April 24, 2025 — The Limitation on Benefits provision is one of the most distinctive features of US bilateral tax treaty practice. The provision, in its modern form, sets out detailed objective tests that a person must satisfy to qualify as a resident of a contracting state for purposes of the treaty's benefits. The tests cover ownership, substance, activities, and other factors. A person that fails the tests is denied treaty benefits regardless of its formal residency. The provision was developed in US treaty practice principally to address treaty shopping concerns, and has been refined through several decades of US bilateral negotiations.

The OECD's BEPS project considered the LOB as one of the principal mechanisms for addressing treaty shopping, alongside the Principal Purpose Test. The 2017 update to the OECD Model Tax Convention incorporated a simplified LOB as an alternative or complement to the PPT, with treaties able to adopt either or both. The Multilateral Instrument provided for the adoption of either approach by signatory jurisdictions. The cumulative effect has been that LOB-style provisions have spread beyond US treaty practice into a wider portion of the bilateral treaty network.

The architecture of the LOB

The LOB provision in its US form contains several alternative tests that a person can satisfy to qualify as a resident for treaty purposes. The tests vary across treaty texts but typically include the following.

The publicly traded test qualifies a person whose principal class of stock is regularly traded on a recognised stock exchange. The test addresses the concern that publicly traded entities are typically held by diverse shareholders for genuine economic reasons rather than for treaty access.

The ownership-and-base-erosion test requires a person to demonstrate that residents of the same contracting state hold a sufficient percentage of the entity (typically 50 percent or more) and that the entity does not pay more than a specified percentage of its income to non-resident persons in the form of deductible payments. The test addresses the conduit concern by requiring substantive ownership and limiting payment-through arrangements.

The active trade or business test qualifies a person engaged in an active trade or business in the contracting state, where the income claimed for treaty benefits is connected to that business. The test addresses the concern that genuine business operations should qualify for treaty benefits regardless of ownership patterns.

The derivative benefits test, present in some bilateral treaties, qualifies a person whose ownership consists of equivalent beneficiaries — persons who would be entitled to comparable treaty benefits if they had invested directly. The test recognises that some ownership chains involve persons who have legitimate treaty claims of their own.

The discretionary determination test allows the competent authority to grant treaty benefits to a person who fails the other tests, where the competent authority determines that the establishment, acquisition, or maintenance of the person did not have as one of its principal purposes the obtaining of treaty benefits.

The contrast with the PPT

The LOB and the PPT operate as alternative or complementary mechanisms for addressing treaty shopping. The two have different design philosophies.

The LOB provides objective tests that produce determinate outcomes. A person either qualifies for treaty benefits under one of the tests or does not. The advantage of the approach is certainty: taxpayers and tax authorities can determine the outcome by applying the tests to the relevant facts.

The PPT provides a subjective test based on the principal purpose of the arrangement. The test produces determinate outcomes only after analysis of the specific facts. The advantage of the approach is flexibility: it can capture arrangements that the LOB tests might miss while permitting arrangements that the LOB tests might inappropriately deny.

The disadvantage of each approach is symmetrical to its advantage. The LOB's certainty produces inflexibility: arrangements that fail the tests but have legitimate purposes may be denied benefits. The PPT's flexibility produces uncertainty: taxpayers cannot determine outcomes in advance with the same confidence.

The OECD adoption

The OECD's 2017 model includes both the LOB and the PPT as alternative mechanisms, with treaties able to adopt either or both. The MLI provided for the adoption of either approach by signatory jurisdictions, with the PPT being more widely adopted than the simplified LOB.

The reasons for the PPT's wider adoption include its conceptual simplicity, its alignment with European anti-abuse jurisprudence, and the fact that the simplified LOB in the OECD model is less detailed than the full LOB found in modern US treaties. Several jurisdictions adopted the PPT as the principal anti-shopping mechanism in their MLI notifications, with the LOB applying only in bilateral relationships where both parties agreed to its use.

The result is a network where the PPT operates broadly and the LOB operates in specific bilateral relationships, principally those involving the United States. The two frameworks coexist in the bilateral treaty network, with the LOB providing the more determinate framework where it applies.

The operational implications

For multinational groups operating cross-border, the LOB and PPT frameworks combine to provide a comprehensive anti-shopping framework that constrains the use of intermediate holding structures. The principal operational implications are described below.

The first implication is the importance of qualifying ownership patterns. The LOB ownership tests require that the person claiming treaty benefits be owned by qualifying residents. The pattern of ownership through the entity chain must be analysed to determine whether the LOB tests are satisfied.

The second implication is the importance of active business activities. Where the LOB ownership tests are not satisfied, the active trade or business test may provide an alternative path to qualification. The business activities must be substantial and connected to the relevant income for the test to apply.

The third implication is the importance of competent authority engagement where the objective tests are not satisfied. The discretionary determination test allows the competent authority to grant benefits in appropriate cases, but requires application and demonstration that the arrangement was not principally for treaty access.

The fourth implication is the increased complexity of cross-border investment planning. The LOB and PPT must both be analysed for arrangements that potentially trigger them, with the consequence that the analytical work for cross-border investments has expanded compared with the pre-LOB and pre-PPT environment.

The trajectory

The LOB framework's trajectory through the second half of the 2020s is one of stable operation in US bilateral treaty practice and continued limited adoption in other bilateral relationships. The framework is unlikely to displace the PPT as the dominant anti-shopping mechanism, but it will continue to operate in the bilateral relationships where it has been adopted.

For multinational groups, the LOB framework requires careful analysis of ownership patterns and business activities. Forward-looking structures must be designed with both LOB and PPT considerations in mind. Historical structures must be reviewed periodically for continued qualification under the relevant tests. The framework, like the PPT, has become a fixed feature of cross-border tax compliance, with consequent effects on how multinational groups approach their treaty positions.