Multilateral Instrument (MLI)
The Multilateral Instrument (MLI) is a groundbreaking international treaty that modifies existing tax agreements to prevent tax avoidance and treaty abuse. Developed under the OECD’s BEPS Action Plan 15, the MLI streamlines the process of updating multiple tax treaties at once, making it a key tool in the global fight against Base Erosion and Profit Shifting (BEPS).
Below, we answer the most frequently asked questions about the MLI.
1. What is the Multilateral Instrument (MLI)?
The Multilateral Instrument (MLI) is a multilateral tax treaty designed to modify existing bilateral tax treaties without requiring separate renegotiations. It introduces anti-tax avoidance measures aligned with the OECD’s BEPS (Base Erosion and Profit Shifting) framework, ensuring multinational enterprises (MNEs) pay taxes where they generate value.
2. Why was the MLI introduced?
Before the MLI, countries had to negotiate and amend thousands of bilateral tax treaties separately, making the process slow and inefficient. The OECD and G20 nations developed the MLI under BEPS Action 15 to:
- Prevent treaty abuse, such as treaty shopping.
- Reduce tax avoidance, particularly profit shifting.
- Close loopholes in international tax agreements.
- Improve dispute resolution between tax authorities.
By allowing multiple treaties to be updated at once, the MLI provides a faster, more efficient approach to international tax reform.
3. How does the MLI work?
The MLI operates as an overlay treaty, meaning it automatically modifies pre-existing tax treaties between participating countries. Instead of renegotiating each tax treaty, countries adopt MLI provisions to align their treaties with international anti-BEPS standards.
The treaty applies only if both countries in a bilateral tax treaty choose to adopt the same MLI provisions. Each country can opt in or out of certain provisions, making the MLI a flexible but standardized approach.
4. What are the key provisions of the MLI?
The MLI introduces several anti-tax avoidance measures, including:
- Preventing Treaty Abuse
- Principal Purpose Test (PPT): Denies tax benefits if obtaining a tax advantage was one of the main purposes of a transaction.
- Limitation on Benefits (LOB) rule: Restricts treaty benefits to entities with substantial economic activity.
- Avoiding Artificial Avoidance of Permanent Establishment (PE)
- Expands the definition of Permanent Establishment to prevent companies from avoiding taxation by artificially structuring their business activities.
- Improving Dispute Resolution
- Enhances tax dispute resolution through Mutual Agreement Procedures (MAPs) and introduces mandatory binding arbitration for resolving cross-border tax disputes.
- Hybrid Mismatches
- Neutralizes mismatches that allow companies to take advantage of differences in tax treatment across jurisdictions.
Each country can choose which provisions to apply, provided both treaty partners agree.
5. How many countries have signed the MLI?
As of today, over 100 jurisdictions have signed the Multilateral Instrument, making it one of the most widely adopted international tax treaties. The MLI continues to evolve as more countries ratify and implement its provisions.
To check the latest list of signatories and their specific treaty modifications, visit the OECD’s MLI Database.
6. Does the MLI automatically apply to all tax treaties?
No, the MLI only applies when:
- Both countries in a bilateral treaty have signed and ratified the MLI.
- Both countries have chosen the same MLI provisions.
Each country submits a list of Covered Tax Agreements (CTAs) indicating which treaties they want to modify under the MLI. If both treaty partners agree on provisions, the MLI takes effect for that treaty.
7. What is the Principal Purpose Test (PPT)?
The Principal Purpose Test (PPT) is a key anti-abuse provision in the MLI. It prevents treaty shopping, where companies use tax treaties to artificially lower their tax burden.
Under the PPT rule, tax benefits (e.g., reduced withholding tax rates) can be denied if:
- The main purpose of a transaction or structure was to obtain a tax advantage.
- The tax authorities determine that the arrangement lacks genuine economic substance.
The PPT is a default provision under the MLI, meaning it applies unless a country opts for the stricter Limitation on Benefits (LOB) rule.
8. How does the MLI affect Permanent Establishment (PE) rules?
The MLI expands the definition of Permanent Establishment (PE) to prevent businesses from avoiding taxation by fragmenting their activities across multiple jurisdictions. Changes include:
- Preventing “commissionaire arrangements” that artificially avoid PE status.
- Extending PE to cover dependent agents who play a key role in contract negotiations.
- Addressing artificial business fragmentation to avoid tax obligations.
These updates ensure that companies with substantial operations in a country cannot escape taxation through artificial arrangements.
9. How does the MLI improve dispute resolution?
The MLI strengthens the Mutual Agreement Procedure (MAP), allowing tax authorities to resolve cross-border tax disputes more efficiently. Key improvements include:
- Faster dispute resolution by ensuring countries follow standardized procedures.
- Mandatory binding arbitration (if chosen by both countries) to resolve disputes when tax authorities cannot agree.
This reduces the risk of double taxation and provides greater certainty for businesses operating across multiple jurisdictions.
10. What is mandatory binding arbitration under the MLI?
Mandatory binding arbitration is an optional provision under the MLI that ensures unresolved tax disputes between two countries are settled by an independent panel.
This prevents prolonged tax disputes that could lead to double taxation, making international taxation more predictable for businesses. However, not all countries have adopted this provision.
11. When did the MLI take effect?
The MLI officially entered into force on July 1, 2018. However, its provisions only apply to specific tax treaties once both treaty partners ratify the MLI and agree on the provisions to implement.
For withholding taxes, the MLI takes effect from January 1 of the following year. For other taxes, it applies from the start of the tax period six months after ratification.
12. How does the MLI impact multinational enterprises (MNEs)?
The MLI directly affects MNEs by:
- Limiting tax treaty benefits if transactions lack economic substance.
- Expanding Permanent Establishment (PE) rules, increasing tax obligations.
- Enhancing dispute resolution mechanisms, reducing double taxation risks.
Companies must review their international tax structures to ensure compliance with new treaty provisions.
13. How can businesses prepare for MLI changes?
To stay compliant, businesses should:
- Review tax treaties applicable to their operations.
- Assess treaty eligibility under the Principal Purpose Test (PPT).
- Monitor Permanent Establishment (PE) risks under expanded definitions.
- Update transfer pricing policies in line with BEPS requirements.
- Engage with tax advisors to evaluate exposure and compliance strategies.
14. How does the MLI relate to BEPS?
The MLI is a core component of the OECD BEPS Action Plan 15, implementing key anti-avoidance measures from BEPS Actions 6, 7, 14, and 2. It strengthens tax treaties to prevent profit shifting, artificial tax arrangements, and treaty abuse.