• Canada to Unilaterally Override All Tax Treaties With New Anti-Treaty Shopping Rule
  • March 5, 2014
  • Law Firm: Borden Ladner Gervais LLP - Toronto Office
  • International tax avoidance has received considerable attention over the past few years. As a result, there has been a flurry of activity, most notably by the OECD in establishing the base erosion and profit shifting (BEPS) initiative, which includes as one of its 15 work streams the prevention of treaty abuse. Canada has been participating in the BEPS initiative as a member of the OECD, but also issued a consultation paper in August 2013 setting out different possible approaches for addressing what it terms “treaty shopping”.

    In the federal budget of February 11, 2014, Canada announced its own proposed initiative to combat “treaty shopping” (the inappropriate use of tax treaties between Canada and other countries). The proposed new rule would dramatically change Canadian tax policy with a “go it alone” approach: Canada proposes to enact domestic legislation that will effectively override all of its tax treaties with other countries by imposing a new test for when a tax treaty will reduce Canadian tax. Essentially, if it is reasonable to conclude that one of the main purposes for a transaction that results in (or is part of a series of transactions that results in) Canadian tax being reduced under a treaty, the new rule applies, and Canada will allow treaty benefits only to the extent “reasonable” in the circumstances. If enacted, this sweeping new rule will affect non-residents earning Canadian-source income or gains, Canadians who are liable for withholding tax on payments to non-residents (e.g., interest, dividends and royalties), and ultimately (since Canada’s treaty partners are likely to respond with similar rules) Canadians with foreign subsidiaries or earning foreign-source income.

    In an article published in Tax Notes International, Steve Suarez of BLG’s tax group provides a critical analysis of Canada’s proposed new anti-treaty shopping rule. Steve concludes that (1) the proposed rule is not an appropriate change in substantive tax policy, and (2) unilateral action is not the right way to go about addressing whatever concerns Canada has with tax treaty abuse. The proposed rule is vague and overbroad-in terms of both its focus (on “treaty shopping” rather than specifically on treaty abuse) and its scope (relying on a general “one size fits all” solution rather than more targeted measures)-leaving taxpayers with too much uncertainty. A superior approach would be (in the short term) to wait for the release of the OECD’s BEPS recommendations in September 2014 in order to develop a multilateral broad- based response to treaty abuse, and to fully utilize Canada’s existing domestic law GAAR supported by newly developed extrinsic guidance on the object, spirit and purpose of tax treaty provisions. In the medium term, the Canadian government should seek bilateral solutions (i.e., treaty renegotiation or development of treaty technical explanations) that would give priority to tax treaties that it considers particularly problematic.