Department of Finance Releases Consultation Paper on Anti-Treaty Shopping Measures

by Bennett Jones LLP
Contact

In the March 2013 Federal Budget, the Department of Finance indicated that it intended to initiate a consultation process on certain "treaty shopping" practices.  On August 12, 2013, the government released a consultation paper entitled Treaty Shopping - The Problem and Possible Solutions in which it invites stakeholders to comment on possible approaches to curtail treaty shopping. The government released the consultation paper amidst a broad international review of the potential abuses of tax treaties. On July 19, 2013, the Organization for Economic Cooperation and Development (OECD) published its highly anticipated Action Plan on Base Erosion and Profit Shifting, which was subsequently endorsed by the G20 Finance Ministers and Central Bank Governors in Moscow on July 20, 2013.

This update provides a brief summary of the consultation paper and highlights issues that stakeholders, including multinational enterprises with Canadian inbound investment and financing structures, may wish to consider, including providing submissions to the government regarding developing an appropriate approach to treaty shopping.

Treaty Shopping in Canada

Treaty shopping in the Canadian context refers to a situation where an enterprise 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 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. In the consultation paper, the government indicates that it considers the following circumstances as hallmarks of treaty shopping: (1) the intermediary entity is owned or controlled primarily by residents of another country which are not entitled to the same treaty benefits; (2) the intermediary entity pays little or no taxes in its country of residence on the income earned in Canada; and (3) the intermediary entity does not carry on "real and substantial business activities" (other than managing investment income) in its country of residence.

The government's position on treaty shopping is that it is inappropriate to indirectly access tax treaty benefits through the use of an intermediary resident in a country with favourable tax treaty terms for the following reasons: (1) the benefits of the reduction in Canadian tax realized by the third country residents are not necessarily reciprocated to Canadians investing in that country; (2) it denies Canada the opportunity to negotiate terms that reflect the tax system of the third country as well as the ability to determine the countries with which Canada is willing to negotiate bilateral tax treaties for political or other reasons; and (3) Canada's intention to reduce Canadian taxation of non-residents is implemented by amendments to the Income Tax Act (Canada) and not by indirectly accepting structures which implement treaty shopping.

Judicial Response

To date the Minister of National Revenue has been largely unsuccessful in challenging treaty shopping in court.  In MIL (Investments) S.A. v The Queen, the corporate taxpayer, which was resident in the Cayman Islands, a jurisdiction with which Canada has no treaty, continued into Luxembourg prior to claiming an exemption under the Canada-Luxembourg Treaty in respect of capital gains realized on the subsequent disposition of taxable Canadian property.  The Crown alleged that the taxpayer was involved in abusive treaty shopping and the exemption should be denied.  However, the Federal Court of Appeal held that the textual provisions of the treaty supported the availability of the exemption and rejected the Minister's argument that treaty shopping was against the object and purpose of the treaty.  More recently, in Prévost Car Inc. v The Queen and Velcro Canada Inc. v The Queen, the Minister argued unsuccessfully that favourable treaty withholdings rates on dividends and royalties, respectively, should be denied because the intermediate entity receiving payments from Canada was not the "beneficial owner" of the payments.  In light of being unsuccessful in the courts, the government is now attempting to develop a workable legislative approach to prevent what it perceives as abusive treaty shopping.

Approaches to Anti-Treaty Shopping

The purpose of the consultation paper is to discuss the relative merits of a number of possible approaches to preventing treaty shopping into Canada in an attempt to find a workable solution.  The paper indicates that the government is not only committed to ensuring that the purposes of Canada's tax treaties are achieved, but also ensuring that Canada remains an attractive destination for foreign investors.

As a threshold matter, Canada must decide whether to incorporate anti-treaty shopping rules into its domestic tax laws or its bilateral tax treaties.  Although the consultation paper recognizes that negotiating effective anti-treaty shopping provisions in Canada's tax treaties might ultimately produce the most comprehensive and effective measures, that approach could take decades to implement as it would depend on the amount of resources dedicated to treaty negotiations and would require consent from treaty partners.  The consultation paper appears to favour the domestic law approach, which could be implemented consistently across Canada's treaty network in a timely manner.  As a potential drawback, the paper notes that the government's ability to draft effective domestic legislation might be constrained by potential conflicts with Canada's existing treaty obligations.

The consultation paper also provides a discussion of the range of legislative approaches to curtailing treaty shopping, from general to specific anti-treaty shopping rules.  The paper discusses a number of approaches, including the U.S.-style "limitation on benefits" article, similar to Article XXIX-A of the Canada-US Treaty, as well as a general anti-abuse rule that would apply only to specific types of income, such as dividends, interest and royalties.  There are a number of factors to consider in weighing the appropriate response to treaty shopping.  A general approach may be over-inclusive, and accordingly, may expose businesses to compliance risk.  A general approach may also impose a significant administrative burden on the Canada Revenue Agency in terms of developing guidance, responding to administrative ruling requests, and carrying out enforcement. Specific rules, on the other hand, have the advantage of greater certainty for taxpayers, although they are generally more complex and may produce inappropriate results in the absence of effective discretionary authority.

While encouraging discussion on all aspects of the consultation paper, the government is asking stakeholders to submit comments by December 13, 2013, on seven specific questions, each of which deals with different approaches to preventing treaty shopping:

  1. Comment on the advantages and disadvantages of a domestic law approach, a treaty-based approach, or a combination of both.
  2. Comment on the relevant merits of the various approaches to treaty shopping identified by the OECD as well as whether there are other approaches and types of rules that should be considered in Canada in evaluating how best to address the problem of treaty shopping.
  3. Provide views on whether a general approach is preferred over a relatively more specific and objective approach.
  4. Provide views on whether a main purpose test, if enacted in domestic tax laws, would be effective in preventing treaty shopping and achieve an acceptable level of certainty for taxpayers.
  5. Provide input on which of the approaches (a main purpose approach or a more specific approach) strikes the best overall balance between effectiveness, certainty and simplicity, and ease of administration.
  6. For stakeholders who favour a more specific approach over a main purpose approach, provide input on the design of the conditions and exceptions (e.g., the substantive business operations and derivative benefits exceptions) under a more specific approach as well as any other exceptions that should be considered under this approach with a view to ensuring the measure is effective and applies in a reasonably straightforward manner with predictable outcomes.
  7. Comment on whether or not a domestic anti-treaty shopping rule should apply if a tax treaty contains a comprehensive anti-treaty shopping rule.

Next Steps

The government's approach to treaty shopping is a matter of concern for any multinational enterprise that has, or is intending to have, an intermediary entity in its corporate structure.  It appears clear from the consultation paper that the government intends to introduce anti-treaty shopping rules, and it may simply be a matter of determining when they will be implemented and in what form.  While the consultation paper does not address how these rules will impact current structures, it is clear that they will impact many Canadian businesses that rely on foreign investment.  The government has stated that one of the purposes of the consultation paper is to ensure that Canada remains an attractive destination for foreign investors.  As such, interested stakeholders that are considering making submissions on the consultation paper are encouraged to consider the following:

  • presenting their preferred approach to treaty shopping in light of their business operations and capital structure and highlighting the business risks associated with the different approaches to anti-treaty shopping rules;
  • requesting exemptions that would be appropriate for businesses that are not using intermediary entities primarily to access treaty benefits;
  • providing information about the various business reasons for using intermediary entities other than obtaining a tax benefit; and
  • requesting transitional rules for existing structures.

 

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.
Custom Email Digest
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.