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BEPS, treaty shopping and the Canadian response
In July 2013 the OECD released its BEPS Action Plan which followed the Declaration on BEPS adopted at the May 2013 Ministerial Council Meeting in Paris. The BEPS Action Plan is an ambitious, 15 part multilateral plan to address a number of concerns that the G20 and OECD have expressed relating to international corporate tax planning. This plan was triggered in part by headline grabbing articles in the international press focusing on what were argued as being 'inappropriately low' global effective tax rates of a number of high profile multinational enterprises.
BEPS and treaty shopping
The BEPS Action Plan includes 15 actions points, one of which is “Action 6 – Prevent Treaty Abuse”. The BEPS Action Plan states that “treaty abuse is one of the most important sources of BEPS concerns”.
On 14 March 2014 the OECD released its public discussion draft relating to Action 6. In that discussion draft the OECD recommended an approach to treaty shopping that is based on changes to the OECD model tax treaty and to individual bilateral tax treaties. In particular the discussion draft recommended the following “three-pronged approach”:
- It is recommended to include in the title and preamble of tax treaties a clear statement that the Contracting States, when entering into a treaty, wish to prevent tax avoidance and intend to avoid creating opportunities for treaty shopping
- It is recommended to include in tax treaties a specific anti-abuse rule based on the limitation-on-benefits provisions included in treaties concluded by the United States and a few other countries
- In order to address other forms of treaty abuse, including treaty shopping situations that would not be covered by the specific anti-abuse rule described in the preceding paragraph (such as certain conduit financing arrangements), it is recommended to add to tax treaties a more general anti-abuse rule
The discussion draft expands on these recommendations and contains far more detail. The appropriateness of these recommendations can be debated, as they currently are. It is notable that the recommendations are all treaty-based – in other words none suggests that individual countries should adopt unilateral, domestic law-based approaches to treaty shopping (although it should be noted that the BEPS Action Plan did indicate that recommendations would be developed regarding the design of domestic rules to prevent the granting of treaty benefits in inappropriate circumstances). It seems obvious that a coordinated, multilateral, treaty based approach to addressing perceived treaty shopping issues would be preferable to having individual countries adopt their own approaches. Nevertheless Canada seems to be prepared to “go it alone” or, as some might argue - “lead the way”.
Canada and treaty shopping
Throughout the time that the BEPS Action Plan has been developing, and notwithstanding the fact that Canada is known to be actively involved in the international discussions and efforts behind the BEPS Action Plan, Canada has been taking its own steps and its own approaches to treaty shopping. In particular the Canadian Minister of Finance (at the time the late Jim Flaherty) announced in his Budget of March 2013 “the Government’s intention to consult on possible measures that would protect the integrity of Canada’s tax treaties while preserving a business tax environment that is conducive to foreign investment”. These are laudable objectives and hard to dispute. Nevertheless, as noted above, their appropriateness at this time can be debated.
Following this announcement the Department of Finance released a consultation paper in August 2013 with the consultation period open to 13 December 2013. The federal budget of February 2014 (Budget 2014) included a formal proposal for a domestic Canadian anti-treaty shopping rule. The main elements of the proposed rule were described in Budget 2014 as follows:
- Main purpose provision: subject to the relieving provision a benefit would not be provided under a tax treaty to a person in respect of an amount of income, profit or gain (relevant treaty income) if it is reasonable to conclude that one of the main purposes for undertaking a transaction, or a transaction that is part of a series of transactions or events that results in the benefit, was for the person to obtain the benefit
- Conduit presumption: it would be presumed, in the absence of proof to the contrary, that one of the main purposes for undertaking a transaction that results in a benefit under a tax treaty (or that is part of a series of transactions or events that results in the benefit) was for a person to obtain the benefit if the relevant treaty income is primarily used to pay, distribute or otherwise transfer, directly or indirectly, at any time or in any form, an amount to another person or persons that would not have been entitled to an equivalent or more favourable benefit had the other person or persons received the relevant treaty income directly
- Safe harbour presumption: subject to the conduit presumption it would be presumed, in the absence of proof to the contrary, that none of the main purposes for undertaking a transaction was for a person to obtain a benefit under a tax treaty in respect of relevant treaty income if:
- The person (or a related person) carries on an active business (other than managing investments) in the state with which Canada has concluded the 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 relevant treaty income
- The person is not controlled, directly or indirectly in any manner whatever, by another person or persons that would not have been entitled to an equivalent or more favourable benefit had the other person or persons received the relevant treaty income directly
- The person is a corporation or a trust the shares or units of which are regularly traded on a recognised stock exchange
- Relieving provision: if the main purpose provision applies in respect of a benefit under a tax treaty, the benefit is to be provided, in whole or in part, to the extent that it is reasonable having regard to all the circumstances
What does all this mean?
The potential impact of a Canadian domestic anti-treaty shopping rule will of course depend on what form the proposed rule ultimately takes. However, at this point it seems like a very reasonable assumption that Canada will forge ahead with a domestic anti-treaty shopping rule and that the rule will take a form substantially similar to what was proposed in Budget 2014, notwithstanding the OECD public discussion draft released on 14 March 2014 recommending a treaty based approach to treaty shopping, not individual, domestic law approaches.
Coming into force
Budget 2014 indicates that “the rule would apply to taxation years that commence after the enactment of the rule into Canadian law”. This seems inordinately tight. In some circumstances it could have application to a taxpayer the day after enactment. Changes to Canadian tax laws generally provide taxpayers with appropriate grandfathering for existing situations or a transition period to allow taxpayers to reorganise and adapt if grandfathering is inappropriate. Hopefully this will be reconsidered. Indications seem to be that the proposed treaty shopping rule will be included in the second BIA this autumn which would mean that the proposed rule could potentially have effect before the end of 2014.
It seems that the Canadian Minister of Finance and the Department of Finance plan to move forward with their anti-treaty shopping proposals notwithstanding the 14 March 2014 BEPS Action Plan discussion draft and the very different approaches suggested therein. As well, unless the coming-into-force is relaxed, the proposed rule could be in effect before the end of 2014. Accordingly, non-resident multinationals will have to pay close and immediate attention to developments in this regard, both with respect to the structuring of proposed investments into Canada and with respect to the structure of existing investment.
However, this may prove challenging. Although aspects of the proposed rule, such as the “main purpose” test, the granting of derivative benefits that are “reasonable in the circumstances”, and views expressed by Canada’s Department of Finance that the proposed rule should not impact “normal commercial transactions”, can be superficially attractive, one’s view of what is “reasonable” or “normal” depends on one’s perspective. These will be challenging concepts for all stakeholders, be they taxpayers, their advisors (or auditors) or the Canada Revenue Agency to apply in practice.
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