Bill C-82, An Act to implement a multilateral convention to implement tax treaty related measures to prevent base erosion and profit shifting, has received royal assent. The federal government is now one step closer to completing the ratification process that will bring into force for Canada the Multilateral Convention to Implement Tax Treaty Related Measures to Prevent Base Erosion and Profit Shifting (MLI).
What you need to know
- Canada is currently one of 88 countries that has signed the MLI. It is expected over 80 of Canada's tax treaties will be modified by the MLI.
- The MLI will modify the majority of Canada's bilateral tax treaties to incorporate certain anti-avoidance countermeasures, including a principal purpose test (PPT). This could impact the ability of taxpayers to access treaty benefits, such as relief in respect of withholding taxes and taxes on capital gains.
- With the royal assent of Bill C-82, the MLI will come into force for Canada within a prescribed period following the date when Canada deposits its instrument of ratification with the OECD, which, for example, will be January 1, 2020 if this instrument is deposited in September 2019.
- The coming into effect date of the MLI will vary from treaty to treaty based on various factors, including in particular the coming into force dates of the MLI for each contracting party to the particular treaty and the type of tax sought to be relieved under the tax treaty (i.e., withholding tax or capital gains tax).
- The Canada-United States Income Tax Convention (1980), which contains a detailed limitation on benefits (LOB) provision, will not be modified by the MLI.
Explainer: BEPS project and the MLI
In 2013, the OECD launched an action plan to address BEPS concerns. As part of this project, the OECD identified several concerns in the tax treaty context and developed countermeasures to address these, including measures to prevent treaty abuse, improve dispute resolution, prevent the artificial avoidance of permanent establishment status and neutralize the effects of hybrid mismatch arrangements.
The MLI is an international tax treaty developed as part of the BEPS project. Its purpose is to permit the countries which are contracting parties to the MLI to implement tax treaty-related BEPS measures in a synchronized and efficient manner across a network of existing tax treaties, without the need to renegotiate those treaties. The MLI will operate to modify a particular tax treaty between contracting parties where each such party has provided notice that they wish to modify that tax treaty using the MLI (these tax treaties are referred to as Covered Tax Agreements).
By signing the MLI, a contracting party is committing to adopt the treaty-related minimum standards to prevent treaty abuse and improve dispute resolution. In addition, the MLI contains optional provisions that will apply when the MLI comes into effect, unless a contracting party makes a reservation for these provisions not to apply. A contracting party's summary of choices, including reservations with respect to optional provisions and notifications under stipulated Articles of the MLI, is included in that contracting party's MLI position that is tendered to and maintained by the OECD. A contracting party is free to remove its reservations with respect to optional provisions, but it cannot add new reservations once it has tendered its MLI position to the OECD.
The treaty-related minimum standard to prevent treaty abuse will be satisfied through (i) a modification to the pre-amble of applicable tax treaties (as described further below), and (ii) the adoption of one of the following rules:
- A PPT;
- A PPT and either a detailed or simplified LOB provision; or
- A detailed LOB provision and a mechanism to deal with conduit arrangements.
Since the PPT is the only option that can satisfy the minimum standard on its own, this rule is the default option in the MLI. Under the PPT, a tax benefit obtained under a tax treaty (such as a reduced rate of withholding tax) will be denied if it is reasonable to conclude that obtaining the benefit was one of the principal purposes of the arrangement or transaction that resulted in the benefit, unless it is established that granting the benefit is otherwise in accordance with the object and purpose of the relevant provisions of the particular tax treaty, including the pre-amble. By virtue of the modified pre-amble, tax treaties will include a clear statement that countries do not intend for tax treaties to create opportunities for non-taxation or reduced taxation through tax evasion or avoidance, including through treaty-shopping arrangements.
Current parties and the position of the U.S.
As of June 18, 2019, 88 countries had signed the MLI and six additional countries have expressed their intent to sign the MLI. Of the 88 countries that have signed the MLI, 27 countries have deposited their respective instruments of ratification with OECD, including, for example, Australia, France, Ireland, Luxembourg, the Netherlands and the United Kingdom.
Notably, the United States is not a signatory to the MLI. In this regard, the U.S. Department of Treasury has noted that the U.S. tax treaty network is already robust enough to prevent treaty shopping and already has a low degree of exposure to BEPS. For example, in the case of the Canada-United States Income Tax Convention (1980), this treaty already contains a detailed LOB provision and a rule clarifying the application of general anti-abuse provisions.
Provisions expected to be adopted by Canada
Canada signed the MLI on June 7, 2017 and submitted its provisional MLI position, where, among other things:
- it listed 75 of its tax treaties as Covered Tax Agreements;
- the modification in the MLI to the pre-amble to tax treaties will apply and Canada accepted the PPT on an interim basis, noting that it intends, where appropriate, to adopt detailed LOB provisions (in addition to or in replacement of the PPT) through bilateral negotiation;
- the MLI minimum standard of "mutual agreement procedure" style dispute resolution will apply, and Canada accepted the optional provision relating to mandatory binding arbitration for the resolution of treaty-based disputes; and
- Canada made reservations for the remaining optional provisions (including the optional provisions discussed below) not to apply to its tax treaties and did not provide any notifications in respect of the "coming into effect" rules in Article 35 of the MLI.
As part of the domestic ratification process of the MLI, on May 28, 2018, the Department of Finance released a Notice of Ways and Means Motion (NWMM) which became Bill C-82. In the accompanying backgrounder titled "The Next Step in the Fight Against Aggressive International Tax Avoidance," Canada indicated it intended to adopt a number of the optional provisions in the MLI on which Canada initially reserved in June 2017. These optional provisions include the following items.
- Dividend withholding taxes: Subject to exceptions dealing with corporate reorganizations, Canada will impose a 365-day holding period for shares of Canadian companies held by non-residents before such non-residents can access the lower treaty-based rate of withholding tax on dividends.
- Tax on certain capital gains: Canada will have the right to tax capital gains from the disposition of shares (or comparable interests) that derive more than a certain percentage of their value from real property situated in Canada if the relevant value threshold is met at any time during the 365 days preceding the disposition.
- Dual residents: Canada will incorporate the MLI provision for resolving dual resident entity cases.
- Relief from double taxation: Canada will adopt a provision of the MLI that allows certain contracting parties to move from an exemption system as their method of relieving double taxation to a foreign tax credit system.
While Canada initially listed 75 of its tax treaties as Covered Tax Agreements, it is expected that the number will increase to 84 when Canada submits its updated MLI position with the OECD in connection with the ratification process. It is also possible Canada will revise more of its reservations and adopt additional optional provisions of the MLI. Once Canada chooses to adopt optional provisions of the MLI, it will not be able to reverse its decision.
The status of the MLI in Canada
Coming into force
A key step in the ratification process from a Canadian perspective is the enactment of the MLI into domestic law. In furtherance of this, and following the release of the NWMM in May 2018, the federal government introduced Bill C-82 into the House of Commons on June 20, 2018, and this bill received royal assent on June 21, 2019.
Now that Bill C-82 has been passed into law, the only remaining step for Canada to bring the MLI into force is to deposit its instrument of ratification with the OECD, which requires an order in council. The Department of Finance indicated at the May 2019 International Fiscal Association conference it was hopeful Canada would make this deposit before the end of 2019. The MLI will then come into force for Canada on the first day of the month following the expiration of a period of three calendar months beginning on the date of the deposit. For example, if Canada were to deposit its instrument of ratification with the OECD on September 30, 2019, the MLI would come into force for Canada on January 1, 2020.
Coming into effect
Absent any notifications under Article 35 of the MLI, the provisions of the MLI will come into effect with respect to a Covered Tax Agreement in accordance with the following rules.
- Withholding taxes: Effective for transactions giving rise to withholding taxes on payments to non-residents on or after the first day of the next calendar year that begins on or after the latest of the dates on which the MLI comes into force for each of the contracting parties to the Covered Tax Agreement.
- Other taxes: Effective for other taxes levied by a contracting party with respect to taxable periods beginning on or after the expiration of six calendar months from the latest of the dates on which the MLI comes into force for each of the contracting parties to the Covered Tax Agreement.
By way of example, if the MLI comes into force on January 1, 2020 for Canada and comes into force on or prior to January 1, 2020 for another contracting party, the MLI will apply to the Covered Tax Agreement between Canada and that other contracting party as follows.
- Withholding taxes: Transactions on or after January 1, 2020.
- Other taxes: Taxable periods beginning on or after July 1, 2020.
In summary, Canada must still complete the ratification process to bring the MLI into force for Canada, and absent any notifications under Article 35, the MLI will then generally come into effect in respect of a Covered Tax Agreement based on the latest of the coming into force dates of the two contracting parties. The OECD maintains a list of the MLI coming into force dates for the various contracting parties so that the impact of the MLI to any particular Covered Tax Agreement can be determined.
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.