Christian Pellone, Head of Tax, Ernst & Young Mongolia, on recent developments in corporate tax law

The tax laws in Mongolia were updated to deal with the new market economy following the withdrawal of the former Soviet Union in the early 1990s. Today’s tax landscape is experiencing change as policymakers seek to protect strategic assets without deterring foreign investment. One area of recent focus has been double tax treaties, about which the authorities have long expressed concern, specifically treaty shopping or tax avoidance attributed to tax treaties and lost revenue.

In early 2012 the Ministry of Finance (MoF) conducted research into Mongolia’s double tax treaties, comparing treaties with those of other similar ranking economies (i.e. the Philippines and Ghana) and undertaking a quantitative analysis of the lost revenue. The research concluded that Mongolia’s double tax treaties were too generous toward taxpayers, resulting in significant tax revenue being lost. The MoF also documented its concerns and rationale behind the recommendation to cancel these treaties in a paper entitled “Recommendation, Reason and Explanation to Cancel Tax Treaties”, noting that the government consider terminating all of its tax treaties and renegotiating them upon revision to domestic law.

On November 2, 2012, the parliament passed laws to terminate Mongolia’s double tax treaties with Luxembourg, the Netherlands, Kuwait and the UAE. International and domestic due process still needs to be adhered to before termination is effective, including notifying the governments of those states through diplomatic channels. These treaties are likely to be cancelled with effect from January 1, 2014 (or possibly later). Treaty protection should continue to apply until termination officially occurs, which means companies should have at least a year to consider the impact of this development and reorganise into alternative structures where appropriate with minimum or no transition tax cost.

Mongolia has the right to cancel those treaties that are pursuant to the treaties themselves (Termination Article) and international law; however, due process must be followed. Under Article 10.2 of the Constitution of Mongolia, “Mongolia shall fulfill in good faith its obligations under international treaties to which it is a Party.” Mongolian tax treaties are ultimately subject to the 1969 Vienna Convention on the Law of Treaties (VC), to which the country is a signatory. On November 2, 2012 the draft law to cancel four tax treaties was voted and passed by the parliament. According to the country’s Constitution, a law is effective 10 days after its appearance in the State Information Publication Booklet, which has yet to occur.

Under Article 65 of the VC, Mongolia must notify the other contracting state in writing of its intention to terminate the treaty and the reasons therefore. The MoF sends the notification through diplomatic channels to the respective government. Upon receipt, the other contracting party has a period of a minimum of three months to respond and raise an objection. On condition that no objection is raised, Mongolia may proceed to terminate the treaty. If an objection has been raised, then both parties are required to resolve the matter under Article 33 of the Charter of the UN, via negotiation and enquiry. The termination of the Luxembourg and Netherlands tax treaties could result in objections and engagement from these states.

Under the Termination Article of the various tax treaties, the treaties themselves shall cease to have effect for taxable years and periods beginning after the end of the calendar year in which the notice of termination has been given. The Minister of Finance has confirmed that the termination dates will be 1 January 2014 for the Netherlands and Luxembourg, 1 January 2015 for the UAE and 1 April 2015 for Kuwait.

Companies should assess the implications of these tax developments on their business structures, and in particular, withholding taxes on dividends and other offshore payments, which could potentially revert to 20%. There could be deferred tax liabilities or income tax expenses required to be booked for future dividend withholding tax on profits earned today, depending on the company's business and dividend strategy.