LOB – Limitation on Benefits

The Limitation on Benefits (LOB) clause is an objective, rules-based anti-abuse provision for tax treaties that can be implemented under Article 7(4) of the MLI as an optional supplement to the Principal Purpose Test (PPT). Article 7 MLI (‘Prevention of Treaty Abuse’) primarily governs the PPT; the simplified LOB is included therein as an additional option. The LOB concept originally derives from American DTT policy and was incorporated into the BEPS measures.

The LOB denies treaty benefits to persons who do not satisfy certain qualification tests, thereby limiting the circle of treaty-entitled persons to residents with a genuine economic connection to the state concerned. Unlike the PPT — which examines the intentions of the taxpayer — the LOB focuses on objective, structural characteristics of the treaty-entitled persons.

The LOB clause has its origins in American treaty policy of the 1980s, which aimed to prevent ‘treaty shopping’ through shell companies in third states:

• 1981: First anti-treaty-shopping provisions in the US DTT with the Netherlands (precursor to the LOB)
• 1989: First comprehensive LOB clause in the modern sense in the US DTT with Germany
• 1996: LOB first anchored in the US Model Income Tax Convention
• 2006: Updated LOB in the 2006 US Model Treaty; proliferation in American DTT networks
• 2013: BEPS AP 6 examines LOB as a possible measure against treaty abuse
• 2015: BEPS final report AP 6 presents LOB and PPT as equivalent alternatives for the minimum standard
• 2017: MLI contains a simplified LOB provision in Article 7(4) and gives jurisdictions various options; full LOB only negotiable bilaterally
• 2018 onwards: LOB clauses enter into force in tax treaties through the MLI

The LOB clause determines which persons qualify as 'Qualified Persons' entitled to treaty benefits:

• Qualified Person Tests: Natural persons, governments and political subdivisions always qualify; companies through stock exchange listing (Publicly Traded Company Test), ownership structure (Ownership Test) and activity tests
• Publicly Traded Company Test: Company is listed on a recognised stock exchange and regularly traded thereon
• Ownership and Base Erosion Test: Company is owned to a certain proportion by residents of the contracting states and satisfies no 'Base Erosion' test
• Active Business Test: Company carries on active business in the state of residence from which the income derives
• Discretionary Relief: Tax authority may grant treaty benefits even to non-qualifying persons
• Simplified LOB in MLI: The MLI contains only a simplified version; a full LOB based on the US model must be negotiated bilaterally

• Rules-based approach: Unlike the PPT, the LOB relies on objective criteria and allows less discretion for tax authorities
• Legal certainty: Taxpayers can clarify in advance whether they satisfy the qualification tests
• BEPS minimum standard: LOB together with PPT or as a simplified LOB with PPT backstop can satisfy the BEPS minimum standard
• Full LOB: A full LOB based on the US model satisfies the minimum standard alone; however, the MLI only contains a simplified version
• PPT/LOB interaction: Many jurisdictions combine the simplified LOB with PPT as a backstop rule
• Documentation obligation: Taxpayers should be able to demonstrate that they satisfy the applicable qualification tests

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