Understanding South Africa’s adoption of the Multilateral Instrument

The Multilateral Instrument (MLI) marks a pivotal advancement in the realm of international tax law, designed to counteract tax avoidance strategies that exploit discrepancies and mismatches in tax treaties among nations. South Africa’s formal ratification of the MLI on September 30, 2022, underscores its commitment to global tax reform efforts aimed at enhancing transparency and fairness in the taxation of international operations. This article briefly delves into the implications of the MLI for South Africa and the global community at large.

South Africa’s engagement with the MLI represents a significant step towards aligning its tax treaty network with international efforts to curb base erosion and profit shifting (BEPS). By depositing its instrument of ratification for the MLI, South Africa joins over 100 countries in a unified approach to amend bilateral tax treaties and close loopholes that facilitate tax avoidance.

The MLI, officially known as the Multilateral Convention to Implement Tax Treaty Related Measures to Prevent Base Erosion and Profit Shifting, is an initiative spearheaded by the Organisation for Economic Co-operation and Development (OECD). It targets the prevention of practices that allow profits to be shifted from jurisdictions with higher tax rates to those with lower or no tax. Initiated in 2018, the MLI’s adoption varies among countries, with South Africa being one of the nations that took a deliberate path to ratification.

The BEPS initiative, driven by the OECD, identifies 15 actions to tackle tax avoidance, with Action 15 focusing on the development of the MLI. The MLI aims to prevent treaty abuse and ensure tax treaties do not inadvertently offer opportunities for tax evasion. It introduces measures against practices that exploit treaty gaps, including provisions for dual-resident entities, methods to eliminate double taxation and criteria to deny treaty benefits under specific conditions.

The most notable measures include amendments to limit the availability of the permanent establishment (PE) exemption rule where activities are considered to be of a ‘preparatory or auxiliary’ nature and the adoption of the Principal Purpose Test that will deny treaty benefits where one of the principal purposes of an arrangement is to directly or indirectly obtain the benefit of the tax treaty.

The MLI modifies the application of existing tax treaties without directly amending the treaty texts. It operates alongside existing treaties, introducing measures where both treaty partners consent to identical amendments. For this reason, the OECD maintains a ‘matching database’ so as to facilitate the determination of the impact of the MLI on the DTA concluded between two specific countries. This nuanced approach adds complexity to treaty interpretation but significantly strengthens the global tax treaty network against abuse.

South Africa has designated 76 of its tax treaties as covered by the MLI, signalling a broad commitment to reform. However, treaties with countries that have not signed the MLI, such as the USA and several African nations, will not be affected. Additionally, treaties currently under renegotiation or deemed incompatible with the MLI’s provisions are excluded from South Africa’s list of covered agreements.

In order for the provisions of the MLI to take effect with respect to a specific covered tax agreement, not only must the parties both have selected the same amendments, it is also necessary that both parties to the covered tax agreement have deposited their instrument of ratification with the OECD and the relevant time period has passed in order for the MLI to enter into effect.

The MLI takes effect for:

  • Taxes withheld at the source from the first day of the calendar year that begins on or after the MLI enters into force for the last of the contracting states to the treaty, and
  • All other taxes levied for taxable periods that begin on or after six calendar months (or a shorter period agreed between states) from the date that the MLI enters into force for the last of the contracting states to the treaty.

It follows that the application of the MLI to a treaty requires consideration of, amongst others:

  1. Whether and when the MLI came in force for the respective contracting state(s), and
  2. Reservations and elections by each state and how the combination of these affect the application of each article of the treaty.

Given that the MLI does not change the actual text of a DTA, the OECD has prepared mocked up versions of the DTAs as they would read, if the applicable MLI provisions are incorporated therein. These ‘synthesised’ versions of the DTAs entered into by South Africa are available on the SARS website.

The effectiveness of the MLI for South Africa and its treaty partners hinges on mutual ratification and the selection of compatible amendments. As of January 1, 2023, the MLI is in force for South Africa, with its applicability to specific treaties dependent on the ratification status and choices of its treaty partners. This milestone in South Africa’s tax policy exemplifies its dedication to global efforts against tax avoidance, setting a precedent for transparency and fairness in international taxation.

South Africa’s adoption of the MLI is a critical step towards mitigating tax avoidance and enhancing the integrity of the international tax system. By participating in this global initiative, South Africa reaffirms its commitment to combating BEPS and fostering a more equitable and transparent tax environment. As the MLI continues to be implemented worldwide, it promises to reshape the landscape of international taxation, promoting cooperation and fairness among nations.