Finance Minister Flaherty’s Federal budget predicts the current deficit in finances to continue until 2016 when he expects a surplus of 6.4 billion.
Like his counterparts around the world his February 11th budgetary statement focused on job creation, innovation and infrastructure.
As a member of the G8, G20 and the OECD, Flaherty also addressed international tax reform in the areas of tax transparency and the prevention of tax base erosion and profits shifting (BEPS).
It is for this reason that Canada’s 2014 budget merits more than a passing interest by treaty-based offshore financial centres (OFCs).
In this regard, Flaherty has called for comments from stakeholders on a series of questions designed to inform a national action plan to combat tax avoidance, including:
- What are the impacts of international tax planning by multinational enterprises on other participants in the Canadian economy?
- Which of the international corporate income tax and sales tax issues identified in the BEPS Action Plan should be considered the highest priorities for examination and potential action by the government?
- Are there other corporate income tax or sales tax issues related to improving international tax integrity that should be of concern to the government?
- What considerations should guide the government in determining the appropriate approach to take in responding to the issues identified – either in general or with respect to particular issues?
- Would concerns about maintaining Canada’s competitive tax system be alleviated by coordinated multilateral implementation of base protection measures?
- What actions should the government take to ensure the effective collection of sales tax on e-commerce sales to residents of Canada by foreign-based vendors?
Following submissions on treaty shopping consultation paper,the budget confirmed that the government now believes that a treaty-based approach would not be as effective as a domestic law rule.
As a result the budget invites comment on what the general outline of such a domestic rule should look like.
Main Purpose Test
Minister Flaherty also confirmed that Canada has opted to use a “main purpose” approach to its treaty shopping rule, rather than the specific “limitation on benefits” approach favoured by the U.S in its treaties.
Under such a provision, a benefit would not be provided under a tax treaty to a person in respect of an amount of income, profit or gain if it is reasonable to conclude that one of the main purposes for undertaking a transaction – or a transaction that is part of a series of transactions or events – that results in the benefit, was for the person to obtain the benefit.
Presumption of ‘Conduit’
Furthermore, in the absence of proof to the contrary, it will be presumed, that one of the main purposes for undertaking a transaction was to obtain a benefit under a tax treaty if the relevant treaty income is primarily used to pay, distribute or otherwise transfer an amount to another person that would not have been entitled to an equivalent, or more favourable benefit, had the other person received the relevant treaty income directly.
Safe Harbour Presumption
Under a safe harbour presumption, and subject to the conduit presumption, it would be presumed, in the absence of proof to the contrary, that none of the main purposes for undertaking a transaction was for a person to obtain a benefit under a tax treaty in respect of relevant treaty income if one of the following conditions is met:
- The person carries on an active business in the state with which Canada has concluded the tax treaty and, where the relevant treaty income is derived from a related person in Canada, the active business is substantial compared to the activity carried on in Canada giving rise to the relevant treaty income;
- The person is not controlled, directly or indirectly in any manner whatever, by another person that would not have been entitled to an equivalent or more favourable benefit had the other person received the relevant treaty income directly; or
- The person is a corporation or a trust the shares or units of which are regularly traded on a recognized stock exchange.
The proposed treaty shopping rules would apply to all of Canada’s tax treaties through inclusion in Canada’s Income Tax Convention Interpretation Act.
It is interesting to note that the new anti-treaty-shopping measures announced in this year’s budget are illustrated using the following examples well-known to onshore and offshore financial centres:
- sub-licensing of royalty income through a favourable treaty jurisdiction,
- payment of dividends through a holding company located in a favourable treaty jurisdiction; and
- the continuation of a company into a more favourable treaty jurisdiction prior to the realization of a capital gain.
To the extent that Canada has rejected a treaty-based approach to treaty-shopping in favour of a domestic route, its OFC tax treaty-partners will want to monitor the continuing national dialogue on how transitional relief and coming-into-force measures could apply.