Canada: Update On The Status Of The Multilateral Instrument In Canada
Last Updated: July 12 2019
Article by Alain Ranger
On June 21, 2019, one year after it was tabled in the House of Commons, Bill C-82, An Act to implement a multilateral convention to implement tax treaty related measures to prevent base erosion and profit shifting, received Royal Assent and became law. By way of background, Canada had signed the Multilateral Instrument (the "MLI") on June 7, 2017 and had then announced its intention to adopt the minimum standards proposed by the Organisation for Economic Co-operation and Development (the "OECD") under the Base Erosion and Profit Shifting project, as well as mandatory arbitration for tax treaty disputes.
The next step for Canada is to notify the OECD through the deposit of its instrument of ratification which is likely to be done before the end of the year. The MLI will then enter into force for Canada on the first day of the month following the expiration of a three-month period from the date of notice to the OECD. For example, if the notice is sent in October 2019, the MLI will enter into force for Canada on February 1, 2020.
The MLI provisions on withholding tax will then take effect between Canada and a treaty partner where the MLI is already in force on the first day of the next calendar year, i.e. January 1, 2021. For other taxes, such as the capital gains tax on shares meeting the real property asset valuation threshold (discussed below), the MLI will have effect for the taxable periods beginning after a six month period (or a shorter period if the contracting states notify the OECD that they intend to apply such a period), i.e. for the taxable periods beginning August 1, 2020.
As of July 4, 2019, out of the 89 countries who signed the MLI, 29 have deposited their instrument of ratification with the OECD, including Australia, Finland, France, India, Ireland, Luxemburg, Japan, the Netherlands, New Zealand, Sweden and the United Kingdom.
As indicated, Bill C-82 confirms the adoption of the minimum standards, along with other measures for which Canada had initially registered a reservation, including the two following measures which are noteworthy.
1. MLI – Article 8, paragraph 1: Dividend Transfer Transactions
Most tax treaties signed by Canada call for a reduction in the domestic withholding tax rate on dividends from 25% to 5% when the beneficial owner of the dividends is a corporation subject to corporate tax in the contracting jurisdiction that directly or indirectly holds at least 10% of the voting rights (and, in some cases, of the capital) of the Canadian corporation paying the dividend. Fulfillment of the 10% ownership test is determined when the dividend is paid.
By adopting the restriction described in paragraph 1 of Article 8 of the MLI, Canada agrees to apply the reduced withholding tax rate of 5% only if shares granting voting rights (and capital, where applicable) of at least 10% are owned throughout a 365-day period, including the day on which the dividend is paid. For the purpose of computing that period, no account shall be taken of changes of ownership that are a direct result of a corporate reorganisation, such as a merger or divisive reorganisation, of the corporation that holds the shares or the Canadian corporation that pays the dividend. This amendment will block surplus exit planning strategies where the shareholding of a Canadian corporation was modified within days prior to the payment of a dividend, which was generally easy to achieve from a Canadian tax perspective as the gain on the sale of the shares of a Canadian corporation is not taxable unless more than 50% of the value of the shares is derived directly or indirectly from real or immovable property, resource property or timber resource property situated in Canada.
2. MLI – Article 9, paragraph 1: Capital Gains from Alienation of Shares or Interests of Entities Deriving Their Value Principally from Immovable Property
Canadian domestic law stipulates a five-year test to determine taxation of a capital gain from disposition of shares or other interests in entities whose value is or was mainly (i.e. more than 50%) derived from immovable property in Canada. Thus, if, at any time during this 60-month period ending on the date of disposition of the shares, more than 50% of their value was derived directly or indirectly from an immovable property located in Canada, the capital gain from the disposition is taxable in Canada. In comparison, most tax treaties signed by Canada do not include a retroactive test. In fact, the value test is generally applied at the time of disposition. It was therefore possible, subject to the general anti-avoidance rule, to proceed with an asset "stuffing" to decrease the relative value of the immovable property in Canada below the 50% threshold before the sale.
With paragraph 1 of Article 9 of the MLI, Canada is adopting a one-year retroactive look back, i.e. Canada is reserving the right to tax the capital gain if the 50% value threshold is exceeded at any time during the 365 days preceding the disposition.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
China Tax & Investment Consultants Ltd expresses great gratitude to Mr. Ranger for his permission to reproduce this article here and below.
Canada: Canada Ratifies The Multilateral Instrument
Last Updated: September 6, 2019
Article by Ehsan Wahidie
and Michel M. Ranger
On June 7, 2017, Canada along with numerous other jurisdictions signed the Organisation for Economic Co-operation and Development’s (“OECD”) Multilateral Convention to Implement Tax Treaty Related Measures to Prevent Base Erosion and Profit Shifting (the “MLI” or “multilateral instrument”). The multilateral instrument is the culmination of work undertaken as part of the OECD/G20 BEPS Project to equip governments with domestic and international instruments to address tax avoidance.
On June 21, 2019, Canada took an important step forward in the domestic ratification process required to bring the MLI into effect in Canada when Bill C-82, An Act to implement a multilateral convention to implement tax treaty-related measures to prevent base erosion and profit shifting, received Royal Assent enacting the MLI into law in Canada.
The final step that would bring the MLI into force in Canada was completed on August 29, 2019 when Canada deposited its instrument of ratification with the OECD. The deposit of the instrument of ratification brings the MLI into force for Canada on December 1, 2019. The MLI will enter into effect for certain of Canada’s tax treaties, including tax treaties with France and the United Kingdom, as early as January 1, 2020.
The MLI consists of various countermeasures that were proposed as part of the OECD/G20 BEPS Project aimed at thwarting base erosion and profit shifting-type planning activities. However, rather than undertake the lengthy and tedious process of renegotiating existing bilateral tax conventions with each treaty partner jurisdiction, the MLI provides a framework and a mechanism to modify existing bilateral tax treaties where each bilateral treaty partner has ratified the MLI and has notified the OECD that the MLI applies to the treaty. Such bilateral tax treaties are referred to as Covered Tax Agreements in the MLI. At the time of signing the MLI, Canada had identified 75 tax treaties as Covered Tax Agreements, which has now been increased to 84 with the inclusion of nine additional treaties.
The overall effect of the MLI is to modify specific provisions of Covered Tax Agreements based on the standards introduced in the MLI. Subject to adopting the minimum standards set out in the MLI that all participating countries have agreed to adopt, signatories can opt in to one or more provisions of the MLI. Under the MLI, a country may expand the scope of its commitment by withdrawing or limiting a reservation, but it cannot subsequently narrow its commitment by adding or broadening a reservation at a later date.
Commitments by Canada
Canada had originally taken a conservative approach and registered provisional reservations on all of the measures contained in the MLI except (i) the minimum standards on treaty abuse and dispute resolution, and (ii) the mandatory binding arbitration for disputes involving tax treaties.
The minimum standards to address treaty abuse, consisting of the preamble (Article 6) and a substantive anti-abuse rule (Article 7), will operate alongside Canada’s Covered Tax Agreements. The preamble clarifies that the purpose of a bilateral tax treaty is to eliminate double taxation without creating opportunities for non-taxation or reduced taxation through tax evasion or avoidance. The anti-abuse rule consists of the “principal purpose test”, which denies treaty benefits for an item of income or capital if it is reasonable to conclude, having regard to all relevant facts and circumstances, that obtaining the benefit was one of the principal purposes of any arrangement or transaction that resulted directly or indirectly in the benefit (unless the taxpayer establishes that granting the benefit in the circumstances would be consistent with the object and purpose of the relevant provisions of the treaty in question).
Dispute Resolution Measures
The minimum standards for resolving treaty-related disputes will also operate alongside Canada’s Covered Tax Treaties once the MLI takes effect, requiring signatory jurisdictions to implement a mutual agreement procedure under which the competent authorities of each jurisdiction must attempt to resolve certain disputes within three years of notification of the dispute.
Finally, Canada has also opted into the mandatory arbitration procedures under the MLI, which are similar to the existing arbitration provisions under the Canada-US Income Tax Convention.1 The mandatory binding arbitration measures provide for two different arbitration mechanisms:
- The default mechanism, a “final offer” mechanism, where the competent authorities of two jurisdictions cannot come to an agreement within a specified period of time, under which each competent authority presents its own proposed resolutions and the arbitrators choose their preferred outcome between the two proposals that were submitted.
- An “independent opinion” mechanism, under which a decision is rendered by the arbitrators on the basis of their own analysis of the information provided to them.
Canada has expanded the scope of its initial commitment under the MLI by adopting the following additional optional provisions geared towards foreclosing perceived opportunities for taxpayers to avoid or reduce taxation in inappropriate circumstances:
- Deny the benefit of lower treaty-based withholding rate on dividends where non-resident companies hold shares of a Canadian company for less than 365-days (Article 8);
- Allow taxation by the source jurisdiction of capital gains derived by non-residents on interests that derive their value from Canadian immovable property where the relevant value threshold is met at any time during the 365 days preceding the alienation (Article 9); and
- Implement an approach to resolve dual resident entity cases, designed to prevent double taxation, as well as ensure that companies and other entities cannot avoid or reduce their taxes by strategically selecting their tax residence (Article 4).
Canada has also adopted a provision of the MLI that will allow certain treaty partners to move from an exemption system as their method of relieving double taxation to a foreign tax credit system (Article 5).
The Department of Finance has expressed its intention to adopt the detailed limitation on benefits provisions (composed of specific criteria) contained in the MLI over the longer term through the re-negotiation of its bilateral tax treaties (rather than through the MLI mechanism).
With the deposit of the instrument of ratification with the OECD, the MLI would enter into force in Canada on December 1, 2019.
Generally, the provisions of the MLI would then come into effect in Canada in respect of Covered Tax Agreements with countries that have completed their domestic procedures to cause the MLI to come into effect
- with respect to source withholding taxes paid or credited to non residents, on January 1, 2020; and
- with respect to all other taxes, for taxable periods beginning six months after July 1, 2020.
The MLI will have far-reaching effects on the tax treatment of many cross-border arrangements. Canada’s commitment under the MLI requires businesses to be forward thinking and anticipate transactions that may materialize in the near future to ensure compliance with the new requirements; otherwise, the MLI could operate to deny benefits under Canada’s bilateral tax treaties, resulting in substantially higher tax burdens.
Now that the MLI has obtained Royal Assent, companies and individuals engaging in transactions with international tax implications should seek legal advice to ensure that their tax planning considers and addresses the new standards.
1 The United States is not a signatory to the MLI.
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