Tax Alert

On June 7, 2017, in Paris, Canadian officials signed the Multilateral Convention to Implement Tax Treaty Related Measures to Prevent Base Erosion and Profit Shifting (the MLI). This is an opportunity for Canada and the other 67 signing countries to close gaps in existing international tax rules by implementing the recommendations of the OECD's Base Erosion and Profit Shifting (BEPS) Action Plan that require modifications to bilateral tax treaties. Nine other countries have indicated that they intend to sign the MLI in the near future. As expected, the U.S. has not signed the MLI and will not use it to modify their bilateral tax treaties.

The OECD's BEPS project aimed to help countries secure their tax base by adopting rules that ensure the tax burden on multinational businesses aligns with where the profit-generating economic activities take place. To achieve this, the OECD set out to create a single set of consensus-based international tax rules, with recommendations released in October 2015 under a 15-point Action Plan. The OECD recognized that most issues set out in the Action Plan could be addressed through a combination of changes to domestic tax laws and changes to bilateral tax treaties. The MLI was developed to provide a synchronized method of facilitating modifications to these treaties, which is considered much more efficient than having countries renegotiate their tax treaties country by country, and could take decades to achieve.

How Does the MLI Work?

The MLI will allow countries to implement the minimum standards recommended under the BEPS project in their tax treaties to counter tax treaty abuse, to modify the definition of a Permanent Establishment (PE) to prevent the artificial avoidance of a PE, and to resolve tax treaty disputes to incorporate the mandatory arbitration procedures of the OECD Model Tax Convention. The signing of the MLI allows governments to modify existing treaties without formally renegotiating them. Renegotiating each treaty would not be feasible in the near term as Canada has 93 tax treaties in force, four signed but not in force, and five under negotiation or renegotiation. The MLI allows Canada to modify existing treaties with other countries that also sign the MLI on or after June 7, 2017. The MLI does not actually amend the text of a tax treaty, but will operate alongside the treaty if both countries sign the MLI and include the other country's treaty in their list of covered tax agreements. Not only are Canada and the other countries required to include each other in their list of covered tax agreements, the provisions that are chosen to be modified by each country must match. If both Canada and the other country adopt the same provisions of the MLI, the MLI provision will modify the treaty provision for that treaty.

What Has Canada Signed up for?

Canada has indicated that they will use the MLI to modify up to 75 of its bilateral tax treaties. Canada will use the MLI to address treaty abuse in accordance with the BEPS minimum standard. This means that Canada will include a substantive technical rule in its tax treaties that it will modify with the MLI. This is intended to prevent the use of bilateral tax treaties by third-country residents to reduce or eliminate tax, such as withholding taxes on capital gains. Canada is opting for the rule known as the principal purpose test, which is a general anti-abuse rule based on the principal purpose of transactions or arrangements. This rule has the effect of denying a benefit under a tax treaty where one of the principal purposes of an arrangement or transaction is to obtain a benefit under a tax treaty. It is anticipated that there could be many interpretation difficulties with this rule, as it can apply even if there is a business purpose for the arrangement or transaction. It was also announced that over the longer term, Canada will seek to negotiate, on a bilateral basis, a detailed limitation of benefits provisions that would also meet the BEPS minimum standard. This could be similar to the provision that already exists in the Canada-U.S. tax treaty.

In addition, Canada has chosen to adopt a provision to improve dispute resolution, namely a mandatory binding arbitration provision, which is good news for taxpayers. It will also be similar to the provision already included in the Canada-U.S. tax treaty.

Canada has reserved on all other provisions of the MLI at this time, meaning it will not use the MLI to modify the definition of a PE in Canadian tax treaties.

When Will All This Be Effective?

Now that Canada has signed the MLI, it must be passed into law by both Houses of Canadian Parliament and then given Royal Assent. Notice to the OECD would then be provided. For the MLI to apply to a particular tax treaty with another country, the other country must also sign the MLI and complete its own domestic procedures. The MLI will come into force three months after Canada and the other country complete these procedures. In addition, the MLI must also be ratified by a minimum of five countries to have legal effect.

Once the MLI comes into force, it will apply to withholding taxes on the first day of the following calendar year. With respect to all other taxes, it will come into force for fiscal periods beginning six months after that date. For example, if Canada and another country both ratify and give notice to the OECD that their ratification procedures are complete by the end of June 2018, the MLI would come into force for that particular tax treaty on October 1, 2018. It would be applicable to withholding taxes on January 1, 2019, and with respect to all other taxes for fiscal years beginning on or after April 1, 2019.

Summary

Most of Canada's tax treaties are about to change as a result of the MLI. When effective, these changes could significantly impact the tax efficiency of your international business structure. If you have questions about the MLI and how it may impact you, please contact a member of our International Tax Team or your local BDO advisor.