On May 28, 2018, Canada moved closer to ratifying the Multilateral Instrument (MLI) by tabling the Notice of Way and Means Motion (NWMM) in the House of Commons. See our previous communication on the MLI entitled "Tax Alert - Canada Signs the Multilateral Instrument to Modify its Tax Treaties" for additional background information.
The MLI will allow signatory countries to modify their bilateral tax treaties more efficiently rather than having to renegotiate individual tax treaties. The MLI incorporates the Organization for Economic Co-operation and Development's (OECD) anti-base erosion and profit shifting (BEPS) provisions. Some of the MLI provisions are mandatory, while other provisions are optional. The mandatory provisions relate to the minimum standards established by the OECD (standards that all participating countries have agreed to adopt). Countries are free to choose among the optional provisions.
Update on the Minimum Standard Provision
Canada has committed to adopting the following minimum standards:
- The treaty preamble, which states the treaty purposes, clarifies that the covered tax treaty intends to eliminate double taxation without creating opportunities for non-taxation or reduced taxation through tax evasion or avoidance.
- The anti-abuse rule, also known as the principal purpose test (PPT), has the effect of denying a benefit under a tax treaty where one of the principal purposes of any arrangement or transaction was to obtain a benefit under the treaty.
- Canada confirmed its commitment, under the MLI, to implement the minimum standard with respect to the dispute resolution features of its tax treaties.
- Canada confirmed its commitment to adopt mandatory binding arbitration as a mechanism to ensure the effective and timely resolution of treaty-based disputes.
As bilateral treaties are renegotiated, Canada will seek to introduce a more comprehensive limitation of benefits (LOB) article. Currently, Canada only has a handful of treaties with a LOB clause; the one with the United States has the most comprehensive LOB.
Optional Provisions Canada Will Adopt
Canada intends to adopt the following MLI optional provisions:
- A 365-day holding period for shares of Canadian companies held by non-resident companies to obtain the lower treaty withholding tax rates on dividends. The holding period test essentially discourages short-term share transfer transactions and the ability to access treaty withholding tax rates.
- A 365-day test period for non-residents who realize capital gains on the disposition of shares or other interests that derived their value from Canadian immovable property. Currently, Canadian domestic legislation has a 60-month look-back rule to tax taxable Canadian property (TCP). Generally, our tax treaties do not have a similar look-back. This provision will align Canadian domestic law with our tax treaties to allow Canada to tax certain transaction that were previously exempted under treaty provisions.
- Incorporate the MLI provision for resolving dual resident entity cases. This provision employs an effective approach to resolving dual resident cases to prevent potential double taxation, while providing protection against companies and other entities that attempt to manipulate their tax residence to avoid or reduce their taxes.
- Canada intends to adopt a provision of the MLI that will allow certain treaty partners to move from an exemption system as their method of relieving double taxation, to a foreign tax credit system.
Impact on Canadian Companies
The MLI will significantly impact Canadian companies that operate internationally and how cross-border transactions are structured. For example, transactions structured with the main purpose of obtaining treaty benefits will not meet the minimum standard provisions (i.e. the preamble or the PPT) of the MLI and treaty benefits will be denied. Documentation around the business purpose of the transaction will be crucial. This will add an additional layer of complexity on cross-border tax transactions.
In addition, with the optional provisions being adopted, additional analysis must be undertaken, which was not previously required. For example, dividend payments normally subject to a 25% withholding tax reduced to 5% or 15% under most treaties are now subject to a holding period test. Canadian companies will need to document how this holding period test was met — no guidance is provided on this as of yet or whether the Canada Revenue Agency may amend their NR301, NR302 or NR303 forms to address this point.
This NWMM is a critical step for Canada to adopt the MLI. The following are the next steps for fully adopting the MLI:
- A bill must be introduced to implement the MLI into Canadian domestic law (known as an Implementation Bill).
- The Implementation Bill must be approved by Parliament and receive Royal Assent.
- An Order in Council is then needed to notify the OECD that the ratification procedures in Canada are complete.
- The MLI may come to force as early as 2019.
Once the MLI comes into force, there are up to 75 tax treaties with Canada that could be affected by the MLI measures. The MLI will not impact Canada's tax treaty with this US, as the US is not a participant in the MLI.
Please contact a member of our International Tax Team or your local BDO advisor with questions about the MLI and its impact.