Limitation on Benefits (LOB) Provision

A Limitation on Benefits (LOB) provision is a clause commonly included in international tax treaties designed to prevent treaty abuse or “treaty shopping.” It ensures that the benefits of a tax treaty—such as reduced withholding tax rates or exemptions—are available only to genuine residents of one of the contracting states who meet specific qualifying criteria.

Purpose: The primary aim of the LOB provision is to restrict the misuse of tax treaties by entities or individuals who attempt to obtain treaty benefits without having substantial economic or business presence in the treaty country.

Key Features:

1. Eligibility Criteria: Only those entities or individuals that meet certain objective tests, such as local ownership, active business operations, or substantial presence, are entitled to claim treaty benefits.
2. Prevention of Treaty Shopping: Helps curb situations where companies from third countries establish shell entities in low-tax jurisdictions solely to exploit favorable treaty provisions.
3. Transparency and Fairness: Promotes fair application of treaty benefits to legitimate taxpayers and maintains integrity in international tax systems.

Example: Suppose a company incorporated in Country A establishes a shell company in Country B (which has a favorable tax treaty with Country C) solely to take advantage of reduced withholding tax rates. The LOB provision in the treaty between Country B and Country C would deny benefits to such a shell entity unless it meets criteria such as local ownership or active business operations in Country B