On July 21, 2014, a protocol (Protocol) to amend the Canada-U.K. tax treaty (Treaty) was signed in London, England. Negotiations to update the Treaty had been ongoing since the fall of 2011.
Key provisions of the Protocol include the following:
- The Protocol will generally eliminate the ability of source states to impose withholding tax on interest paid to a person "dealing at arm's length" with the payer. This parallels recent changes in Canadian domestic law which generally eliminated withholding tax on arm's length interest payments. Under an addendum to the Protocol, it was agreed that, for Canadian tax purposes, the codified rules in the Income Tax Act for determining whether persons deal at arm's length would apply; parallel provisions set out the U.K. rules for determining whether persons are "dealing at arm's length."
- As worded, the new interest withholding tax provision will override a rule in the Income Tax Act which generally permits Canada to impose withholding tax on interest payments to an unrelated person where the interest coupons have been stripped from a debt obligation held by a related person. This appears to mean that if a U.K. resident dealing at arm's length with a Canadian debtor is the recipient of an interest payment from a "stripped" coupon, Canada may be precluded from imposing withholding tax even if the debt obligation itself is held by a related person.
- New time limits will apply to transfer pricing assessments. As a general matter, once eight years have elapsed from the tax year in question, tax authorities will be precluded from assessing a "primary adjustment" to the profits of an enterprise. This wording appears to differ from the language typically used in Canadian treaties which impose similar limitations. While not entirely clear, the unusual reference to a "primary adjustment" may be intended to signal that the limitation rule is not intended to limit a tax authority's ability to assess a "secondary" (typically withholding tax) adjustment.
- A new eight-year time limit is also added to the mutual agreement (competent authority) procedure article relating to relief from double taxation. As well, unresolved double tax cases are to be resolved through a new arbitration process that generally takes effect once three years have elapsed from the start of the competent authority process. The detailed procedures for arbitration are to be agreed between the two countries' tax authorities.
- The Protocol adds a new "exchange of information" article which is stated to reflect the "common reporting standard" adopted by the Organization for Economic Co-operation and Development (OECD) as well as a new collection assistance article. These new provisions permit a tax authority from one country to enter the other country to conduct tax audits in accordance with procedures to be developed.
Equally interesting is what was not included in the Protocol, specifically:
- No amendment will be made to the "capital gains" article. Under this existing provision, "immovable property" is defined narrowly; specifically, it generally does not include property in which the business of the enterprise is carried on. This generally has the effect of enabling a U.K. resident to realize a gain on the sale of shares of, for example, an active Canadian resource company (the real property of which is used in its business) without facing any Canadian capital gains tax. The Department of Finance had previously stated that this provision – found in not only the U.K. Treaty, but also a number of other European treaties – was generally no longer consistent with Canadian treaty policy. Thus it had been widely expected that the provision would be replaced by a broader definition of "immovable property" more consistent with the usual OECD capital gains provisions. Such a change would have allowed Canada to tax gains from sales of shares of, for example, active resource companies. One can only speculate that the retention of the existing language reflects the usual trade-offs arising in the negotiation process.
- No specific provisions were included in the Protocol related to "treaty shopping." The Government of Canada is currently considering a statutory amendment to enact a rule of general application under which a treaty benefit otherwise available under any tax treaty could be denied if "one of the main purposes" of a transaction was to obtain the benefit. Interestingly, the Treaty already contains a "main purpose" rule, but it applies only to the dividends, interest and royalties articles, and not, for example, to the business profits or capital gains articles.
- Unlike the latest protocol to the Canada-U.S. treaty, the Protocol does not eliminate withholding tax on related party interest payments. Thus, payments of within-the-group interest from Canada to the U.K. will continue to be subject to withholding tax.
The Protocol must be ratified by Parliament in both countries. If ratification occurs in 2014, the Protocol will generally enter into force January 1, 2015 for withholding tax purposes, and for income tax purposes, for tax years beginning after ratification.
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.