Canada: Are Private Equity And Other Collective Investors Entitled To Tax Treaty Benefits?

In November 2015, Prime Minister Justin Trudeau and the other G20 leaders endorsed the OECD's base erosion and profit shifting (BEPS) measures. The BEPS project is an ambitious plan undertaken jointly by the OECD and G20 to overhaul the global international tax system, culminating in a 2015 "Final Report" with hundreds of pages of recommendations. (A summary of the 2015 BEPS Report can be found here).

2015 BEPS Report – Action 6 minimum standards

Action 6 of the 2015 BEPS Report (Preventing the Granting of Treaty Benefits in Inappropriate Circumstances), included an agreed "minimum standard" for countries to prevent tax treaty abuse by:

  1. including in their tax treaties an express statement that their common intention is to eliminate double taxation without creating opportunities for non-taxation or reduced taxation through tax evasion or avoidance, including through treaty shopping arrangements; and
  2. implementing such common intention through (a) a general anti-abuse rule based on the principal purposes of transactions or arrangements (the principal purpose test or "PPT" rule), (b) a limitation on benefits (LOB) rule that is supplemented by an "anti-conduit" mechanism, or (c) a combination of a LOB and PPT rule.

The 2015 BEPS report concluded that treaty benefits should be provided to collective investment vehicles (CIV), being widely held funds that hold a diversified investment portfolio and are subject to investor protection in the country in which they are established, in the circumstances set out in the OECD's 2010 Report (The Granting of Treaty Benefits with Respect to the Income of Collective Investment Vehicles) [PDF]. That 2010 Report provided for a variety of alternative methods that countries could choose from.

The 2015 BEPS Report also recognized the economic importance of cross-border investments by non-CIV funds such as private equity and hedge funds, and the need to ensure that treaty benefits are granted where appropriate. Without concluding on the appropriate treatment for non-CIV funds, the OECD indicated that further work would be done in the "first part of 2016" to ensure that new treaty provisions adequately address the treaty entitlement of various non-CIV funds. 

2016 discussion draft

In March 2016, the OECD released a discussion draft (Treaty Entitlement of Non-CIV Funds [PDF]), and undertook public consultations. Osler and many others responded to the discussion draft with suggestions on how the OECD could clarify when private equity and other collective investors should be entitled to treaty benefits [PDF].

2016 multilateral instrument (MLI)

In November 2016, the OECD released a multilateral instrument or MLI [PDF] together with a detailed Explanatory Statement [PDF] arising from negotiations involving more than 100 jurisdictions, including Canada. The MLI is intended to allow swift implementation of a series of tax treaty measures that were contained in the 2015 BEPS Report, including the Action 6 treaty abuse "minimum standards." Unfortunately, neither the MLI nor the Explanatory Statement included any changes in response to the March 2016 discussion draft, nor any further guidance on when treaty benefits should be provided to private equity and other collective investors. (A summary of the MLI and the resulting process to amend existing bilateral tax treaties is here). While it is not yet clear whether Canada intends to sign the MLI, the OECD has planned a general signing ceremony for June 2017.

2017 discussion draft – examples

On January 6, 2017 the OECD released its latest discussion draft entitled "BEPS Action 6 Discussion Draft on non-CIV examples." [PDF] This discussion draft includes three examples that are intended to illustrate the application of the OECD's proposed treaty shopping minimum standards for private equity and other non-CIV investors.  In each example, the OECD concludes that (absent additional adverse facts) the PPT ought not to apply to deny treaty benefits despite the fact that such benefits were taken into account in structuring the relevant investment.

  • Example 1Regional Investment Platform: This example involves a resident of State R, RCo, that is a subsidiary of a regulated institutional fund investor (Investor) resident in State T.  RCo makes investments in countries in a regional grouping that includes State R and State S, and earns dividends from State S. Although the regional grouping factor may limit the direct relevance of this example outside of the EU context, Example 1 may be the most helpful of the three examples since RCo is entitled to a lower rate of State S dividend withholding tax than the Investor would have been entitled to if it had invested in a State S issuer directly (5% for RCo vs 10% for the Investor). However, the conclusion that the PPT does not apply in Example 1 is based in part on certain assumed non-tax factors for choosing to set up RCo in State R and on there being material investment functions and other activities carried out in State R. Also, Example 1 is only applicable by analogy to multi-investor funds, as it deals with the special purpose vehicle of a single institutional investor.
  • Example 2 – Securitization Vehicle: RCo, a corporate securitization vehicle resident in State R, was established by a State T bank which sold to RCo a portfolio of receivables from debtors in a number of countries. RCo is funded through the issuance of widely-held notes that are listed and traded on a stock exchange. For regulatory reasons, the bank holds a small percentage of the RCo notes. RCo claims a treaty-reduced rate of interest withholding tax imposed by State S, where 60% of the RCo receivables payments arise. The bank would have been entitled to equivalent benefits on interest payments under a treaty between the country in which the bank is resident and State S. The example is silent on whether the other noteholders would be entitled to equivalent treaty benefits if they held the receivables directly but concludes, based on the bank's taking into account legitimate non-tax factors for choosing State R as the jurisdiction for RCo, that the PPT would generally not apply.     
  • Example 3 – Real Estate Fund: RE Fund is treated as fiscally transparent under the tax law of State C, where it has been organized to invest in a portfolio of real estate investments. RE Fund makes investments indirectly through its holding company, RCo, which enjoys treaty benefits with respect to its real estate investments.  RE Fund's investors would have been entitled to equivalent treaty benefits, and the countries where the real estate investments are based can tax the directly earned income on those investments (e.g. rent). Based on those factors, and the fact that RCo's real property investments are made for commercial purposes, the PPT should generally not apply.

Although the OECD has acknowledged that it is important to provide treaty benefits to private equity and other collective investors in "appropriate" circumstances, the OECD has done very little to provide such investors with the certainty they need at the time investments are made. The above examples provide some guidance but little certainty. In each case, the OECD says that the PPT could apply if there are further facts or circumstances showing that RCo's investments are part of an arrangement, or relate to another transaction, undertaken for a principal purpose of obtaining the benefit of the applicable treaty, which gives leeway for tax authorities seeking to distinguish the examples. Also, there is little indication about how to apply the PPT where most but not all of the investors are equivalent beneficiaries. Finally, the relevance of certain facts is left unexplained: in Example 2, for instance, would treaty benefits potentially be denied if the notes were (as is more often the case) not listed on a stock exchange?  This lack of actionable guidance is particularly disappointing since the OECD, after considering the issue for several years, appears content to proceed with an MLI signing ceremony while offering private equity and other collective investors virtually no guidance on when treaty benefits may or may not be available, other than through the three limited examples in its latest discussion draft. 

The PPT is vague and subjective, allowing tax authorities the potential ability to deny treaty benefits in respect of practically any cross-border investment. This has prompted significant criticism from the United States Treasury and many others. The general uncertainty under the PPT is compounded by the OECD's use of a "one of principal purposes" test, with very little guidance on how to determine whether or when a particular tax consideration may be elevated into a principal purpose, particularly when an investor may have multiple purposes.

The latest discussion draft examples provide little guidance on how to distinguish a "principal purpose" from a general consideration. If a tax benefit is significant, could a tax authority always view it as having been a principal purpose? Could treaty benefits be denied if any of the assumed facts in the examples are missing (such as where investments are not confined to a particular geographic region)? This opens the PPT to being potentially used  as a form of "smell test" under which tax authorities could simply unilaterally decide whether treaty benefits ought to be allowed. Investors would unlikely proceed with an investment based upon the mere hope that tax authorities will subsequently agree that treaty benefits apply.  

The OECD stated that it deliberately kept the number of examples in the discussion draft low and has avoided any "controversial" examples, perhaps with a view to maintaining the illusion of consensus among its members. However, controversial examples are precisely where clarity is most needed, especially in situations where countries may take differing views regarding particular fact patterns. It is important to bring differing views to light, rather than obscuring them. 

The OECD has suggested that countries may address the granting of treaty benefits for private equity and other collective investors on a bilateral basis. While such an approach could work, it is unclear why the OECD would not include sample provisions into its model (and the MLI) for this purpose. For example, the MLI could include a presumption that the PPT would not apply if at least 75% of the ultimate investors in a fund would have been entitled to the same or similar treaty benefits had they not invested on a collective basis (the use of a 75% threshold would allow consistency between the PPT rule and the proposed derivative benefits rule under the MLI's simplified LOB approach). Countries would then be free to include such a rule or follow an alternative approach as desired. In addition, if countries were to address the issue on a bilateral basis they could provide further examples or other guidance on the intended application of the rule in particular circumstances. While such a bilateral approach would be helpful, it would nevertheless be preferable for the OECD to simply provide such guidance on a multilateral basis prior to the MLI changes coming into effect.

Finally, we note that the OECD could also link its Action 6 minimum standards with its recommendations on Action 14 (Making Dispute Resolution Mechanisms More Effective). This could be done, for example, through the use of a pre-ruling mechanism that would allow private equity or other collective investors to determine, on an expedited basis and in advance of an investment, whether treaty benefits will apply to a particular investment. 

Comments on the discussion draft should be sent to the OECD by February 3, 2017. Osler intends to convey our concerns, including those noted above, to the OECD.

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.

To print this article, all you need is to be registered on Mondaq.com.

Click to Login as an existing user or Register so you can print this article.

Authors
 
In association with
Related Video
Up-coming Events Search
Tools
Print
Font Size:
Translation
Channels
Mondaq on Twitter
 
Register for Access and our Free Biweekly Alert for
This service is completely free. Access 250,000 archived articles from 100+ countries and get a personalised email twice a week covering developments (and yes, our lawyers like to think you’ve read our Disclaimer).
 
Email Address
Company Name
Password
Confirm Password
Position
Mondaq Topics -- Select your Interests
 Accounting
 Anti-trust
 Commercial
 Compliance
 Consumer
 Criminal
 Employment
 Energy
 Environment
 Family
 Finance
 Government
 Healthcare
 Immigration
 Insolvency
 Insurance
 International
 IP
 Law Performance
 Law Practice
 Litigation
 Media & IT
 Privacy
 Real Estate
 Strategy
 Tax
 Technology
 Transport
 Wealth Mgt
Regions
Africa
Asia
Asia Pacific
Australasia
Canada
Caribbean
Europe
European Union
Latin America
Middle East
U.K.
United States
Worldwide Updates
Check to state you have read and
agree to our Terms and Conditions

Terms & Conditions and Privacy Statement

Mondaq.com (the Website) is owned and managed by Mondaq Ltd and as a user you are granted a non-exclusive, revocable license to access the Website under its terms and conditions of use. Your use of the Website constitutes your agreement to the following terms and conditions of use. Mondaq Ltd may terminate your use of the Website if you are in breach of these terms and conditions or if Mondaq Ltd decides to terminate your license of use for whatever reason.

Use of www.mondaq.com

You may use the Website but are required to register as a user if you wish to read the full text of the content and articles available (the Content). You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these terms & conditions or with the prior written consent of Mondaq Ltd. You may not use electronic or other means to extract details or information about Mondaq.com’s content, users or contributors in order to offer them any services or products which compete directly or indirectly with Mondaq Ltd’s services and products.

Disclaimer

Mondaq Ltd and/or its respective suppliers make no representations about the suitability of the information contained in the documents and related graphics published on this server for any purpose. All such documents and related graphics are provided "as is" without warranty of any kind. Mondaq Ltd and/or its respective suppliers hereby disclaim all warranties and conditions with regard to this information, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. In no event shall Mondaq Ltd and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use or performance of information available from this server.

The documents and related graphics published on this server could include technical inaccuracies or typographical errors. Changes are periodically added to the information herein. Mondaq Ltd and/or its respective suppliers may make improvements and/or changes in the product(s) and/or the program(s) described herein at any time.

Registration

Mondaq Ltd requires you to register and provide information that personally identifies you, including what sort of information you are interested in, for three primary purposes:

  • To allow you to personalize the Mondaq websites you are visiting.
  • To enable features such as password reminder, newsletter alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our information providers who provide information free for your use.

Mondaq (and its affiliate sites) do not sell or provide your details to third parties other than information providers. The reason we provide our information providers with this information is so that they can measure the response their articles are receiving and provide you with information about their products and services.

If you do not want us to provide your name and email address you may opt out by clicking here .

If you do not wish to receive any future announcements of products and services offered by Mondaq by clicking here .

Information Collection and Use

We require site users to register with Mondaq (and its affiliate sites) to view the free information on the site. We also collect information from our users at several different points on the websites: this is so that we can customise the sites according to individual usage, provide 'session-aware' functionality, and ensure that content is acquired and developed appropriately. This gives us an overall picture of our user profiles, which in turn shows to our Editorial Contributors the type of person they are reaching by posting articles on Mondaq (and its affiliate sites) – meaning more free content for registered users.

We are only able to provide the material on the Mondaq (and its affiliate sites) site free to site visitors because we can pass on information about the pages that users are viewing and the personal information users provide to us (e.g. email addresses) to reputable contributing firms such as law firms who author those pages. We do not sell or rent information to anyone else other than the authors of those pages, who may change from time to time. Should you wish us not to disclose your details to any of these parties, please tick the box above or tick the box marked "Opt out of Registration Information Disclosure" on the Your Profile page. We and our author organisations may only contact you via email or other means if you allow us to do so. Users can opt out of contact when they register on the site, or send an email to unsubscribe@mondaq.com with “no disclosure” in the subject heading

Mondaq News Alerts

In order to receive Mondaq News Alerts, users have to complete a separate registration form. This is a personalised service where users choose regions and topics of interest and we send it only to those users who have requested it. Users can stop receiving these Alerts by going to the Mondaq News Alerts page and deselecting all interest areas. In the same way users can amend their personal preferences to add or remove subject areas.

Cookies

A cookie is a small text file written to a user’s hard drive that contains an identifying user number. The cookies do not contain any personal information about users. We use the cookie so users do not have to log in every time they use the service and the cookie will automatically expire if you do not visit the Mondaq website (or its affiliate sites) for 12 months. We also use the cookie to personalise a user's experience of the site (for example to show information specific to a user's region). As the Mondaq sites are fully personalised and cookies are essential to its core technology the site will function unpredictably with browsers that do not support cookies - or where cookies are disabled (in these circumstances we advise you to attempt to locate the information you require elsewhere on the web). However if you are concerned about the presence of a Mondaq cookie on your machine you can also choose to expire the cookie immediately (remove it) by selecting the 'Log Off' menu option as the last thing you do when you use the site.

Some of our business partners may use cookies on our site (for example, advertisers). However, we have no access to or control over these cookies and we are not aware of any at present that do so.

Log Files

We use IP addresses to analyse trends, administer the site, track movement, and gather broad demographic information for aggregate use. IP addresses are not linked to personally identifiable information.

Links

This web site contains links to other sites. Please be aware that Mondaq (or its affiliate sites) are not responsible for the privacy practices of such other sites. We encourage our users to be aware when they leave our site and to read the privacy statements of these third party sites. This privacy statement applies solely to information collected by this Web site.

Surveys & Contests

From time-to-time our site requests information from users via surveys or contests. Participation in these surveys or contests is completely voluntary and the user therefore has a choice whether or not to disclose any information requested. Information requested may include contact information (such as name and delivery address), and demographic information (such as postcode, age level). Contact information will be used to notify the winners and award prizes. Survey information will be used for purposes of monitoring or improving the functionality of the site.

Mail-A-Friend

If a user elects to use our referral service for informing a friend about our site, we ask them for the friend’s name and email address. Mondaq stores this information and may contact the friend to invite them to register with Mondaq, but they will not be contacted more than once. The friend may contact Mondaq to request the removal of this information from our database.

Security

This website takes every reasonable precaution to protect our users’ information. When users submit sensitive information via the website, your information is protected using firewalls and other security technology. If you have any questions about the security at our website, you can send an email to webmaster@mondaq.com.

Correcting/Updating Personal Information

If a user’s personally identifiable information changes (such as postcode), or if a user no longer desires our service, we will endeavour to provide a way to correct, update or remove that user’s personal data provided to us. This can usually be done at the “Your Profile” page or by sending an email to EditorialAdvisor@mondaq.com.

Notification of Changes

If we decide to change our Terms & Conditions or Privacy Policy, we will post those changes on our site so our users are always aware of what information we collect, how we use it, and under what circumstances, if any, we disclose it. If at any point we decide to use personally identifiable information in a manner different from that stated at the time it was collected, we will notify users by way of an email. Users will have a choice as to whether or not we use their information in this different manner. We will use information in accordance with the privacy policy under which the information was collected.

How to contact Mondaq

You can contact us with comments or queries at enquiries@mondaq.com.

If for some reason you believe Mondaq Ltd. has not adhered to these principles, please notify us by e-mail at problems@mondaq.com and we will use commercially reasonable efforts to determine and correct the problem promptly.