Backgrounder: The Next Step in the Fight Against Aggressive International Tax Avoidance
Canada's economy won't work for everyone, if everyone doesn't pay their fair share.
By ensuring that all Canadians pay their fair share of taxes, and by taking the next step in the fight against aggressive international tax avoidance, the Government of Canada will safeguard its ability to invest in the programs and services that help the middle class and people working hard to join it. At the same time, the Government recognizes that these actions cannot be done in isolation. Ensuring tax fairness is a complex process, requiring ongoing engagement with a wide range of partners both at home and internationally.
One important part of that process is the Multilateral Convention to Implement Tax Treaty Related Measures to Prevent Base Erosion and Profit Shifting (also known as the Multilateral Instrument, or MLI). The MLI is the product of a global initiative involving over 100 jurisdictions. It allows participating jurisdictions to implement treaty-based measures developed through the Organisation for Economic Co-operation and Development (OECD) and the G20's project to counter base erosion and profit shifting (BEPS).
BEPS refers to tax avoidance strategies in which businesses and wealthy individuals can use tax treaty loopholes to inappropriately shift profits to low-tax or no-tax locations, to avoid paying taxes. In some cases, this includes transactions designed to shift taxable profits to a lower-tax jurisdiction, and away from the jurisdiction where the underlying economic activity has taken place, in order to avoid paying the full and fair share of taxes owed.
In its efforts to address BEPS, the OECD identified a number of specific instances in which the terms of current tax treaties could give rise to potential abuse. Accordingly, the OECD developed countermeasures that countries could choose to incorporate into their tax treaties to effectively close these loopholes. However, given the large number of tax treaties in existence, and the extended period of time that bilateral renegotiation of each of those agreements would entail, a new approach was developed so that these changes could be implemented in a more timely and efficient manner. That new approach is the MLI.
The MLI will allow signatory nations to swiftly modify their bilateral tax treaties to incorporate the OECD's anti-BEPS provisions, and to work more effectively together in the fight against aggressive international tax avoidance. It was developed and negotiated by more than 100 countries and jurisdictions, including Canada, and is the first multilateral convention to modify the application of bilateral tax treaties. At the same time, the MLI will improve the functioning of the international tax system, and provide greater certainty for Canadian taxpayers by improving dispute resolution under Canada's tax treaties.
Some of the MLI provisions are mandatory, and others are optional. The mandatory provisions relate to the minimum standards established by the OECD (standards that all participating countries have agreed to adopt). Countries are free to choose among the optional provisions.
Consistent with the Government's expressed intentions when Canada signed the MLI on June 7, 2017, the Government proposes to adopt the BEPS minimum standards on treaty abuse and improving dispute resolution, as well as mandatory binding arbitration in relation to tax treaty disputes. In addition, Canada proposes to adopt a number of the optional provisions in the MLI upon ratification. This will foreclose opportunities for taxpayers to avoid or reduce taxation in inappropriate circumstances.
By tabling legislation in the House of Commons to implement the MLI, the Government of Canada will be taking the next step in the fight against aggressive international tax avoidance, safeguarding the Government's ability to invest in Canadians, and ensuring that the benefits of economic growth are felt by more people, not just the wealthy few.
Technical Details on Implementing the MLI
Assuming that Parliament approves the implementing legislation, Canada intends, at the time of depositing its instrument of ratification, to confirm its commitment to the minimum standards on treaty abuse and to improving dispute resolution.
The minimum standard to address treaty abuse consists of the inclusion of a new tax treaty preamble and a substantive anti-abuse rule:
- The preamble, which is a statement of the aims or purposes of a treaty, clarifies that the covered tax treaty is intended to eliminate double taxation without creating opportunities for non-taxation or reduced taxation through tax evasion or avoidance.
- The anti-abuse rule is based on the principal purpose of transactions or arrangements. It has the effect of denying a benefit under a tax treaty where one of the principal purposes of any arrangement or transaction was to obtain that benefit, unless the granting of that benefit is in accordance with the purpose and object of the relevant provisions of the treaty.
In addition, Canada will seek, over the longer term and where appropriate, to include in its bilateral tax treaties a detailed limitation on benefits provision. Such a limitation on benefits provision would deny treaty benefits to a taxpayer in circumstances where the taxpayer does not meet specific criteria.
Canada will also confirm its commitment, under the MLI, to implement the minimum standard with respect to the dispute resolution features of its tax treaties. As well, Canada will confirm its commitment to adopt mandatory binding arbitration as a mechanism to ensure the effective and timely resolution of treaty-based disputes.
Mandatory binding arbitration is a mechanism that obligates the parties to a tax treaty to submit unresolved cases to an independent and impartial decision maker—an arbitration panel. The decision reached by the arbitration panel is binding on the parties. The mandatory binding arbitration procedure adopted through the MLI will be substantially the same as the mandatory binding arbitration procedure under the Canada-United States Tax Convention.
Canada intends to adopt a number of the MLI's optional provisions for the purposes of Canada's tax treaties. Three of the provisions of the MLI that Canada intends to adopt on ratification will foreclose opportunities for taxpayers to avoid or reduce taxation in inappropriate circumstances.
In respect of the tax treaties to which they apply, these provisions will:
- impose a 365-day holding period for shares of Canadian companies held by non-resident companies. The holding period will ensure that the lower treaty-based rate of withholding tax on dividends will not be available to non-resident companies that engage in certain short-term share acquisitions;
- impose a 365-day test period for non-residents who realize capital gains on the disposition of shares or other interests that derived their value from Canadian immovable property. The test period will guard against certain transactions designed to obtain a treaty-based exemption from Canadian taxes on capital gains; and
- incorporate the MLI provision for resolving dual resident entity cases. This provision employs an effective approach to resolving dual resident cases to prevent potential double taxation, while providing protection against companies and other entities that attempt to manipulate their tax residence to avoid or reduce their taxes.
In addition, Canada intends to adopt 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.
A party to the MLI may expand the scope of its commitment under the MLI but it cannot subsequently narrow its commitment in respect of those provisions that it has agreed to adopt. As such, Canada is committing to the adoption of provisions relating to the minimum standards and the optional provisions described above. Canada also has the flexibility, if it so chooses, to adopt additional provisions of the MLI after ratification.
The adoption of the optional measures described above, along with the treaty-based minimum standards for preventing treaty abuse and the measures to improve the dispute resolution process, will significantly enhance Canada's ability to protect its tax base and support the international effort to address BEPS.