Canadian Treaty Shopping Proposal Shelved Pending Final OECD Recommendation, First To Be Released September 16

The Canadian federal government has been concerned for some time about “treaty shopping” by non-residents – the practice of non-residents not residing in a treaty country interposing a treaty resident entity between it and a Canadian source of income. On August 29, 2014 the Canadian government shelved its proposal for a domestic treaty shopping rule pending recommendations from The Organization for Economic Co-operation and Development (OECD). On September 16, 2014 the OECD will release its first recommendations on the prevention of treaty shopping.

“Treaty Shopping”. Canada has negotiated tax treaties with a number of countries providing for a reduction or elimination of Canadian withholding tax on payments such as interest, dividends, royalties, and management fees, and for the elimination of Canadian income tax on certain types of gains or business income.  However, a non-resident whose country of residence does not have a tax treaty with Canada could obtain the benefit of a tax treaty by interposing an intermediary (such as a corporation) that is resident in a country with a favourable tax treaty between it and the Canadian source of income.  Accordingly, the tax benefits of a tax treaty would be indirectly available to the non-resident investor simply by earning the income through the intermediary.

OECD Role.   Ever since the 2008 financial crisis, the G20 has expressed concern about multinational enterprises paying too little corporate tax by employing complex tax planning strategies.  The OECD answered the G20’s siren call by studying and recommending measures to prevent “base erosion and profit shifting” (BEPS).  One area the OECD is studying is the abuse of tax treaties as outlined in action item 6 of the OECD’s July 19, 2013 “Action Plan on Base Erosion and Profit Shifting”.

Canadian Proposal. Despite the OECD’s work, on August 12, 2013 the Canadian government released a Consultation Paper on Treaty Shopping seeking feedback on a domestic treaty shopping rule. On February 11, 2014 – after the consultation period closed – the Canadian government included a proposal for a domestic treaty shopping rule in its 2014 federal budget.  The proposal met with a great deal of resistance, especially since the government drafted it without the benefit of the OECD’s final recommendation on how to address abusive treaty shopping.  Thankfully, the federal government has agreed to shelve its proposal for now and wait until the OECD has completed its work.  The federal government’s August 29, 2014 news release accompanying its draft tax legislation to implement the 2014 federal budget contains this statement from the Canadian Department of Finance:  “[a]fter engaging in consultations on a proposed anti-treaty shopping measure, the Government will instead await further work by the Organisation for Economic Co-operation and Development and the Group of 20 (G-20) in relation to their Base Erosion and Profit Shifting initiative”.

OECD Recommendations. On September 16, 2014 the OECD released its recommendations dealing with the first seven action items – including treaty shopping – set out in its Action Plan to combat international tax avoidance by multinational enterprises. The OECD lived streamed the newscast of its recommendations, followed by a technical briefing via webcast on the BEPS deliverables.