The United States Senate approved the September 21, 2007 protocol (the Protocol) to the Canada-United States Income Tax Convention (the Treaty) on September 23, 2008. The Protocol will enter into force once the U.S. exchanges instruments of ratification with Canada. Ratification procedures were completed on December 14, 2007. The procedures will be completed in the U.S. once the President and the Secretary of the Treasury sign the Protocol (which is expected to occur before the end of 2008).
Among other changes to the Treaty, the Protocol:
- eliminates withholding tax on most cross-border interest payments (phased in over two years for related party interest) and many guarantee fees;
- allows (or denies) treaty benefits for certain amounts derived through or paid by hybrid entities (with a delayed coming into force in the case of the benefit denial rules);
- introduces a comprehensive bilateral limitation on benefits provision; and
- requires the tax authorities of Canada and the United States to resolve certain issues through binding arbitration.
For more detail on these and other changes introduced by the Protocol, please see the Osler Update of July 11, 2008.
The effective date for many of the Protocol's provisions varies. The changes in the Protocol related to withholding tax on payments (other than interest) generally apply as of the first day of the second month beginning after the Protocol comes into force. The elimination (or, in the case of payments to related persons, the first-phase reduction to 7%) of withholding tax on most cross-border interest payments is retroactively effective to January 1, 2008 (assuming the Protocol comes into force in 2008).
In that case, U.S. residents who received interest payments from Canadians in 2008 in respect of which tax was withheld at the previous 10% rate should apply to the Canada Revenue Agency for a refund of the excess amount withheld. Recent Canadian case law suggests that the recipient of the interest (and not the payer) should apply for the refund, regardless of whether a tax gross-up applied on the original payment. In the U.S. context, the recipient of the interest (and not the payer) should apply for a refund of over withheld U.S. withholding tax, although there is some authority suggesting that the payer may have standing to claim such a refund if it is subject to a gross-up obligation.
The Protocol's changes will generally be effective for other (non-withholding) taxes for tax years that begin in 2009 (assuming the Protocol comes into force in 2008). Such changes would generally apply, for example, to a company with a November 30 year end on December 1, 2009 (unless an earlier tax year end arises in 2009, resulting, for example, from an amalgamation in 2009 involving the company).
Special timing applies to certain other provisions in the Protocol, such as the Treaty benefit denial rules in respect of certain hybrid entities and the new "services permanent establishment" rule. The application of these rules is delayed until January 1, 2010 (assuming the Protocol comes into force in 2008).
Binding Arbitration Conditions
Members of the U.S. Senate Foreign Relations Committee have expressed concerns about certain procedural aspects of the mandatory arbitration process (including concerns about the lack of direct taxpayer participation). As a result, ratification of the Protocol by the United States Senate is subject to two conditions relating to the binding arbitration provisions. First, within two years of ratification and before the first arbitration proceeding under the Protocol, the U.S. Secretary of Treasury must provide a report on the "rules of procedure applicable to arbitration boards, including conflict of interest rules to be applied to members of the arbitration board." Second, within 60 days of the tenth arbitration under the Protocol or under the United States' tax treaties with Belgium and Germany (each of which contains similar binding arbitration provisions to those in the Protocol), the U.S. Secretary of the Treasury must provide a report on the operation and application of the arbitration provisions in each of the three tax treaties. The second report must include details on the results of the ten arbitration decisions, the number of outstanding arbitration cases, and the number of cases that have otherwise been settled by the applicable competent authorities through the mutual agreement procedures. The second report must also be updated on March 1 of each year for five years. These two conditions allow the U.S. to monitor the procedural effectiveness of the mandatory arbitration mechanism for the purpose of shaping the U.S. treaty policy regarding mandatory arbitration in the future.
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