax treaties based on the OECD Model, given
that the United Kingdom intends to tax profits earned by
a non-resident company, regardless of the effective char-
acterization of a PE in its jurisdiction. In other words, the
question that arises is whether, in the event that the non-
resident company is headquartered in a state that has con-
cluded a tax treaty with the United Kingdom, the UK gov-
ernment may levy the DPT on profits allegedly diverted,
even without the effective characterization of a PE within
the state.
Article 7(1) of the OECD Model, as adopted by the United
Kingdom in most of its tax treaties, reads as follows:
Profits of an enterprise of a Contracting States shall be taxable
only in that State unless the enterprise carries on business in the
other Contracting State through a permanent establishment sit-
uated therein. If the enterprise carries on business as aforesaid,
the profits that are attributable to the permanent establishment
in accordance with the provisions of paragraph 2 may be taxed
in that other State.
Article 7(1) of tax treaties has the objective scope of pro-
tecting the profits earned by individuals or legal entities
resident in the other contracting state through the devel-
opment of an economic activity.7
Consequently, profits
arising from the exercise of a business activity should be
taxed exclusively in the residence state. The only excep-
tions to this general rule rely on the economic activity per-
7. L.E. Schoueri, The Objective Scope of Article 7 and the Treaty Protection
to Deemed Distributed Dividends Kluwer Intl. Tax Blog (2015), available
at http://www.kluwertaxlawblog.com/blog/2015/04/27/the-objective-
scope-of-article-7-and-the-treaty-protection-to-deemed-distributed-
dividends/.
Exported / Printed on 20 July 2016 by biblio2@ibdt.org.br.

3. 401© IBFD BULLETIN FOR INTERNATIONAL TAXATION JULY 2016
The United Kingdom’ s Diverted Profits Tax and Tax Treaties: An Evaluation
formed in the source state being undertaken by way of a
PE, as well as on the income being classified under specific
distributive rules, which establish a specific allocation of
the right to tax.
It is, therefore, clear that article 7 of the OECD Model has a
universal scope, thereby serving as an umbrella for differ-
ent types of income derived from business activities. The
reason for this is because it covers the results arising from
the exercise of an economic activity conducted by a resi-
dent of a contracting state (i.e. the residence state) in the
other contracting state (i.e. the source state), provided that
therelevantincomeisnotexpresslydealtwithinoneofthe
specific distributive rules. That is why article 7(1) of the
OECD Model may be considered to be the heart of a tax
treaty, under which the largest portion of income derived
from international economic activities is classified.8
ThedefinitionofPEsetoutinarticle5oftheOECDModel
is one of the key concepts in tax treaties for the alloca-
tion of taxing rights relating to foreign business activities.
This is because the concept of a PE serves as a criterion to
legitimate the attribution of the taxing rights to the source
state. It also indicates a substantial degree of presence in
the economic life of the source state, which justifies the
taxation of a foreign person on the profits attributable to
the business activity developed in its consumer market, in
the same way as a domestic person.
Nevertheless, as the wording of the definition of a PE has
remained nearly unchanged for the last 50 years,9
new
business models developed during the last decades allow
taxpayers to derive a high level of income without a physi-
cal presence in the host state. MNEs can, therefore, have a
significant business presence in the economy of another
state, without becoming liable to tax due to the lack of
nexus under the current definition of a PE.
The DPT is intended to counter the artificial avoidance of
the status of a PE. However, the DPT does not appear to
differentiatebetweensituationsinwhichataxpayersimply
does not have a fixed place of business in the source state
over a particular duration of time from those in which a
taxpayer effectively makes use of schemes or pre-planned
arrangements that are designed to artificially avoid the
characterization of a PE in the source state.
Article 5 of the OECD Model deals with the following
three different types of PEs: (1) a general PE; (2) a con-
struction PE; and (3) a dependent agent PE. Each of these
definitions of a PE requires the presence of certain ele-
ments for its characterization, such as, inter alia: (1) a ter-
ritorial link evidenced by a fixed place of business; (2) a
time threshold that indicates the level of permanence; and
(3) the authority to conclude contracts in the name of the
enterprise. All of these concepts and requirements may be
usedbythetaxpayertodesignabusinessmodelthatavoids
the characterization of a PE in the source state, thereby
8. A. Xavier, Direito tributário internacional do Brasil p. 567 (Forense 2010).
9. A. Storck A. Zeiler, Beyond the OECD Update 2014: Changes to the Con-
cepts of Permanent Establishment in the Light of the BEPS Discussion, in The
OECD-Model-Convention and its Update 2014 sec. I, p. 242 (M. Lang et al.
eds., IBFD/Linde 2015), Online Books IBFD.
reducing its tax burden. As a result, the current rules leave
room for the use of valid tax planning strategies in rela-
tion to the definition of a PE, as new economic activities
and technological developments offer a reasonable degree
of flexibility for the taxpayers to structure their business
without crossing the PE threshold.
Article 5(4) of the OECD Model also contains a list of
preparatory or auxiliary activities that are to be treated
as exceptions to the general definition of a PE, even when
a fixed place of business is characterized. Although orig-
inally designed for a different economic context, these
exemptions are granted by the treaty provision itself. As a
result, the simple adoption of a business model that either
avoids the characterization of a PE or exploits the exemp-
tions for preparatory or auxiliary activities cannot be con-
sidered to be the artificial avoidance of the status of a PE.
In practice, it is unclear whether the DPT only encom-
passes cases where a taxpayer artificially avoids the char-
acterization of a PE in the market jurisdiction through the
artificial fragmentation of its transaction. As the relevant
UK law is drafted in broad terms, it is very likely that the
DPT also affects cases in which the taxpayer designs its
businessmodeltofallwithinthePEthreshold,butwithout
using transactions structured in an artificial manner. In
this respect, only artificial structures, instigated exclu-
sively for tax purposes and with no economic substance,
should be countered by tax authorities.
If the structure adopted by a taxpayer is congruent with
the business model chosen, the tax authorities cannot dis-
regard a valid tax planning strategy just because it reduces
the tax liability in the source state. Conversely, when the
structure used by the taxpayer does not have a certain
degree of economic substance and coherence, the tax
authorities may counter it, irrespective of the introduc-
tion of a specific tax for that purpose.
The problem is that the United Kingdom intends to levy
the DPT on international structures adopted by MNEs
that were not intended to be covered by the PE definition
as originally drafted. Nevertheless, as these structures are
not artificial from a legal standpoint, the United Kingdom
should, in theory, renegotiate its tax treaties to amend the
definition of a PE, instead of levying a new tax.
As taxpayers have the right to choose the legal actions and
transactions that best fit their needs, the simple fact that
the business model adopted falls within the definition of a
PE does not, in itself, authorize the collection of a substan-
tially similar tax that contradicts the international obliga-
tions assumed in a tax treaty. This is why the levying of the
DPT should be restricted to cases where the tax authorities
can demonstrate the artificiality of the legal structure used
by the taxpayer or, at best, the lack of any other plausible
justification for the means adopted.
Recently, the OECD BEPS initiative has resurrected the
debate regarding the adequacy and convenience of the
concept of a PE with regard to the allocation of the tax
jurisdiction given the very significant pressure exerted by
developed countries. In particular, numerous European
countries, which have become a major market for many
Exported / Printed on 20 July 2016 by biblio2@ibdt.org.br.

4. 402 BULLETIN FOR INTERNATIONAL TAXATION JULY 2016 © IBFD
Ramon Tomazela Santos
US MNEs, such as Amazon, Apple, Google and Starbucks,
have begun to demand more forcefully their right to tax
at least part of the profits derived by such MNEs in their
territories.
However, the proposals presented in Action 7 of the
OECD BEPS initiative reveal an unsuccessful attempt
to adapt an outdated concept to a new economic reality,
without directly challenging the paradigms of interna-
tional taxation.10
Action 7 only targets circumvention of
the PE definition, i.e. artificial fragmentation, commis-
sionaire arrangements, preparatory or auxiliary exemp-
tions, among others, without departing from the current
rules on the allocation of taxing rights between contract-
ing states. Consequently, as in the vast majority of Action
Plans in its BEPS initiative, the OECD has insisted on
maintaining the current paradigms of international taxa-
tion, in seeking only to adapt outdated concepts to a new
economic scenario.
The amendment of the PE definition, as envisaged under
Action 7 of the OECD BEPS initiative, would most prob-
ably not encompass all cases in which foreign enterprises
can undertake a substantial level of economic activity in
thesourcestatewithoutestablishingthedegreeofpresence
required by the PE threshold. Against this background, it
is easy to see why the United Kingdom decided to enact
the DPT to ensure the taxation of a portion of the profit
derived by such MNEs. The United Kingdom probably
found the approach followed by the OECD in Action 7
ineffective and, therefore, opted for the introduction of a
more radical tax measure that targets profits diverted to
other countries.
The point is that, despite all possible justifications, the
compatibility of the DPT with article 7 of the tax treaties
concluded by the United Kingdom is very questionable.
The various specific objections to the DPT with regard to
tax treaties are now summarized below.
First, the rules regarding the DPT do not only apply to
cases where the sole or main purpose of the taxpayer is to
avoid taxes. This would be essential in characterizing the
rule in the DPT as an anti-abuse provision. The use of UK
law is a simple mechanism that permits the taxation of any
sales or services undertaken in the UK internal market,
regardless of the characterization of a PE. This flagrantly
contradicts article 7 of the tax treaties.
Second, the deemed characterization of a PE based on
a domestic anti-abuse rule without the support of the
wording in a tax treaty could result in double taxation,
as a residence state only grants an exemption or a foreign
tax credit in relation to taxes levied in accordance with the
distributive rules of a tax treaty. Consequently, the imposi-
tion of the DPT by the United Kingdom could result in the
double taxation of corporate profits, which is precisely the
phenomenon that a tax treaty is intended to avoid.
10. OECD, Action 7 Final Report 2015 – Preventing the Artificial Avoidance of
Permanent Establishment Status (OECD 2015), International Organiza-
tions’ Documentation IBFD.
This demonstrates that the United Kingdom should have
extended or amended the definition of a PE in its tax trea-
tiestoencompassnewactivitiesdevelopedwithoutaphys-
ical presence within the country. The United Kingdom
could also have included in its tax treaties specific anti-
avoidance rules against common tax planning strategies
used to avoid the characterization of a PE. What cannot
be agreed to is the introduction of a new tax to cover these
situations which violate treaty obligations.
The conclusion would be different if the DPT were to be
levied only when the taxpayer’ s conduct consisted of con-
cealing the existence of a PE in the source state by means of
fraudulent manoeuvres. However, as the UK law is drafted
in broad terms, it would appear that, in several cases where
a structure used by a taxpayer could not be considered to
be artificial, the levying of the DPT by the UK tax authori-
ties, Her Majesty’ s Revenue Customs (HMRC), would
be incompatible with tax treaties.
4. Domestic Anti-Avoidance Rules and Tax
Treaties
Despite the protection granted by article 7 of the OECD
Model, HMRC could argue that the DPT would only be
levied in abusive situations involving the requalification
of legal structures used by taxpayers as artificially circum-
venting the concept of PE. Based on this, HMRC could
argue that, with the support of the OECD’ s position on
the compatibility of domestic general anti-avoidance rules
(GAARs) with treaty provisions, the mere requalification
of the facts, to be able to consider that there is a PE in the
United Kingdom, would not be affected by tax treaties.
This line of reasoning would allow the collection of the
DPT even in the face of a tax treaty.
In fact, the OECD argues, in the Commentary on Article
1 of the OECD Model, that:
... to the extent these anti-avoidance rules are part of the basic
domestic rules set by domestic tax laws for determining which
facts give rise to a tax liability, they are not addressed in tax trea-
ties and therefore not affected by them. Thus, as a general rule,
there will be no conflict between such rules and the provisions
of tax conventions.11
ThisinterpretationofthecompatibilityofdomesticGAARs
with the tax treaties, which is reinforced in the Commen-
tary on Article 1 of the OECD Model,12
is adopted by most
OECD member countries. The only exceptions are Lux-
embourg, the Netherlands and Switzerland, which have
recorded observations against such a questionable inter-
pretation as proposed by the OECD.13
This is not the place to review this subject in all of its vari-
eties. It is, however, important to present brief comments
regarding the position of the OECD on the compatibility
of domestic GAARs with treaty provisions.
Initially, it should be emphasized that the title of and the
preamble to tax treaties includes the purpose of avoiding
11. OECD Model Tax Convention on Income and on Capital: Commentary on
Article 1, para. 9.2 (26 July 2014), Models IBFD.
12. Id., at paras. 22.1 and 23.
13. Id., at paras. 27.6, 27.7 and 27.9.
Exported / Printed on 20 July 2016 by biblio2@ibdt.org.br.

5. 403© IBFD BULLETIN FOR INTERNATIONAL TAXATION JULY 2016
The United Kingdom’ s Diverted Profits Tax and Tax Treaties: An Evaluation
double taxation and the prevention of tax evasion. As a
result, even if a prescriptive content is assigned to the pre-
amble of tax treaties, it is clear that domestic anti-abuse
rules may only be applied in conflict with the provisions of
tax treaties in the event of demonstrable tax evasion,14
but
not in the case of tax avoidance or tax mitigation.
The passages of the Commentaries on the OECD Model
that use the term “tax avoidance” are mainly related to the
exchange of information and administrative assistance
in the collection of taxes. Consequently, it is not possible
to include the efforts aimed at tax avoidance as a general
objective of tax treaties, which should guide the interpre-
tation of their provisions, in the light of article 31(1) of the
Vienna Convention on the Law of Treaties (the Vienna
Convention) (1969).15
In addition, in other passages that refer to the need to
counter tax avoidance, it has been expressly decided to
include specific anti-avoidance measures in the OECD
Model, such as: (1) the concept of beneficial owner in art-
icles 10 (Dividends), 11 (Interest) and 12 (Royalties); (2)
the replacement of the expression “each fiscal year” with
“any twelve month period” in article 15 (Income from
employment); and (3) the inclusion of article 17(2) (Enter-
tainers and Sportspersons), which permits the taxation at
source of income attributed to star companies, regardless
of the use of an artificial structure by the entertainer or
sportsperson.
These examples demonstrate that, in order to deal with
tax avoidance, states should amend the wording of treaty
provisions to prevent their circumvention by taxpayers
by way of tax planning, rather than simply implement
domestic anti-avoidance rules that overlap with the obli-
gations assumed at an international level, which consti-
tutes a treaty override.16
The application of domestic anti-avoidance rules may also
result in an unilateral change of a tax treatment granted by
a tax treaty, as the tax obligation created by the domestic
law of a contracting state, based on its interaction with the
domesticanti-avoidancerules,maymodifyorfrustratethe
effects that could have been derived from the application
of the tax treaty.17
This is precisely what may happen in
the case under analysis, as the DPT as levied by the United
Kingdom frustrates the typical effects derived from article
7 of the OECD Model, which provides for the exclusive
taxation of business profits in the residence state, except
where a PE can be characterized in the source state, which
does not occur in the case of the DPT.
In addition, the position expressed by the OECD in para-
graph 9.2 of the Commentary on Article 1 of the OECD
14. G. Maisto, Domestic Anti-Abuse Rules and Bilateral Tax Conventions in
the Light of Public International Law, in Essays on Tax Treaties A Tribute
to David A. Ward pp. 334/335 (G. Maisto, A. Nikolakakis J.M. Ulmer
eds., IBFD/CTF 2012).
15. UNViennaConventionontheLawofTreaties(23May1969),TreatiesIBFD.
16. With regard to treaty override, see L.E. Schoueri, Tax Treaty Override A
Jurisdictional Approach, 42 Intertax 11 (2014) and C. de Pietro, Tax Treaty
Override (Kluwer L. Intl. 2014).
17. Maisto, supra n. 14, at p. 336.
Model was only first included in 2003.18
This makes its
application questionable with regard to tax treaties con-
cluded before 2003.
It is known that the OECD argues that the amendments
to the Commentaries on the OECD Model are not rele-
vant for the interpretation and application of tax treaties
concluded prior to their issue when there is a difference
in substance.19
On the other hand, where the amendments
to the OECD Commentaries are regarded as merely inter-
pretive, the OECD argues that such clarifications should
be applied to existing tax treaties20,21
to the extent that
they reflect the consensus of the OECD member coun-
tries regarding the correct interpretation of existing treaty
provisions and their proper application to actual cases.22,23
It can sometimes be difficult to identify whether a change
to the Commentaries on the OECD Model has instituted
a substantial change in the underlying treaty provision,
especially when the wording of the OECD Model itself
remains unchanged.24
Despite this, when it comes to the
compatibility of domestic anti-abuse rules with tax trea-
ties, the new position adopted by the OECD is diamet-
rically opposed to that which had been adopted by the
OECD since the Commentaries on the OECD Model
(1977),25
which makes the change made in the Commen-
taries on the OECD Model 2003 applicable only to tax
treaties entered into after that date.26
In fact, the pre-2003
version of the Commentaries on the OECD Model sug-
gested that:
it may be appropriate for Contracting States to agree in bilateral
negotiations that any relief from tax [provided by a tax treaty]
should not apply in certain cases, or to agree that the application
of the provisions of domestic laws against tax avoidance should
not be affected by the Convention.27
Thus, the pre-2003 version followed the view that domes-
tic anti-avoidance rules should be either included or
18. OECD Model Tax Convention on Income and on Capital: Commentary on
Article 1 para. 9.2. (28 Jan. 2003), Models IBFD.
19. M. Schmitt, The Relevance of Amendments to the OECD Commentary for
the Interpretation of Tax Treaties (Static or Dynamic Approach), in Funda-
mental Issues and Practical Problems in Tax Treaty Interpretation p. 121 (M.
Schilcher P. Weninger eds., Linde 2008).
20. M. Lang, The Application of the OECD Model Tax Convention to Partner-
ships A Critical Analysis of the Report Prepared by the OECD Committee
on Fiscal Affairs p. 15 (Linde 2000).
21. K. Provodová, The Relevance of the OECD Report for the Interpretation of
Tax Treaties, in Schilcher Weninger, supra n. 19, at p. 151.
22. Seepara.35oftheintroductiontotheOECD Model: Commentaries(2014),
according to which: “Needless to say, amendments to the Articles of the
Model Convention and to the Commentaries that are a direct result of
these amendments are not relevant to the interpretation or application
of previously concluded conventions where the provisions of those con-
ventions are different in substance from the amended Articles. However,
other changes or additions to the Commentaries are normally applicable
to the interpretation and application of conventions concluded before
their adoption, because they reflect the consensus of the OECD Member
countries as to the proper interpretation of existing provisions and their
application to specific situations.”
23. Schmitt, supra n. 19, at p. 121.
24. G. Nolte, Report 3. Subsequent Agreements and Subsequent Practice of States
Outside of Judicial or Quasi-judicial Proceedings, in Treaties and Subsequent
Practice p. 362 (G. Nolte ed., Oxford U. Press 2013).
25. OECD Model Tax Convention on Income and on Capital: Commentary on
Article 1 para. 10 (11 Apr. 1977), Models IBFD.
26. Maisto, supra n. 14, at p. 339.
27. OECD, supra n. 25, at para. 10.
Exported / Printed on 20 July 2016 by biblio2@ibdt.org.br.

6. 404 BULLETIN FOR INTERNATIONAL TAXATION JULY 2016 © IBFD
Ramon Tomazela Santos
confirmed by tax treaty provisions. This approach only
changed in 2003, when the OECD put forward the argu-
ment that domestic anti-avoidance rules are used to deter-
mine the facts that create the tax obligation. Therefore,
since these changes in the Commentaries represent a new
interpretation, there are good grounds to claim that they
cannot be applied to older tax treaties. In any event, due to
the lack of consensus on the legal status of the Commen-
taryanditsroleintheinterpretationoftaxtreaties,ithasto
be acknowledged that tax authorities and national courts
may adopt different positions in this regard.
A more critical point relies on the fact that the United
KingdomsharestheviewoftheOECD,setoutintheCom-
mentary on Article 1 of the OECD Model,28
in the sense
that tax treaties do not affect the application of domestic
anti-abuse rules, as the United Kingdom representatives
did not record any observation against this interpretation.
As a result, regardless of the legal relevance to be attributed
to the Commentaries on the OECD Mode,29
it is clear that
the United Kingdom, in interpreting its tax treaties, acts in
good faith and in accordance with its unilateral stance, as
it did not make any observation on the content of relevant
paragraphs of the OECD Commentaries.30
The matter becomes even more complex when it is con-
sidered that the UK tax law provides that its GAAR can
be applied in a treaty context31
to counter any tax arrange-
mentswhenitisreasonabletoconclude,havingtakenallof
the facts and circumstances into account, that a taxpayer
intended to obtain a tax advantage. In this sense, HMRC
has clearly stated that:
where there are abusive arrangements which try to exploit par-
ticular provisions in a double tax treaty, or the way in which such
provisions interact with other provisions of UK tax law, then the
GAAR can be applied to counteract the abusive arrangement.32
Although the UK tax law extends its GAAR to a treaty
context, this domestic legal provision may also give rise to
a debate about whether it constitutes a treaty override,33
as
it is a later domestic law that can be applied by HMRC in
conflict with treaty provisions. A treaty override, in addi-
tion to representing a breach of international law, also
gives rise to serious consequences, as it undermines the
legal certainty that tax treaties intend to develop. From
an international law perspective, article 60 of the Vienna
Convention (1969) establishes that:
28. Para. 9.2 OECD Model: Commentary on Article 1 (2014).
29. It is not within the scope of this article to analyse the legal relevance of
the OECD Model: Commentaries (2014). In this context, see J.M. Mössner,
Klaus Vogel Lecture 2009 Comments, 64 Bull. Intl. Taxn. 1, sec. 2. (2010),
Journals IBFD. It is assumed here that the relevance to be attributed to
the OECD Model: Commentaries (2014) should be considered on a case-
by-case basis. With regard to this, see J. Sasseville, Temporal Aspects of Tax
Treaties, in Tax Polymath: A Life in International Taxation Essays in Honour
of John F. Avery Jones sec. 3, p. 46 (P. Baker C. Bobbett eds., IBFD 2011),
Online Books IBFD.
30. Paras. 9.2, 22.1 and 23 OECD Model: Commentary on Article 1 (2014).
31. J. Schwarz, Schwarz on Tax Treaties, 3rd edn., p. 45 (Wolters Kluwer (UK)
Ltd. 2013).
32. HMRC, General Anti Abuse Rule (GAAR) Guidance, para. B.53, available
at www.gov.uk/government/uploads/system/uploads/attachment_data/
file/399270/2__HMRC_GAAR_Guidance_Parts_A-C_with_effect_
from_30_January_2015_AD_V6.pdf.
33. Schwarz, supra n. 31.
a material breach of a bilateral treaty by one of the parties entitles
the other to invoke the breach as a ground for terminating the
treaty or suspending its operation in whole or in part.
From economic and practical perspectives, non-resident
taxpayers may lose their confidence in the behaviour of
the other contracting state, as the tax treatment applying
to their investments may suddenly be amended by a uni-
lateral and uncoordinated action.
Additionally, as tax treaties are primarily concluded by
sovereign states, it is clear that the provisions set out in
tax treaties must be observed in view of the international
public law principle of pacta sunt servanda, as set out in
article 26 of the Vienna Convention (1969), which pro-
vides that “every treaty in force is binding upon the parties
and must be performed in good faith”. This fundamen-
tal principle is supplemented by article 27 of the Vienna
Convention (1969), according to which “a party may not
invoke the provisions of internal law as a justification for
its failure to perform a treaty”. Consequently, the contract-
ing states embrace a commitment that binds them to not
impose taxes on situations in which a tax treaty restricts
their taxing rights. Under the international law, there are
no possible justifications for a treaty override.34
As a result,
even if, under the UK legal system, the doctrine of parlia-
mentary sovereignty admits the enactment of domestic
laws to override a treaty provision, such a breach of in-
ternational law may be invoked by the other contracting
state.35
In addition to this infringement, which may be questioned
bytheothercontractingstate,itshouldbeemphasizedthat
the domestic GAAR enacted by the United Kingdom and
extended to the level of tax treaties does not represent a
general legitimization of the DPT. The domestic GAAR
may be used by HMRC to counter tax advantages arising
from tax arrangements that are abusive, but it does not
legitimatetheimpositionoftheDPTinanycircumstances,
without demonstrating a practice of abusive tax arrange-
ments by a taxpayer.
It is also important to note that the fictitious character-
ization of a PE on the basis of a domestic anti-abuse rule
without the support of the wording in the tax treaty may
result in double taxation, as the residence state only grants
a credit or an exemption in relation to the taxes levied in
accordance with the distributive rules of a tax treaty.36
Even if the United Kingdom were to apply its domestic
GAAR on the basis that a taxpayer intentionally avoided
the characterization of a PE, the other contracting state
could hardly adopt the same approach in granting double
taxationreliefinatreatycontext.Consequently,thecollec-
tion of DPT by the United Kingdom could easily result in
the double taxation of business profits, which is precisely
what a tax treaty is designed to prevent.
34. P. Ribeiro de Souza, Tax Treaty Override, in Schilcher Weninger, supra
n. 19, at p. 255.
35. Schwarz, supra n. 31, at p. 42.
36. M. Helminen, The International Tax Law Concept of Dividend, Series on
International Taxation vol. 36, pp. 105-106 (Kluwer L. Intl. 2010).
Exported / Printed on 20 July 2016 by biblio2@ibdt.org.br.

7. 405© IBFD BULLETIN FOR INTERNATIONAL TAXATION JULY 2016
The United Kingdom’ s Diverted Profits Tax and Tax Treaties: An Evaluation
As a result, even if the position of the United Kingdom
and its domestic GAAR is considered to consistent with
the interpretation in the Commentaries on the OECDC
Model, the truth is that the collection of the DPT would be
contrary to the objective and purpose of a tax treaty. Con-
sequently, in a treaty context, the levying of the DPT could
only be justified in cases of proven abusive transactions.
Another aspect that must be addressed is the fact that
various tax treaties concluded by the United Kingdom
contain a general anti-abuse clause based on the principal
purpose test (PPT). The PPT permits the investigation of
the business purpose that guided a taxpayer in undertak-
ingcertainactionsortransactions.Theapplicationofsuch
a clause to justify the collection of the DPT would depend
on a case-by-case analysis. With regard to tax treaties with
PPT clauses, tax authorities can only reclassify an action
or a transaction carried out by a taxpayer when one of the
main purposes of the action or transaction is to prevent,
reduce or delay the payment of taxes, without any other
economic or business purpose. As a result, only actions or
transactions undertaken with the sole or main purpose of
avoiding taxes could be recharacterized by tax authorities.
Nevertheless, as stated in section 3., the DPT rules do not
appear to require an investigation as to whether the sole
or primary purpose of a taxpayer is to avoid taxes. In this
context, it can be asked whether the DPT is really intended
to counter cases in which MNEs artificially avoid the char-
acterization of a PE in the United Kingdom without any
other business purpose or, conversely, whether it is only
a stringent mechanism to tax any sales or services per-
formed in the UK domestic market, regardless of the char-
acterization of a PE. In the latter case, even if the relevant
tax treaty contains a PPT clause, it is possible to challenge
the compatibility of the DPT with the equivalent to article
7 of the OECD Model in the tax treaty, given that the tax
is levied on the profits obtained by a company resident in
the other contracting state without the characterization of
a PE in the United Kingdom.
Finally, it should be noted that, in the UK tax system, tax
treaties only have effect insofar as domestic law so pro-
vides. It may be debatable whether the Taxation (Inter-
national and Other Provisions) Act (TIOPA) 2010 gives
effect to tax treaties in relation to DPT, as this states that:
[d]ouble taxation arrangements have effect in relation to income
tax and corporation tax so far as the arrangements provide ... (b)
for taxing income of non-UK resident persons that arises from
sources in the United Kingdom.37
Although the DPT cannot be considered to be income tax
or corporation tax under the UK domestic tax law, it is
37. UK: Taxation (International and Other Provisions) Act (TIOPA) sec. 6(2)
(b) 2010.
undeniable that a tax treaty validly concluded is binding
from an international law perspective. For this reason, the
other contracting state may challenge the breach of the
provisions of a tax treaty by the United Kingdom given
the introduction of the DPT. This may result in a tax treaty
being terminated or suspended under international law.
5. Conclusions
The equivalent of article 2(4) of the OECD
Model in the tax treaties concluded by the United
Kingdom encompasses any identical or substantially
similar taxes that are imposed after the date of the
signature of a tax treaty. As the tax base of the DPT
corresponds to the profits that would have been
attributed to a PE, it can be considered to be a tax
levied on elements of income.
As taxpayers have the right to choose the actions
and transactions that they put into effect, the simple
fact that the business model adopted falls within the
definition of a PE does not authorize the collection
of a similar tax, in contradiction to the international
obligations assumed in a tax treaty. Consequently,
the levying of the DPT should be restricted to
cases where HMRC can clearly demonstrate the
artificiality of the legal structure used by a taxpayer.
In addition, if the structure used by the taxpayer
has an unintended result in light of the traditional
definition of a PE, the United Kingdom should
renegotiate its tax treaties to amend the definition of
a PE, instead of imposing a new tax.
Although UK tax law provides that its GAAR can
be applied in a treaty context, such a breach of
international law through a treaty override may be
invoked by the other contracting state to terminate
the tax treaty. In addition, the fact that the UK
domestic GAAR may be used by HMRC to counter
artificial tax arrangements does not legitimate the
levying of the DPT in any circumstances, without
proof of abuse.
Finally, despite the fact that, within the UK legal
system, tax treaties only have effect insofar as the
domestic law so provides, it is undeniable that a
tax treaty validly concluded is binding from an
international law perspective. Consequently, the
other contracting state may challenge the breach of
the tax treaty by the United Kingdom arising as a
result of the introduction of the DPT.
Exported / Printed on 20 July 2016 by biblio2@ibdt.org.br.