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Canada's Tax Treaty Anti-Abuse Changes Explained

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Canada's Tax Treaty Anti-Abuse Changes Explained (1).jpgThe Canadian Government has explained how it will incorporate into its tax agreements new provisions to counter base erosion and profit shifting (BEPS), having signed the OECD's multilateral instrument on tackling treaty abuse.

What’s The Multilateral Instrument?

The MLI, also known as the BEPS Convention, was developed by the OECD under Action 15 of the BEPS project and will transpose BEPS recommendations into tax treaties worldwide.

The Convention is intended to implement minimum standards to counter treaty abuse and to improve dispute resolution mechanisms, while providing flexibility to accommodate countries' specific tax treaty policies. Crucially, the MLI will achieve this without the need for thousands of individual bilateral tax treaties to be renegotiated, a process which could take several years, if not decades.

On June 7, 2017, 68 countries and territories, including Canada, signed the MLI at a ceremony at the OECD’s headquarters in Paris. The instrument remains open for signature by other jurisdictions, and the first modifications to bilateral tax treaties are expected to enter into effect in early 2018. The MLI remains open for additional signatories.

What’s Canada’s New Tax Treaty Policy?

The Canadian Government said in a backgrounder released by the Department of Finance on June 7 that a new preamble and a substantive rule will be included in Canada’s existing treaties. In essence, this text is designed to prevent so-called "treaty shopping," a practice whereby a national or resident of a third country seeks to obtain the benefit of a double tax agreement between two other countries.  Canada will introduce the "principal purpose test" provided for by the Convention, which would deny a benefit under a tax treaty where one of the principal purposes of an arrangement or transaction is to obtain a benefit under the tax treaty.

Over the longer-term, Canada will, where appropriate, seek to negotiate on a bilateral basis a detailed limitation of benefits (LOB) provision that would also meet the minimum standard set out in the MLI. Tax treaty LOB clauses attempt to deny treaty benefits – i.e. their reduced rates of tax for certain types of income – to residents that do not meet additional tests.

Canada has also chosen to adopt a provision to improve dispute resolution, namely the mandatory binding arbitration provision, which is designed to improve the process of resolving double taxation disputes between tax authorities and taxpayers.

The implementation of the minimum standards will affect most of Canada's tax treaties. However, for the amendments to apply, the relevant treaty partners must also ratify the Multilateral Convention and include their tax treaty with Canada. The Department of Finance said that Canada may find it preferable, or necessary,” to update certain treaties bilaterally – a process that is likely to take some time.

Canada will continue to assess whether to adopt further provisions later; signatories to the MLI may expand the scope of their commitment under the Convention but cannot later narrow this.

Taxpayers Beware

The tax treaty changes are expected have a significant impact on individuals and businesses with cross-border tax affairs and who rely on tax treaties to prevent double taxation of the same income. Consequently, in many cases, tax compliance is likely to become more difficult for these taxpayers as jurisdictions take different approaches on implementing the MLI and the tax treaty framework becomes harder to navigate.

Tax

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