Canada: OECD Report Proposes New Treaty Shopping Rules

In February we wrote about a discussion draft of Action 6 of the Action Plan on Base Erosion (BEPS Action Plan) developed by the Organisation for Economic Co-Operation and Development (OECD) at the request of the G20. In October, the OECD published its final report on Action 6 of the BEPS Action Plan.

Action 6 is intended to address the phenomenon of “treaty shopping”, a practice whereby a business structures itself to take advantage of tax treaties with favourable provisions that are ordinarily unavailable. One example of treaty shopping involves a corporation resident in a country that does not have a tax treaty with Canada incorporating a subsidiary in a country that does have a treaty with Canada in order to receive the advantages of the tax treaty, such as a lower rate of withholding tax on the distribution of dividends to a non-Canadian shareholder. The goal of Action 6 is to limit the availability of treaty benefits to businesses that actually carry on business in the country whose treaty is relied on to claim benefit.

As we wrote about in February, Action 6 identified three types of modifications that need to be made in order to achieve its goals:

• Develop model treaty provisions and recommendations regarding the design of domestic rules to prevent the granting of treaty benefits in inappropriate circumstances.
• Clarify that tax treaties are not intended to be used to generate double non-taxation.
• Identify the tax policy considerations that, in general, countries should consider before deciding to enter into a tax treaty with another country.

The final report offers proposals to achieve all three of these goals:

• Action 6 proposes specific amendments to the OECD model tax treaty incorporating “limitation of benefits” provisions already found in certain tax treaties entered by the United States. These provisions would limit treaty benefits to individuals, corporations, and certain other organizations resident in a Contracting State. These provisions would also allow corporations and other organizations not resident in a Contracting State to access treaty benefits if it can be established based on certain criteria that the “principal purposes” of their transactions or arrangements are to actively carry on business in a Contracting State.
• Action 6 proposes to change the title of the OECD model treaty to clearly state that preventing tax evasion and avoidance are part of the purpose of tax treaties. Action 6 also proposes to include in the OECD model tax treaty a preamble explicitly stating that States enter into a tax treaty to prevent double taxation without creating opportunities for tax avoidance or evasion;
• Action 6 recommends that the preamble expressly identify treaty shopping as a form of avoidance and evasion.
  Action 6 identifies numerous tax policy considerations that should be taken into account before countries enter into tax treaties with other countries, including specific issues related to the domestic law of Contracting States.

It remains to be seen how quickly and to what extent these proposals will be implemented. It is certain, however, that as the proposals are implemented, businesses will have to be cognizant of new provisions in international tax treaties that may impact their ability to access favourable terms in such treaties when designing cross-border structures.