Domestic Anti-Treaty-Shopping Proposals and Further Consultation Announced in Canada's Federal Budget 2014

by Bennett Jones LLP
Contact

In the Canadian Federal Budget released on February 11, 2014, the Department of Finance signaled its intention to enact a domestic treaty-shopping rule, generally allowing the Canada Revenue Agency (CRA) to deny treaty benefits when the "main purpose" of a particular transaction is to obtain treaty benefits. This new rule could come into force in the first taxation year after the year in which the final legislation is enacted. The potential for transitional relief is still an open issue. As the government works towards developing draft legislation, it has given stakeholders 60 days to comment on its proposed approach.

This update provides a brief summary of the Budget 2014 announcement and highlights further steps that stakeholders, including multinational enterprises and private equity firms with Canadian inbound investment and financing structures, should consider as this anti-treaty-shopping proposal unfolds.

Road to the 2014 Budget

The government first raised concerns on the issue of treaty shopping in Budget 2013, describing it as an arrangement under which a person not entitled to the benefits of a particular tax treaty with Canada uses an entity that is resident of a state with which Canada has concluded a tax treaty to obtain Canadian tax benefits. The government expressed its concern that Canada's existing anti-abuse provisions were not sufficient to counter these practices, particularly given recent rulings from the tax courts.

In August 2013, the government released a consultation paper wherein it invited stakeholders to comment on the relative merits of various approaches to treaty shopping by December 13, 2013 (See our review of the consultation paper in Department of Finance Releases Consultation Paper on Anti-Treaty Shopping Measures from September 2013). In particular, stakeholders were asked to address the benefits of a general approach relative to a more specific approach, as well as the advantages and disadvantages of a domestic law approach, a treaty-based approach, or a combination of the two. The proposed rule and discussion provided by the government in Budget 2014 highlights the progress since this consultation.

Proposed Rule

While no draft legislation has been released, Budget 2014 provides a detailed examination of the government's proposed anti-treaty-shopping rule, including its potential application in five common scenarios. The proposed rule will focus on avoidance transactions by considering whether one of the main purposes of a transaction is to obtain treaty benefits. The government also provides some certainty and predictability for taxpayers by building in several positive and negative presumptions to inform the main-purpose analysis. The main elements of the proposal are as follows:

  • Main-Purpose Provision: Subject to the relieving provision described below, treaty benefits will be denied where it is reasonable to conclude that one of the main purposes of undertaking a transaction was to obtain a treaty benefit. Of note, other tests in the Income Tax Act (Canada) using similar language (i.e., "one of the main purposes") generally do not have a high threshold.
  • Conduit Presumption: A presumption will arise that one of the main purposes of a transaction was to obtain a treaty benefit where the relevant treaty income is primarily (i.e., at least 50 percent) used to pay, distribute, or transfer an amount to another person who would otherwise not be entitled to the same treaty benefits had the person received the treaty income directly. The presumption can be overcome with evidence to the contrary.
  • Safe-Harbour Presumption: Subject to the conduit presumption, a presumption will arise that the main purpose for undertaking a transaction was not to obtain treaty benefits where:
    • the person (or a related person) carries on an active business (other than managing investments) in a state with which Canada has concluded a tax treaty and, where the relevant treaty income is derived from a related person in Canada, the active business is substantial compared to the activity carried on in Canada giving rise to the treaty income. Notably, this relief appears to be similar to the active-trade-or-business test currently provided in the limitation on benefits provision of the Canada-U.S. Tax Treaty (Article XXIX-A(3));
    • the person is not controlled by another person that would not have been entitled to equivalent treaty benefits had that person received the treaty income directly; or
    • the person is a corporation or a trust, the shares or units of which are regularly traded on a recognized stock exchange.
  • Relieving Provision: Where the main purpose of a transaction is to obtain treaty benefits, the benefit will be provided to the extent that it is reasonable having regard to all of the circumstances.

In developing its proposal, the government has recognized the important objective of tax treaties to encourage trade and investment and, therefore, continues to acknowledge that treaty benefits are a relevant consideration for a non-resident deciding whether to invest in Canada. On this point, the government added that the proposed rule "… would not apply in respect of an ordinary commercial transaction solely because obtaining a tax treaty benefit was one of the considerations in making an investment." It remains to be seen whether the government will adopt standalone relief for ordinary commercial transactions and what this relief might look like.

Basis of Proposals

Contrary to the preference of numerous stakeholders for a treaty-based approach, expressed during the August 2013 consultation process, the government has adopted a domestic rule. It states that a domestic rule could be compatible with existing treaties on the basis that there are no implicit treaty obligations to provide benefits in respect of abusive arrangements. The government noted that this view was shared by both the Organization for Economic Cooperation and Development (OECD) and the United Nations, and highlighted similar domestic legislation enacted in other countries.

The government concluded that a domestic law approach would generally be more effective and suggested that its proposed rule would be added to the Income Tax Conventions Interpretation Act, such that it would apply in respect of all of Canada's tax treaties.

A number of stakeholders also expressed preference for the adoption of a specific rule, such as the limitation-on-benefits provision included in U.S. tax treaties. While the government acknowledged that rules of this nature provide a high level of certainty, it stressed that they do not capture all forms of treaty shopping. Accordingly, the government has favoured a general approach to prevent a wider range of treaty-shopping arrangements. The government added that a general rule, based on a main-purpose provision, has already been included in several of Canada's tax treaties and is relatively familiar to Canadian taxpayers, tax professionals, and Canada's tax treaty partners.

Next Steps

Moving to the second phase of its consultation process, the government has requested further comments from interested parties on its proposed approach to prevent treaty shopping. In particular, the government has sought comments on the potential application of its proposal to five transactional scenarios set out in the Budget. The first three scenarios parallel the facts of several treaty-shopping cases which the CRA unsuccessfully challenged in the past: MIL (Investments) SA v The Queen; Prévost Car Inc v The Queen, and Velcro Canada Inc v The Queen, all of which may now be caught by the proposed rule. In addition, while indicating that its proposed rule would likely apply to taxation years commencing after enactment, the government requested specific comments on whether transitional relief (i.e., grandfathering provisions) would be appropriate. The consultation period ends just 60 days from the Budget announcement (April 12, 2014), suggesting that any comments received may not result in significant alterations to the proposals.

The government has not specified a timeline for the release of draft legislation, however, the Budget suggests that this may not occur until late 2014 or early 2015. In 2013, the OECD issued an Action Plan to address international tax planning by multinational enterprises which, in part, calls for the development of "model treaty provisions and recommendations regarding the design of domestic rules to prevent the granting of treaty benefits in inappropriate circumstances." The Budget notes that the OECD model provisions and recommendations, which are not expected to be released until September 2014, will be relevant in formulating Canada's approach.

The continued progression towards Canadian anti-treaty shopping legislation will be an important issue to watch in 2014. If enacted as described in the Budget, the government's proposals will have a dramatic impact on multinational enterprises and private equity firms with Canadian inbound investment and financing structures. The proposed rule may apply wherever an enterprise or investor not directly entitled to the benefits of a tax treaty with Canada uses an intermediary entity resident in a country with which Canada has entered into a tax treaty (such as Luxembourg or the Netherlands) to hold or finance its investment into Canada thereby earning income or realizing gains without Canadian tax or at a reduced treaty rate that might not otherwise apply had the intermediary entity not been used.

While still in the early stages of development, the proposals in Budget 2014 offer sufficient guidance for those potentially affected to assess the viability of their existing and planned structures. Given that the rules may be effective immediately or shortly after enactment (based on the commencement of a taxpayer's next taxation year), affected taxpayers may find themselves in need of immediate restructuring. These taxpayers should consider taking proactive steps to mitigate the impact of the rules, including making submissions to the government for a reasonable transition time and some form of valuation-day relief with respect to existing gains that would be exempt from tax under an existing treaty.

 

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

© Bennett Jones LLP | Attorney Advertising

Written by:

Bennett Jones LLP
Contact
more
less

Bennett Jones LLP on:

Readers' Choice 2017
Reporters on Deadline

"My best business intelligence, in one easy email…"

Your first step to building a free, personalized, morning email brief covering pertinent authors and topics on JD Supra:
Sign up using*

Already signed up? Log in here

*By using the service, you signify your acceptance of JD Supra's Privacy Policy.
Privacy Policy (Updated: October 8, 2015):
hide

JD Supra provides users with access to its legal industry publishing services (the "Service") through its website (the "Website") as well as through other sources. Our policies with regard to data collection and use of personal information of users of the Service, regardless of the manner in which users access the Service, and visitors to the Website are set forth in this statement ("Policy"). By using the Service, you signify your acceptance of this Policy.

Information Collection and Use by JD Supra

JD Supra collects users' names, companies, titles, e-mail address and industry. JD Supra also tracks the pages that users visit, logs IP addresses and aggregates non-personally identifiable user data and browser type. This data is gathered using cookies and other technologies.

The information and data collected is used to authenticate users and to send notifications relating to the Service, including email alerts to which users have subscribed; to manage the Service and Website, to improve the Service and to customize the user's experience. This information is also provided to the authors of the content to give them insight into their readership and help them to improve their content, so that it is most useful for our users.

JD Supra does not sell, rent or otherwise provide your details to third parties, other than to the authors of the content on JD Supra.

If you prefer not to enable cookies, you may change your browser settings to disable cookies; however, please note that rejecting cookies while visiting the Website may result in certain parts of the Website not operating correctly or as efficiently as if cookies were allowed.

Email Choice/Opt-out

Users who opt in to receive emails may choose to no longer receive e-mail updates and newsletters by selecting the "opt-out of future email" option in the email they receive from JD Supra or in their JD Supra account management screen.

Security

JD Supra takes reasonable precautions to insure that user information is kept private. We restrict access to user information to those individuals who reasonably need access to perform their job functions, such as our third party email service, customer service personnel and technical staff. However, please note that no method of transmitting or storing data is completely secure and we cannot guarantee the security of user information. Unauthorized entry or use, hardware or software failure, and other factors may compromise the security of user information at any time.

If you have reason to believe that your interaction with us is no longer secure, you must immediately notify us of the problem by contacting us at info@jdsupra.com. In the unlikely event that we believe that the security of your user information in our possession or control may have been compromised, we may seek to notify you of that development and, if so, will endeavor to do so as promptly as practicable under the circumstances.

Sharing and Disclosure of Information JD Supra Collects

Except as otherwise described in this privacy statement, JD Supra will not disclose personal information to any third party unless we believe that disclosure is necessary to: (1) comply with applicable laws; (2) respond to governmental inquiries or requests; (3) comply with valid legal process; (4) protect the rights, privacy, safety or property of JD Supra, users of the Service, Website visitors or the public; (5) permit us to pursue available remedies or limit the damages that we may sustain; and (6) enforce our Terms & Conditions of Use.

In the event there is a change in the corporate structure of JD Supra such as, but not limited to, merger, consolidation, sale, liquidation or transfer of substantial assets, JD Supra may, in its sole discretion, transfer, sell or assign information collected on and through the Service to one or more affiliated or unaffiliated third parties.

Links to Other Websites

This Website and the Service may contain links to other websites. The operator of such other websites may collect information about you, including through cookies or other technologies. If you are using the Service through the Website and link to another site, you will leave the Website and this Policy will not apply to your use of and activity on those other sites. We encourage you to read the legal notices posted on those sites, including their privacy policies. We shall have no responsibility or liability for your visitation to, and the data collection and use practices of, such other sites. This Policy applies solely to the information collected in connection with your use of this Website and does not apply to any practices conducted offline or in connection with any other websites.

Changes in Our Privacy Policy

We reserve the right to change this Policy at any time. Please refer to the date at the top of this page to determine when this Policy was last revised. Any changes to our privacy policy will become effective upon posting of the revised policy on the Website. By continuing to use the Service or Website following such changes, you will be deemed to have agreed to such changes. If you do not agree with the terms of this Policy, as it may be amended from time to time, in whole or part, please do not continue using the Service or the Website.

Contacting JD Supra

If you have any questions about this privacy statement, the practices of this site, your dealings with this Web site, or if you would like to change any of the information you have provided to us, please contact us at: info@jdsupra.com.

- hide
*With LinkedIn, you don't need to create a separate login to manage your free JD Supra account, and we can make suggestions based on your needs and interests. We will not post anything on LinkedIn in your name. Or, sign up using your email address.