In Print Treaty Shopping and Base Erosion and Profit Shifting Action 6 Synopsis

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In Print
Treaty Shopping and Base Erosion and
Profit Shifting Action 6
As originally published by the Canadian Tax Foundation.
Synopsis
Gwendolyn Watson (WLLP)
April 2015
This article discusses the treaty shopping proposals in the September 2014
Organisation for Economic Co-operation and Development (OECD) report
and Canada’s 2014 federal budget, commenting on the direction that
Canada may take to counter treaty shopping.
Action 6 of the OECD’s base erosion and profit shifting (BEPS) initiatives
includes options to address treaty shopping. Its September 2014 report
proposed to revise the model convention to include a limitation-onbenefits provision and a new general anti-abuse rule. Canada had
indicated that it would wait for the OECD’s BEPS initiatives, so the
domestic anti-treaty shopping rule likely will be reconsidered in light of
the OECD’s final recommendations, expected in September 2015.
Contact:
Gwendolyn Watson
[email protected]
First published in Canadian Tax Journal (2014) 62:4, 1085 – 1108. Copyright remains
with the author.
PwC refers to PricewaterhouseCoopers LLP, an Ontario limited liability partnership. WLLP refers to
Wilson & Partners LLP, a law firm affiliated with PricewaterhouseCoopers LLP.
www.pwc.com/ca/inprint
canadian tax journal / revue fiscale canadienne (2014) 62:4, 1085 - 1108
International Tax Planning
Co-Editors: Michael Maikawa and Ken Buttenham*
The Canadian Tax Foundation welcomes Ken Buttenham as the new co-editor of
the journal’s International Tax Planning feature. Mr. Buttenham is a partner with
PricewaterhouseCoopers llp, Toronto. He graduated with an accounting degree from
the University of Waterloo and is a member of the Canadian Institute of Chartered
Accountants. Mr. Buttenham practises mainly in the area of inbound international tax
and provides advice to large multinational corporations. He regularly assists Canadian
multinational groups with the acquisition, structuring, reorganization, and financing of
their foreign affiliates. He also assists foreign multinational groups with the acquisition
and structuring of their Canadian investments.
The Foundation gratefully acknowledges the contribution of Pierre Bourgeois of
PricewaterhouseCoopers llp, Montreal, who is retiring as the co-editor of the International
Tax Planning feature. Mr. Bourgeois’s dedication to ensuring the timeliness, technical
accuracy, and readability of the feature’s articles has contributed greatly to the continued
popularity of the feature. On behalf of the journal’s readers, the Foundation extends its
warmest thanks to Mr. Bourgeois for his exemplary service as co-editor since 2010.
Treaty Shopping and Base Erosion
and Profit Shifting Action 6
Gwendolyn Watson**
As part of action 6 of the base erosion and profit shifting (beps) initiatives, the Organisation
for Economic Co-operation and Development (oecd) is considering alternatives to address
“improper uses” of tax treaties, including treaty shopping. In September 2014, the
oecd released a report in which it proposed to revise the model convention to include a
limitation-on-benefits provision and a new general anti-abuse rule in response to treatyshopping concerns. Before beps, Canada started its own treaty-shopping consultation,
and, in the 2014 federal budget, Canada proposed to adopt a domestic anti-treatyshopping rule. However, in August 2014, Canada announced that instead of proceeding
with this domestic solution, it would wait for further work by the oecd as part of the beps
initiatives. Consequently, it is expected that Canada will reconsider the domestic antitreaty-shopping rule in light of the oecd final beps recommendations, which are expected
* Of PricewaterhouseCoopers LLP, Toronto.
** Of Wilson & Partners LLP, Toronto, a law firm affiliated with PricewaterhouseCoopers LLP
(e-mail: [email protected]).
 1085
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in September 2015, and that these recommendations may play a greater role in the
direction that Canada may ultimately take.
Because the various treaty-shopping initiatives are ongoing, this topic is divided into
two articles. In this article, the author discusses the treaty-shopping proposals in the
September 2014 oecd report and the 2014 federal budget, and provides some comments
on the direction that Canada may ultimately take to counter treaty shopping. The final
treaty-shopping recommendations made by the oecd and ensuing developments in the
Canadian context will be discussed in a subsequent article.
Keywords: International taxation n tax treaties n treaty shopping n OECD n base erosion
and profit shifting n limitation on benefits
C o n t e n ts
Introduction
OECD Treaty-Shopping Measures Before BEPS
1977 Amendments
1992 Amendments
2003 Amendments
2014 Amendments
OECD Report
Treaty-Shopping Proposals
Title and Preamble
Limitation on Benefits
Principal Purpose Test
Proposals Relating to the Circumvention of Domestic Tax Laws
Domestic Treaty-Shopping Measures Before BEPS
Domestic Proposal
Concluding Comments
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1088
1089
1089
1090
1092
1093
1093
1094
1095
1098
1103
1104
1105
1108
Introduction
On July 19, 2013, the Organisation for Economic Co-operation and Development
(oecd) released a 15-step action plan1 to address base erosion and profit-shifting
(beps) concerns. More specifically, the objective of the plan is to address instances
of double non-taxation arising from gaps in the interaction between different tax
systems, particularly when taxable income is artificially segregated from the activities that generate this income.
The action plan covers a wide variety of topics, such as transfer pricing, issues
relating to the digital economy, and hybrid mismatch arrangements, and the plan
1 Organisation for Economic Co-operation and Development, Action Plan on Base Erosion and
Profit Shifting (Paris: OECD, 2013) (herein referred to as “the action plan”). The action plan
was produced by the OECD at the request of the G20 and delivered pursuant to the
recommendations in Organisation for Economic Co-operation and Development, Addressing
Base Erosion and Profit Shifting (Paris: OECD, 2013), at 51.
international tax planning  n  1087
identifies treaty abuse, and in particular treaty shopping, as one of the most important
sources of beps concern. Action 6 (prevent treaty abuse) contemplates the following
remedies:
Develop model treaty provisions and recommendations regarding the design of domestic rules to prevent the granting of treaty benefits in inappropriate circumstances.
Work will also be done to clarify that tax treaties are not intended to be used to generate double non-taxation and to identify the tax policy considerations that, in general,
countries should consider before deciding to enter into a tax treaty with another country. The work will be co-ordinated with the work on hybrids.2
In March 2014, the oecd released a discussion draft,3 which included the preliminary results of its work on action 6 of the action plan. Following a public consultation,
in September 2014 the oecd released revised proposals on action 6,4 which supersede the proposals in the oecd discussion draft.
In the introductory comments in the report, the oecd notes that it has previously
examined treaty shopping in different contexts, and has responded by modifying the
oecd model tax convention and accompanying commentary.5 After further reviewing the treaty practices of member and non-member countries, the oecd proposes
to address treaty shopping by adding new article x (entitlement to benefits) to the
model convention, which will encompass a comprehensive limitation-on-benefits
(lob) provision, as well as a more general anti-abuse rule, which is based on the
principal purpose of transactions or arrangements. The oecd notes, however, that
countries will have some flexibility in the approach that they adopt, including the
choice of treaty amendments or a combination of treaty amendments and domestic
rules, provided that the chosen approach meets a minimum standard of protection.
The oecd report states that further work is required and that final recommendations
on action 6 are expected to be released in September 2015 in the oecd final report.
Canada has an extensive network of tax treaties that are based on the model
convention. In the 2013 federal budget, the Department of Finance announced its
intention to consult on possible measures to address treaty shopping to “protect
2 Action plan, supra note 1, at 19.
3 Organisation for Economic Co-operation and Development, BEPS Action 6: Preventing the
Granting of Treaty Benefits in Inappropriate Circumstances (Paris: OECD, March 14, 2014) (herein
referred to as “the OECD discussion draft”).
4 Organisation for Economic Co-operation and Development, Preventing the Granting of Treaty
Benefits in Inappropriate Circumstances (Paris: OECD, September 16, 2014) (herein referred to as
“the OECD report”).
5 Organisation for Economic Co-operation and Development, Model Tax Convention on Income
and on Capital: Condensed Version (Paris: OECD, July 2014) (herein referred to as “the model
convention”), and the accompanying commentary (herein referred to as “the OECD
commentary”). Unless otherwise noted, a reference to an “article” is a reference to an article of
the model convention.
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the integrity of Canada’s tax treaties.”6 Following an initial consultation paper,7 in the
2014 federal budget the Department of Finance invited comments on an outline of
a potential domestic anti-treaty-shopping rule (the domestic proposal).8 Had the
rule been adopted, it would probably have been included in the Income Tax Conventions Interpretation Act,9 thereby making the domestic proposal applicable to all
of Canada’s tax treaties. In the 2014 budget papers, the Department of Finance indicated that the oecd recommendations on action 6 would be “relevant” in developing
the domestic proposal.10
In a surprising but welcome news release in August 2014, the Department of
Finance announced that instead of proceeding with the domestic proposal, it would
wait for further work by the oecd on the beps initiatives.11 In light of this announcement, which appears to signal that the Department of Finance may place greater
weight on the oecd’s work on action 6 in the Canadian context, I address the proposals in the oecd report in this article. Because the various treaty-shopping initiatives
are ongoing, future developments will be discussed in a subsequent article.
This article is organized into five sections. In the first, I review the changes that
the oecd has made to the model convention and the oecd commentary, both before beps, in response to treaty-shopping concerns. The second section contains a
summary of the key treaty-shopping proposals in the oecd report, which build on
the earlier initiatives adopted. The third section contains a discussion of Canada’s
position on treaty shopping and the steps taken, before beps, to address these
concerns. The fourth section consists of a summary of the domestic proposal. The
article concludes with some comments on the direction that Canada may ultimately
take to counter treaty shopping in light of the minimum standard of protection set
out in the oecd report.
OECD Treat y-Shopping Measures Before BEPS
Treaty shopping has long been a concern of the oecd and treaty negotiators. Generally speaking, treaty shopping involves a resident of a country gaining access to
treaty benefits under a tax treaty between two other countries, either through a
conduit company or by other means, that the resident would not otherwise be entitled to claim. Over the years, the oecd has responded to conduit company and
6 Canada, Department of Finance, 2013 Budget, Budget Plan, March 21, 2013, at 373.
7 Canada, Department of Finance, Treaty Shopping—The Problem and Possible Solutions (Ottawa:
Department of Finance, August 12, 2013) (herein referred to as “the domestic consultation
paper”).
8 Canada, Department of Finance, 2014 Budget, Budget Plan, February 11, 2014, at 349-57.
9 RSC 1985, c. I-4, as amended.
10Supra note 8, at 349.
11 Canada, Department of Finance, “Department of Finance Consults on Draft Tax Legislation,”
News Release, August 29, 2014.
international tax planning  n  1089
treaty-shopping concerns through changes to the oecd commentary on article 1
(persons covered) and the “beneficial owner” requirement in articles 10 (dividends),
11 (interest), and 12 (royalties) of the model convention. An overview of these
changes follows.
1977 Amendments
In 1977, the oecd made modest amendments to the model convention and oced
commentary in response to treaty-shopping concerns. For example, the oecd commentary on article 1 was revised to include a statement that the purpose of a tax
treaty is “to promote, by eliminating international double taxation, exchanges of
goods and services, and the movement of capital and persons” and that a treaty
should not “help tax avoidance or evasion.”12
The oecd also revised articles 10, 11, and 12 of the model convention to provide that treaty benefits under these articles would be available to a resident of a
contracting state only if the resident is the “beneficial owner” of the applicable income. This change was intended to address simple treaty-shopping situations—that
is, situations in which an intermediary (such as an agent or nominee) is interposed
between the income payer and another person, and the intermediary is a resident
for treaty purposes but is not the owner of the income for tax purposes.13 After noting that certain concerns were addressed through changes to the model convention
(including the beneficial owner changes), the oecd commentary on article 1 stated
that if countries wished to adopt additional measures to address “improper uses” of
a treaty, they should do so by either including explicit limitations in the treaty itself
or, following the enactment of domestic anti-abuse rules, agreeing in the treaty that
these domestic laws should not be affected by the treaty.
1992 Amendments
Following the oecd’s report on conduit companies,14 in July 1992 the oecd amended the oecd commentary on article 1 to acknowledge the growing use of conduit
companies and to update this commentary to include a summary of the approaches
adopted by countries to counter these practices. The approaches included
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the lookthrough approach, under which a company is not entitled to treaty
benefits if it is owned, directly or indirectly, by persons who are not resident
in the same country as the company;
12 Paragraph 7 of the commentary on article 1 in Organisation for Economic Co-operation and
Development, Model Double Taxation Convention on Income and on Capital (Paris: OECD, 1977).
13 OECD report, supra note 4, at 20-21.
14 Organisation for Economic Co-operation and Development, “Double Taxation Conventions
and the Use of Conduit Companies,” in International Tax Avoidance and Evasion: Four Related
Studies (Paris: OECD, 1987), 87-106.
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the exclusion approach, under which no treaty benefits are granted in respect
of income received or paid by a company that enjoys special tax privileges
(such as a tax-exempt company);
the subject-to-tax approach, under which treaty benefits are granted by the
source country only if the income is subject to tax in the country of residence;
and
the channel approach, under which a company is not entitled to treaty benefits
if persons not resident in the same country as the company have a substantial
interest in or control the company, and more than 50 percent of the com­
pany’s income is used to satisfy the claims (such as interest, royalties, and other
deductible expenses) of these persons.
The oecd stated that it was not making any strict recommendations on the
preferred approach; rather, it was offering the four approaches as suggested benchmarks that treaty negotiators could consider in specific cases, taking into account
the degree to which tax advantages are obtained by conduit companies, the legal
context of the contracting states, and the extent to which bona fide activities might
unintentionally be disqualified. On this last point, the oecd indicated that the four
approaches were general in nature and might need to be accompanied by specific
provisions to ensure that treaty benefits were available in bona fide cases, such as
those in which the resident carries on substantial business operations or is a publicly
traded company.
The oecd also updated its commentary on article 1 to indicate that other forms
of treaty abuse (for example, the use of a base company) and possible ways to deal
with them (such as substance-over-form and subpart f-type provisions) had been
analyzed. Regarding domestic anti-abuse provisions, the oecd noted that the majority of countries were of the view that these rules, and their underlying principles,
did not need to be confirmed in a treaty.
2003 Amendments
In January 2003, following further study of harmful tax practices and possible restrictions on the entitlement to treaty benefits,15 additional changes were made to
the oecd commentary on article 1 and the oecd commentary on articles 10, 11,
and 12 relating to the meaning of “beneficial owner.”
The oecd commentary on article 1 underwent three main changes. First, the
oecd revised paragraph 7 to provide that the “principal purpose” of tax treaties is to
promote exchanges of goods and services, and the movement of capital, by eliminating international double taxation, and added that the purpose of tax treaties is also
15See “Restricting the Entitlement to Treaty Benefits,” in Organisation for Economic Co-operation
and Development, Model Tax Convention on Income and on Capital 2010 (Paris: OECD, July 2010),
R(17)-1 to R(17)-24.
international tax planning  n  1091
“to prevent tax avoidance and evasion.” The oecd also added new paragraph 9.5,
which provides as follows:
A guiding principle is that the benefits of a double taxation convention should not be
available where a main purpose for entering into certain transactions or arrangements
was to secure a more favourable tax position and obtaining that more favourable treatment in these circumstances would be contrary to the object and purpose of the relevant
provisions.16
Second, the oecd revised the commentary to summarize the views of member
countries on the related questions whether treaty benefits must be granted in abusive situations and whether there is a conflict between domestic anti-abuse rules and
treaties. This discussion is found mostly in paragraphs 9.1 to 9.4, and paragraphs 22
to 22.2, of the oecd commentary on article 1.
The oecd noted that countries typically take one of two approaches in addressing treaty abuse. On the one hand, some countries view domestic anti-abuse rules
(such as substance-over-form provisions, economic substance rules, controlled foreign
company provisions, and general anti-abuse rules) as forming part of the domestic
law for determining what facts give rise to a tax liability. Because tax treaties merely
restrict the imposition of taxes, these countries take the position that domestic antiabuse rules are not affected by treaties. As a general rule, having regard to the
principle in paragraph 9.5 of the OECD commentary on article 1, there will be no
conflict between domestic rules and a treaty. Further, countries generally agree that
they should carefully observe their tax treaty obligations to provide relief from
double taxation as long as there is no clear evidence of abuse.
On the other hand, other countries prefer to view some abuses as abuses of the
treaty itself. Article 31 of the Vienna Convention on the Law of Treaties (vclt)17
stipulates that treaty terms are to be given their ordinary meaning in the context of
the treaty and in light of its object and purpose. Thus, these countries are of the
view that a proper construction of a tax treaty, in accordance with its object and
purpose, permits them to disregard abusive transactions. Under either approach,
the oecd noted that countries agree that they do not need to grant treaty benefits
in the context of abusive arrangements.
The third change to the oecd commentary on article 1 was the expansion of the
range of approaches that countries may use to address conduit companies and other
forms of treaty abuse. The oecd noted that the lookthrough, the subject-to-tax,
and the channel approaches dealt only with a particular aspect of treaty shopping.
16 Paragraph 9.5 of the commentary on article 1 in Organisation for Economic Co-operation and
Development, Model Tax Convention on Income and on Capital: Condensed Version (Paris: OECD,
January 2003).
17 Vienna Convention on the Law of Treaties, signed at Vienna on May 23, 1969, UN doc. A/Conf.
39/27, fourth annex, UNTS 1155/331 (herein referred to as “the VCLT”).
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It indicated that countries wishing to address treaty shopping more comprehensively may want to adopt a detailed lob provision in their treaties. However, to
address abuses relating to specific types of income (such as dividends, interest,
royalties, and other income), countries could adopt limitations that would exclude
treaty benefits in respect of transactions that were entered into for the main purpose
of securing those benefits (which is consistent with the guiding principle articulated
in paragraph 9.5 of the oecd commentary on article 1).
Beyond article 1, the oecd revised the commentary to articles 10, 11, and 12 in
an attempt to expand the meaning of the term “beneficial owner.” For example,
former paragraph 12 of the oecd commentary on article 1018 stated that “beneficial
owner” is not used in a narrow technical sense, but must be interpreted in light of its
context and the object and purpose of a treaty, which includes preventing fiscal evasion and avoidance, in accordance with the revised oecd commentary on article 1.
2014 Amendments
Following a consultation process,19 in July 2014 the oecd further refined articles
10, 11, and 12, relating to the meaning of the term “beneficial owner.” For example,
the portion of former paragraph 12 of the oecd commentary on article 10 referred
to above was renumbered as paragraph 12.1, which now states that the term is not
intended to refer to any technical meaning that it could have under the domestic law
of a specific country, but rather is intended to be interpreted in the context of the
words “paid to . . . a resident” in article 10(1). In other words, “beneficial owner” is
intended to have an autonomous treaty definition. In addition, paragraph 12.4 of
the oecd commentary on article 10 clarifies that a recipient of a dividend is not the
beneficial owner of the dividend when the recipient’s right to use the dividend is
constrained by legal or contractual obligations, as determined under the relevant
legal documents or the facts and circumstances.20
The oecd also notes in paragraph 12.5 of the commentary on article 10 that the
finding that a recipient is the beneficial owner of a dividend does not prohibit the
application of treaty or domestic anti-abuse rules to deny treaty benefits in treatyshopping situations generally, since the beneficial owner concept merely addresses
18See paragraph 12 of the commentary on article 10 in the 2003 version of the model convention,
supra note 16.
19See Organisation for Economic Co-operation and Development, Clarification on the Meaning of
“Beneficial Owner” in the OECD Model Tax Convention: Discussion Draft (Paris: OECD, April 29,
2011), and Organisation for Economic Co-operation and Development, OECD Model Tax
Convention: Revised Proposals Concerning the Meaning of “Beneficial Owner” in Articles 10, 11 and
12 (Paris: OECD, October 19, 2012).
20 For a more detailed discussion of the OECD discussion drafts referred to in note 19 and the
effect of the “beneficial owner” changes in the Canadian context, see Steven Baum and
Gwendolyn Watson, “2014 Update to the OECD Model Tax Convention—‘Beneficial Owner’
Changes,” a forthcoming article to be published by Federated Press.
international tax planning  n  1093
a narrow form of tax avoidance involving the interposition of an intermediary that
is obliged to pass the dividend on to a third party.
OECD Report
Action 6 of the action plan contemplates new provisions in the model convention
to prevent the granting of treaty benefits in “inappropriate circumstances,” as well
as proposals to clarify the purpose of treaties. While action 6 and the oecd report
contemplate changes in relation to treaty abuse generally, the following discussion
focuses on the treaty-shopping proposals and recommendations to ensure that
treaties do not circumvent domestic tax laws.21
Treat y-Shopping Proposals
In its report, the oecd states that “treaty shopping” generally refers to arrangements involving the circumvention of the “residence” article in a treaty—that is, it
typically involves a person who is a resident of a third country attempting to gain
indirect access to the benefits of a treaty between two other countries.22 For this
reason, the oecd proposes a treaty-based solution for treaty shopping, and in particular the revision of the model convention to
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amend the title and preamble to state that countries wish to prevent tax avoidance and opportunities for treaty shopping;
include the lob provision to address treaty-shopping situations “based on the
legal nature, ownership in, and general activities of, residents of a Contracting State”;23 and
include the principal purpose test (ppt) to address treaty-shopping situations
that are not covered by the lob provision, such as certain conduit financing
arrangements.
The oecd notes that the lob provision and the ppt each have their strengths
and weaknesses, and that these provisions may not be appropriate in all countries
for a number of reasons. For example, because some countries may have domestic
anti-abuse rules or judicial doctrines to deal with treaty shopping, the ppt may not
be required, or a modified version of the ppt may be preferred. Consequently, while
the oecd proposes to amend the model convention in the manner described above, the
21 In addition to the principal purpose test, which is broad enough to address treaty abuses other
than treaty shopping, the OECD report includes the following recommendations to address
other forms of treaty abuse: (1) the adoption of specific anti-abuse rules in the model convention
to deal with abuses of objective tests in areas such as the residence tie-breaker rules, permanent
establishments, and capital gains on the sale of real property, and (2) revisions to the introduction
of the model convention to set out tax policy considerations that counties should consider
before entering into a tax treaty with another country.
22 OECD report, supra note 4, at 20.
23 Ibid., at 22.
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oecd report states that countries will have some flexibility in the approach that they
adopt. However, the oecd notes that countries agree that their common goal is to
ensure that treaties are revised to include safeguards that prevent treaty shopping. To
implement this common intention, the OECD report recommends that at a minimum
countries should revise their treaties’ titles and preambles to include a statement of
intention regarding the purpose of the treaty, and incorporate one of the following:
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the lob provision and the ppt;
the ppt; or
the lob provision and a mechanism to deal with conduit arrangements, such
as the modified ppt, or alternatively domestic anti-abuse rules or judicial
doctrines that achieve a similar result.
The oecd notes that the treaty-shopping proposals in its report, which are discussed below, are in draft form and subject to improvement before their release in
final form in September 2015.24 In particular, the oecd notes that changes are likely
to be required in connection with the implementation of the minimum standard
and policy considerations in relation to collective investment vehicles (civs) and
non-civ funds.25 In addition, changes will most likely be needed to take into account
recommendations made in relation to other areas of the action plan, which are, for
example, expected to consider beps concerns that may arise from the derivative
benefits test in the lob provision.26
Title and Preamble
The oecd proposes to amend the title and preamble to the model convention to
include clear statements that countries, when entering into a treaty, intend to avoid
creating opportunities for non-taxation or reduced taxation through tax evasion or
avoidance, including that perpetrated by means of treaty-shopping arrangements.
This change parallels the 2003 change to paragraph 7 of the oecd commentary on
24 On November 21, 2014, the OECD released a discussion draft, Follow Up Work on BEPS Action
6: Preventing Treaty Abuse (Paris: OECD, 2014), in which it identifies 20 issues that require
further refinement and invites comments on these issues by January 9, 2015. In addition to the
matters specifically identified in the OECD report (such as those relating to CIV and non-CIV
funds, as well as the derivative benefits test), the November 2014 discussion draft invites
comments about situations in which discretionary relief may be justified following the
application of the PPT, as well as the features of the modified PPT and examples that could be
included in the OECD commentary to illustrate the application of this rule.
25 The OECD commentary on article 1 discusses factors that should be considered for the
purposes of determining the treaty entitlements of CIVs. The OECD report includes some
discussion of CIVs, including a discussion that pertains to the qualified person definition in the
LOB provision. Because the OECD has indicated that further work will be done regarding
CIVs, proposals relating to CIVs are not discussed in this article.
26See the OECD discussion draft, supra note 3, at 9, for an example in which the OECD raises
BEPS concerns in relation to the derivative benefits test.
international tax planning  n  1095
article 1. The oecd indicates that these clear statements of intention of the signatories to a particular treaty will be relevant to the interpretation and application of
the treaty provisions (and in particular to the ppt). In this regard, the oecd notes
that under article 31 of the vclt, treaty terms are to be given their ordinary meaning in the context of the treaty and in light of its object and purpose, and the context
of a treaty includes its preamble.
Limitation on Benefits
The oecd proposes to amend the model convention to include the lob provision
in new article x, which is similar to provisions in treaties concluded by the United
States, Japan, and India, among other countries, as well as in the oecd commentary
on article 1.
The first of six lob paragraphs in the oecd report is article x(1). It provides that
a resident of a contracting state is not entitled to the benefits of a particular treaty,
other than benefits under article 3(4), 9(2), or 25(2), unless the resident is either a
“qualified person” when the resident seeks treaty relief or is eligible for benefits under
article x(3), (4), or (5). A “qualified person” is defined in article x(2), and supporting
definitions are contained in article x(6). A resident who is not a qualified person may
nonetheless be entitled to treaty benefits if the resident satisfies the active business
test in article x(3), satisfies the derivative benefits test in article x(4), or is granted
discretionary relief from the relevant competent authority under article x(5).
The following is a summary of the main features of the qualified person definition
and the active business and derivative benefits tests. The accompanying commentary
to article x in the oecd report includes a detailed discussion of certain aspects of
this rule, but this commentary is not discussed in this article.
Qualified Persons
Article x(2) defines a “qualified person” to generally mean a resident of a contracting state that is
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an individual (article x(2)(a));
a government entity (article x(2)(b));
a publicly listed company or other entity (article x(2)(c)(i));
a subsidiary entity of a publicly listed company or other entity (article x(2)(c)(ii));
a not-for-profit organization (article x(2)(d)(i));
a pension fund or an investment vehicle of a pension fund (articles X(2)(d)(ii)
and (iii)); or
a person, other than an individual, who satisfies an ownership and base erosion test (article x(2)(e)).
Under article x(2)(c)(i), a publicly listed company is a qualified person if, throughout the taxable period that includes the relevant time, the company’s principal class
of shares (and any disproportionate class of shares) is regularly traded on one or
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more recognized stock exchanges, and either the principal class of shares is primarily
traded on one or more recognized stock exchanges located in the contracting state
in which the company is resident, or the company’s primary place of management
and control is in the contracting state in which it is resident. Other types of entities
with listed securities, such as trusts, may be qualified persons under article x(2)(c)(i),
and the term “share” is defined in article x(6)(h) to include interests in entities other
than companies that are comparable to shares.27
Under article x(2)(c)(ii), a subsidiary of a publicly listed company (or other entity) is a qualified person, provided that at least 50 percent of the aggregate voting
power and value of the shares (and at least 50 percent of any disproportionate class
of shares) in the company is owned, directly or indirectly, by five or fewer companies (or other entities) that are qualified persons under article x(2)(c)(i). Countries
may choose to include an indirect ownership requirement, which provides that if
ownership of the subsidiary is indirect, each intermediate owner must be resident in
one of the contracting states. Similar to article x(2)(c)(i), article x(2)(c)(ii) provides
that other types of entities, such as trusts, may be qualified persons.
A person, other than an individual, is a qualified person if the particular person
satisfies the ownership and base erosion requirements in article x(2)(e). The ownership test in article x(2)(e)(i) is satisfied if, on at least half of the days of the taxable
period that includes the relevant time, persons who are residents of the same contracting state as the particular person and qualified persons (other than persons who
are qualified persons under article x(2)(c)(ii) or (e)) own, directly or indirectly,
shares representing at least 50 percent of the aggregate voting power and value (and
at least 50 percent of any disproportionate class of shares) of the particular person.
Countries may choose to include an indirect ownership requirement, which provides that if ownership is indirect, each intermediate owner must be resident in the
same contracting state as the particular person.
The base erosion test in article x(2)(e)(ii) is satisfied if less than 50 percent of the
particular person’s gross income for a taxable period that includes the relevant time,
as determined in the person’s country of residence, is paid or accrues, directly or
indirectly, to persons who are not residents of either contracting state and qualified
persons (other than persons who are qualified persons under article x(2)(c)(ii) or
(e)) in the form of payments that are deductible for tax purposes in the particular
person’s country of residence. For the purposes of the 50 percent threshold, arm’slength payments made in the ordinary course of business for services or tangible
property are not included.
Active Business Test
Even if a resident of a contracting state is not a qualified person, article x(3)(a) provides that the resident is entitled to claim treaty benefits in respect of an item of
27 Article X(6) also includes definitions of “recognised stock exchange,” “principal class of shares,”
“disproportionate class of shares,” “primary place of management and control,” and “dual listed
company arrangement.”
international tax planning  n  1097
income derived from the other contracting state (the source country) if the resident
is engaged in the active conduct of a business in the country of residence, and the
income derived in the source country is derived in connection with, or is incidental
to, that business. This exception recognizes that when a resident actively carries on
business, granting treaty benefits in respect of income connected or incidental to
these activities does not give rise to the same treaty-shopping concerns that arise in
the context of other types of income, regardless of the nature and ownership of the
resident.
The commentary in the oecd report indicates that the term “business” is not
defined, and it should therefore have the meaning it has under the relevant domestic
law. However, the commentary states that an entity is generally considered to be
engaged in the active conduct of a business only if its officers or employees conduct
substantial managerial and operational activities. Further, article x(3)(a) stipulates
that the business carried on by the resident in the country of residence may not be
the business of making or managing investments for the resident’s own account,
unless these activities are banking, insurance, or securities activities that are carried
on by certain enumerated financial-type institutions.
If the business generating the income is carried on directly by the resident or an
associated enterprise in the source country, article x(3)(b) provides that the business
activity carried on by the resident in the country of residence must be substantial in
relation to the business activity carried on by the resident or the associated enterprise in the other contracting state, as determined on the basis of all of the facts and
circumstances. The commentary indicates that the “substantial” requirement is intended to address a narrow case of treaty-shopping abuse when a resident attempts
to obtain treaty benefits by engaging in a de minimis connected business in the
country of residence that has little economic cost or effect with respect to the resident’s business as a whole.
For the purposes of articles x(3)(a) and (b), a person is deemed to conduct activities that are conducted by a “connected” person. Article x(3)(c) provides that a
person generally is connected to another person if one has control of the other, or
both are under the control of a third person, on the basis of the ownership of at least
50 percent of the beneficial interests in a person (and, in the case of a company, at
least 50 percent of the aggregate vote and value of the company’s shares), or the
facts and circumstances.
Derivative Benefits Test
A resident company may qualify for treaty relief under the derivative benefits test in
article x(4) if it satisfies an ownership and base erosion test. The exception is intended to permit a company to claim treaty benefits when its shareholders would be
entitled to claim the same treaty benefits had they earned the income directly.
The ownership test is satisfied if at least 95 percent of the aggregate voting
power and value of the company’s shares (and at least 50 percent of any disproportionate class of shares) is owned, directly or indirectly, by seven or fewer persons
that are equivalent beneficiaries. If the ownership is indirect, each intermediate
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(2014) 62:4
owner must be an equivalent beneficiary. The base erosion test is similar to the one
in article x(2)(e)(ii), with the exception that it focuses on payments to equivalent
beneficiaries, as opposed to qualified persons.
The definition of “equivalent beneficiary” in article x(6) contemplates two categories of persons. The first category includes a resident of one of the contracting
states that is also a qualified person (other than a person who is a qualified person
under article x(2)(c)(ii) or (e)). The second category includes a resident of any third
country that has a comprehensive tax treaty with the contracting state that grants
treaty benefits who is entitled to claim all of the benefits under the third-country
treaty under provisions analogous to article x(2) (other than articles x(2)(c)(ii) and
(e)), and who would be entitled under the third-country treaty to a rate of withholding tax on dividends, interest, or royalties that is at least as low as the rate applicable
under the particular treaty.
The derivative benefits test in article x(4) is potentially applicable to all treaty
benefits. According to the commentary, countries may choose to limit the scope of
this provision to dividends to minimize treaty-shopping risks. In addition, as noted
earlier, article x(4) may be subject to change in response to recommendations made
regarding other areas of the action plan to address beps concerns.
Principal Purpose Test
Because of the objective nature of the tests in the lob provision, the oecd recognizes that the lob provision will address many treaty-shopping arrangements, but
not all. To deal with the exceptions, such as certain conduit financing arrangements,
the oecd proposes to modify the model convention to add the ppt in article x(7).
The ppt provides as follows:
Notwithstanding the other provisions of this Convention, a benefit under this Convention shall not be granted in respect of an item of income or capital if it is reasonable
to conclude, having regard to all relevant facts and circumstances, that obtaining that
benefit was one of the principal purposes of any arrangement or transaction that resulted directly or indirectly in that benefit, unless it is established that granting that
benefit in these circumstances would be in accordance with the object and purpose of
the relevant provisions of this Convention.28
The oecd notes that the ppt effectively incorporates the guiding principles
from paragraphs 9.5 and 22 to 22.2 of the oecd commentary on article 1 into the
model convention itself, thereby ensuring that a treaty applies in accordance with
its purpose, which since 2003 includes preventing tax avoidance and evasion.
The discussion below is a summary of the accompanying commentary to the ppt
in the oecd report, which is subject to further refinement before its release in final
form.
28 OECD report, supra note 4, at 66.
international tax planning  n  1099
Interaction with the Limitation-on-Benefits Provision
The commentary states that the ppt is not intended to restrict the scope of the lob
provision. If a person is not entitled to claim a treaty benefit by virtue of the lob provision, that “forgone” benefit is not considered to be a benefit for the purposes of
the ppt. Conversely, when a person is entitled to claim a benefit by virtue of satisfying the lob provision, the ppt may nonetheless apply to deny that benefit.
Benefits
A “benefit” for the purposes of the ppt includes all limitations on taxation imposed
on a source country under a treaty, including tax reductions, exemptions, deferrals,
and refunds. Further, a benefit could arise under articles 6 through 22 of the model
convention, the relief from double taxation afforded under article 23 (exemption
method and credit method), the protection afforded residents and nationals from
non-discrimination under article 24 (non-discrimination), as well as any limitation
under a tax-sparing provision.
Transactions Resulting in Benefits
The ppt is potentially applicable when “any arrangement or transaction results directly or indirectly” in a benefit. The commentary states that the term “arrangement
or transaction” should be interpreted broadly and includes “any agreement, understanding, scheme, transaction or series of transactions, whether or not they are legally
enforceable.”29 Examples include (1) the creation, assignment, acquisition, or transfer
of a property or a right to income that accrues on a property and (2) the establishment, acquisition, or maintenance of a person as a resident for treaty purposes.
The commentary also states that the ppt is intended to apply when a single transaction results in a benefit, or when a more elaborate series of transactions together
results in a benefit. Further, the words “directly or indirectly” are deliberately broad,
and are intended to include situations in which a benefit is claimed by a person in
respect of a transaction that is not the transaction undertaken for one of the principal purposes of obtaining that benefit.
Purpose Test
The ppt contains a “one of the principal purposes” test. The commentary indicates
that the purpose of an arrangement or transaction is a question of fact to be assessed
by reference to all of the facts and circumstances, including the aims and objects of
all persons involved in structuring or participating in the arrangement or transaction. Because the ppt uses the words “reasonable in the circumstances,” it is not
necessary to find conclusive proof of intent, but rather purpose should be determined on the basis of an objective analysis of the facts. Similarly, a person cannot
avoid the application of the ppt by merely asserting that the arrangement or transaction was not undertaken to obtain a treaty benefit.
29 Ibid., at 69.
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The reference of “one” of the principal purposes means that obtaining a treaty
benefit does not need to be the sole or dominant purpose; it is sufficient if at least
one principal purpose was to obtain the benefit. The commentary indicates that it
should not be “lightly assumed” that the purpose test is satisfied merely because a
treaty benefit results from a transaction. However, when an arrangement can be
explained only by a benefit, it may be reasonable to conclude that the ppt is satisfied. In addition, when similar benefits are obtained under a number of different
treaties, obtaining benefits under other treaties should not prohibit a finding that
obtaining a benefit under one particular treaty is the principal purpose of an arrangement. Nevertheless, when an arrangement is “inextricably linked” to a core
commercial activity and its form is not dictated by the desire to obtain a treaty
benefit, it is unlikely that the purpose test will be satisfied.
Object and Purpose Exception
Under the ppt, a benefit may be denied if one of the principal purposes of an arrangement or transaction is to obtain the benefit, unless it is established that granting the
benefit would be in accordance with the object and purpose of the relevant provisions of the treaty. The commentary indicates that this exception “allows the person”
claiming the benefit “the possibility of establishing that obtaining the benefit” is in
accordance with the object and purpose of the relevant provisions of the treaty.30
Thus, the onus appears to be on the person seeking a treaty benefit to establish that
receiving the benefit is in accordance with this object and purpose. However, the
commentary provides little guidance on the manner in which this onus may be
discharged, other than noting that article x(7) must be read in the context of articles
x(1) to (6) and the rest of the model convention, including its preamble.
Examples
The oecd report includes five examples to illustrate the circumstances in which the
ppt applies. Two of these examples involve a resident of a non-treaty country entering into an arrangement with a resident of a treaty country (one, the assignment of
a dividend right; the other, a share issuance), following which the treaty resident
receives a dividend that is eligible for a reduced rate of withholding. The example
states that “in the absence of other facts and circumstances showing otherwise,”31 it
would be reasonable to conclude that the principal purpose of each transaction is to
permit the resident to gain access to a treaty benefit in respect of the dividends received, and it would be contrary to the object and purpose of the treaty to grant the
benefit under the treaty-shopping arrangement.
In the third example, r co (resident in state r) is engaged in producing electronic
devices and is considering establishing a manufacturing plant in a developing country. r co identifies three possibilities, which all have similar economic and political
30 Ibid., at 66-67.
31 Ibid., at 71.
international tax planning  n  1101
environments, and r co decides to expand into state s in part on the basis of its
being the only country that has a treaty with state r. The example states that even
though the treaty benefits were considered, it is clear that the principal purpose for
building the plant relates to r co’s business expansion plans. Further, because tax
treaties are meant to encourage cross-border investments, obtaining treaty benefits
in this case is consistent with the object and purpose of the treaty.
In the fourth example, r co (resident in state r) is a civ that manages a diversified
portfolio of investments, and r co’s investment decisions take into account treaty
benefits available under state r’s extensive treaty network. Approximately 15 percent of r co’s portfolio is in dividend-paying shares of companies resident in state s,
and the withholding tax rate on dividends is reduced to 10 percent under the treaty
between state r and state s. The majority of investors in r co are resident in state r,
although a minority are resident in non-treaty countries. Decisions to invest in r co
are not made as a result of any particular investment made by r co, and r co’s investment strategy is not motivated by the tax position of its investors. r co annually
distributes most of its income to its investors, and r co pays taxes in state r on any
amounts that are not distributed. The example states that the mere fact that r co
considered the treaty benefits in respect of its investment in the state s companies
is not sufficient to trigger the ppt. Rather, the intent of a tax treaty is to encourage
cross-border investment. Unless r co’s investment is part of an arrangement that
relates to another transaction undertaken for a principal purpose of obtaining the
treaty benefit, it would not be reasonable to deny the dividend withholding tax
benefit.
In the last example, r co (resident in state r) has owned 24 percent of the shares
of s co (resident in state s) for the last five years. Following the adoption of a treaty
between state r and state s, r co decides to increase its ownership of s co to 25 percent in order to qualify for a reduced rate of withholding on dividends from s co.
The example states that even though the principal purpose of the 1 percent share
acquisition is to obtain treaty benefits, the ppt does not apply because it can be
established that granting benefits is in accordance with the object and purpose of
the dividend article in the treaty. The dividend article uses an arbitrary 25 percent
threshold, and it is consistent with the object and purpose of the treaty to grant
treaty benefits to a shareholder that genuinely increases its ownership in the company in order to satisfy this requirement.
Although these examples are intended to provide some guidance concerning the
operation of the ppt, they are of limited practical assistance because they involve
relatively basic facts, and it is difficult to decipher the basis for some of the conclusions reached.32
32 Other commentators have noted the same concerns in the context of the examples in the
OECD discussion draft, which include all but the last example discussed above. See Amanda
Athanasiou, “Stakeholders Weigh in on OECD’s Treaty Abuse Discussion Draft” (2014) 143:3
Tax Notes 316-18.
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Modified PPT
In the commentary, the oecd acknowledges that certain countries may prefer not
to adopt the ppt, but may nonetheless wish to supplement the lob provision with
a rule to counter conduit arrangements. These countries could include the modified
ppt in article X(7), which essentially provides that all or certain enumerated treaty
benefits are not available in respect of income obtained under, or as part of, a conduit arrangement. The commentary includes the following definition of “conduit
arrangement” for this purpose:
The term “conduit arrangement” means a transaction or series of transactions:
a) which is structured in such a way that a resident of a Contracting State entitled
to the benefits of this Convention receives an item of income arising in the other
Contracting State but that resident pays, directly or indirectly, all or substantially all
of that income (at any time or in any form) to one or more persons who are not resident of either Contracting State and who, if they received that item of income direct
from the other Contracting State, would not be entitled under a convention for the
avoidance of double taxation between the State of which those persons are resident
and the Contracting State in which the income arises, or otherwise, to benefits with
respect to that item of income which are equivalent to, or more favourable than, those
available under this Convention to a resident of a Contracting State; and
b) which has as one of its principal purposes obtaining such increased benefits as
are available under this Convention.33
The commentary in the oecd report does not contain any detailed explanations of
the conduit arrangement definition.
Comparison to the Domestic General Anti-Avoidance Rule
Section 245 of the Income Tax Act34 contains the domestic general anti-avoidance
rule (gaar) that can apply to deny certain tax benefits, including benefits under a
tax treaty, arising in the context of tax-motivated transactions that result in a misuse
of the provisions of the Act or the treaty, or an abuse having regard to these provisions read as a whole.
The ppt is similar to gaar in that each rule contains a benefit concept, a purpose test, and a saving provision. However, there are two key differences. First,
while the ppt uses a “one of the principal purposes” test, gaar uses a “primarily”
purpose test. Any purpose test is difficult to apply, but the ppt formulation potentially has a lower threshold than a “primarily” purpose test and also gives rise to
additional uncertainty: the word “principal” suggests that a person may have only
33 OECD report, supra note 4, at 74.
34 RSC 1985, c. 1 (5th Supp.), as amended (herein referred to as “the Act”). Unless otherwise
stated, statutory references in this article are to the Act.
international tax planning  n  1103
one principal purpose.35 In short, it may be more difficult for taxpayers to establish
that “one of the principal purposes” for undertaking an arrangement or transaction
was not merely to gain access to treaty benefits.
Second, the Canadian courts have held that in relation to the saving provision in
subsection 245(4), the onus is on the minister to establish that the transactions result in abusive tax avoidance.36 The comments in the oecd report suggest that this
burden rests on the taxpayer claiming the treaty benefits. This is particularly
troubling in light of the limited guidance in the oecd report on the application of
the object and purpose exception.
Proposals Rel ating to the Circumvention
of Domestic Ta x L aws
The oecd report notes that under articles 26 and 27 of the vclt, if a domestic
anti-abuse rule has the effect of allowing a country to tax an item of income that the
country would not be entitled to tax under the provisions of a treaty, the domestic
law conflicts with the treaty and the treaty should prevail. Thus, treaties may facilitate
arrangements entered into to avoid the application of certain domestic anti-abuse
rules. The types of domestic rules that have been subject to avoidance strategies
include thin capitalization rules, transfer-pricing rules, and foreign tax credit rules.
The oecd report states that many of these transactions will be addressed through
work in other areas of the action plan; therefore, the oecd report focuses on measures to ensure that treaties do not prevent the application of domestic anti-abuse
rules. This issue is particularly important when countries choose to rely on domestic rules or judicial doctrines to counter conduit arrangements, rather than revising
their treaties to incorporate the ppt.
As part of the 2003 amendments to its commentary on article 1, the oecd included a discussion about conflicts between domestic rules and treaties. The general
conclusion was that there is no conflict when a domestic rule applies to a transaction
that constitutes an abuse of the treaty because, as paragraph 9.5 of the oecd commentary on article 1 states, a guiding principle is that treaty benefits should not be
available in the case of tax-motivated transactions that offend the object and purpose
of a treaty. However, some domestic anti-abuse rules are drafted by reference to
objective standards and may apply whether or not they are tax-motivated or result
in an abuse of a treaty. In these cases, the treaty would prevail under the conflict-oflaws principle in the vclt.
The oecd report includes commentary that contains a more thorough discussion
of conflicts between domestic rules and treaties. However, the general conclusion is
that there should be no conflict if the domestic or judicial rules deny treaty benefits
only when these benefits would not be available in accordance with the guiding
35See Groupe Honco Inc. v. Canada, 2013 FCA 128; aff ’g. 2012 TCC 305, and Nathan Boidman,
“ ‘One of the Main Purposes’ Test” (2014) 22:5 Canadian Tax Highlights 9-10.
36See, for example, Canada Trustco Mortgage Co. v. Canada, 2005 SCC 54, at paragraph 63.
1104  n  canadian tax journal / revue fiscale canadienne
(2014) 62:4
principle in paragraph 9.5 of the oecd commentary on article 1 or when the treaty
expressly permits the application of these rules.37
Domestic Treat y-Shopping
Measures Before BEPS
In connection with the 2013 consultation, the Department of Finance released the
domestic consultation paper, in which it provided its views on treaty shopping, as
well as a summary of legislative measures adopted to address treaty shopping and
the results of treaty-shopping challenges in the Canadian courts.
Not surprisingly, the department defines “treaty shopping” in a manner that is
similar to the way in which the oecd defines it:
“Treaty shopping” generally refers to a situation under which a person who is not entitled to the benefits of a tax treaty uses an intermediary entity that is entitled to such
benefits in order to indirectly obtain those benefits.38
The department notes that while this definition could cover a wide variety of
arrangements, in its experience treaty shopping generally occurs when an intermediary entity resident in a treaty country
n
n
n
n
claims benefits under a Canadian tax treaty;
is owned or controlled mainly by residents of a third country that are not entitled to at least the same treaty benefits as the intermediary entity;
pays little or no tax on the Canadian income in its country of residence; and
carries on no real and substantial business activities, other than managing
investment income, in its country of residence.
When all of these hallmarks are present, the Department of Finance considers
the intermediary entity to be lacking in economic substance and believes that there
is strong evidence that there is no bona fide purpose for using the intermediary
entity, other than enabling third-country residents to gain access to treaty benefits
that they would not otherwise have been entitled to claim. However, the department states that the more substantial the commercial or economic presence that an
entity has in a jurisdiction, the less likely it will be to view the entity as engaging in
treaty shopping.
In the domestic consultation paper, the department indicates that Canada has
been taking steps to address treaty shopping for over two decades. In relation to
legislation and treaties, these initiatives include the following:
37 The OECD report also recommends amendments to the model convention and the OECD
commentary to clarify that treaties are not intended to restrict a country’s right to tax its own
residents, except as expressly provided, which is a specific example relating to the interaction of
treaties and domestic rules.
38 Domestic consultation paper, supra note 7, at section 1, “Treaty Shopping—The Hallmarks.”
international tax planning  n  1105
n
n
n
amending gaar and the Income Tax Conventions Interpretation Act in 2004
(with retroactive effect to 1988) to “clarify” that gaar can apply in respect of
treaty benefits;
supporting the development of the oecd commentary on article 1 relating to
the improper use of tax treaties, including the 2003 changes; and
adopting provisions to address treaty shopping, as suggested in the oecd
commentary on article 1, in Canada’s treaties, such as those dealing with entities in preferential tax regimes, main purpose provisions for specific types of
income, and (in case of the treaty with the United States)39 a comprehensive
lob provision.
In addition, the Department of Finance notes that the Canada Revenue Agency
has challenged several treaty-shopping cases in the courts, including Crown Forest
Industries Ltd. v. Canada,40 mil (Investments) sa v. The Queen,41 Canada v. Prévost Car
Inc.,42 and Velcro Canada Inc. v. The Queen.43 The minister relied on gaar only in
mil; the other three cases dealt with whether a particular precondition to treaty
relief was satisfied (residence in Crown Forest and beneficial ownership in Prévost and
Velcro). In mil, the Federal Court of Appeal found that gaar did not apply, noting
that there was nothing inherently abusive about treaty shopping. The treaty under
consideration in mil had been concluded in 1990, and the Tax Court of Canada
refused to take into consideration the oecd commentary on article 1 adopted in
2003, which (as discussed earlier) incorporated the notion that a purpose of a treaty
is to prevent tax avoidance.44 Thus, the effect of this change to the oecd commentary in a gaar analysis remains untested in the Canadian courts.
Domestic Proposal
As part of its treaty-shopping consultation, the Department of Finance released the
domestic consultation paper in 2013 and invited interested parties to respond to
seven specific questions, which in essence explored whether rules should be incor 39 The Convention Between Canada and the United States of America with Respect to Taxes on
Income and on Capital, signed at Washington, DC on September 26, 1980, as amended by the
protocols signed on June 14, 1983, March 28, 1984, March 17, 1995, July 29, 1997, and
September 21, 2007.
40 [1995] 2 SCR 802.
41 2006 TCC 460; aff ’d. 2007 FCA 236.
42 2009 FCA 57; aff ’g. 2008 TCC 231.
43 2012 TCC 57.
44 Note, however, that in Prévost, supra note 42, the Federal Court of Appeal held that later OECD
commentary could be referred to when it does not conflict with the commentary in place at the
time that a treaty was entered into, provided that neither treaty partner has registered an
objection to the new commentary. In Sommerer v. The Queen, 2011 TCC 212, the court found
conflict between the 1977 and 2003 versions of the OECD commentary on article 1 regarding
the interaction of domestic rules and treaties. Interestingly, it determined that the treaty in
question prevented the application of subsection 75(2).
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porated into domestic legislation, or treaties themselves, and whether specific or
general anti-treaty-shopping rules, drawn largely from the alternatives included in
the oecd commentary on article 1, should be adopted.45 In the handful of submissions received, parties questioned whether changes to address treaty shopping were
necessary; however, assuming that they were, the majority favoured introducing
specific anti-treaty-shopping rules into Canada’s tax treaties.46
Because the comments in the domestic consultation paper seemed to favour a
domestic solution,47 it not surprising that the Department of Finance put forward
the domestic proposal in the 2014 federal budget. Its four principal elements are a
main purpose provision, a conduit presumption, safe harbour presumptions, and
a relieving provision.
At the heart of the domestic proposal is the main purpose provision, which provides that a person is not entitled to a treaty benefit if it is reasonable to conclude that
“one of the main purposes” for undertaking a transaction or a series of transactions
that results in a benefit is to obtain the benefit. The scope of the domestic proposal
is significantly expanded by virtue of the conduit presumption, under which a person
is presumed to have a tax-motivated main purpose in certain circumstances:
Conduit presumption: it would be presumed, in the absence of proof to the contrary, that
one of the main purposes for undertaking a transaction that results in a benefit under
a tax treaty (or that is part of a series of transactions or events that results in the benefit)
was for a person to obtain the benefit if the relevant treaty income is primarily used to
pay, distribute or otherwise transfer, directly or indirectly, at any time or in any form,
an amount to another person or persons that would not have been entitled to an
equivalent or more favourable benefit had the other person or persons received the
relevant treaty income directly.48
A person who satisfies the main purpose test may still be entitled to a treaty
benefit by virtue of the safe harbour presumptions or the relieving provision. Importantly, however, relief under the safe harbour presumptions is not available when
the conduit presumption applies.
45 These responses are available online at www.fin.gc.ca/consultresp/ts-cf-eng.asp.
46 For additional commentary on the domestic consultation paper, see Robert Couzin, “A Few
Thoughts on Treaty Shopping” (2013) 61:3 Canadian Tax Journal 671-76; Jack Bernstein,
“Finance Consultation Paper on Treaty Shopping” (2013) 21:9 Canadian Tax Highlights 5-7;
and Jack Bernstein, Ron Durand, and Patrick Marley, “Treaty-Shopping Review,” in Report of
Proceedings of the Sixty-Fifth Tax Conference, 2013 Conference Report (Toronto: Canadian Tax
Foundation, 2014), 27:1-17.
47 For example, in section 3 of the domestic consultation paper, supra note 7, the Department of
Finance indicates that because of the reluctance of Canadian courts to find against taxpayers in
treaty-shopping cases (and MIL in particular), the courts require “clearer legislative direction
to the effect that treaty shopping is an improper use of Canada’s tax treaties.” In addition, in
section 6.2 of the domestic consultation paper, the department notes that a domestic solution
could be implemented quickly, whereas amendments to all of Canada’s treaties could take decades.
48 2014 Budget, supra note 8, at 351.
international tax planning  n  1107
Under the safe harbour presumptions, none of the main purposes of a person
undertaking a transaction or series is presumed to be obtaining a treaty benefit if
one the following conditions is satisfied:
n
n
n
Active business. The person (or a related person) carries on an active business
(other than managing investments) in a treaty country, and, if the treaty income
is derived from a related person in Canada, the active business is substantial
compared with the activity carried on in Canada giving rise to the treaty
income.
Control. The person is not controlled, directly or indirectly in any manner
whatever, by another person (or persons) who would not have been entitled
to an equivalent or more favourable treaty benefit had the other person (or
persons) received the treaty income directly.
Stock exchange. The person is a corporation or a trust whose shares or units
are regularly traded on a recognized stock exchange.
Further, under the relieving provision, treaty benefits may be available “in whole or
in part, to the extent that it is reasonable, having regard to all the circumstances.”49
The 2014 budget papers note that the domestic proposal is not intended to apply
to an “ordinary commercial transaction” solely because obtaining a tax treaty benefit was “one of the considerations” for making an investment.50 The 2014 budget
papers do not contain detailed technical commentary on the domestic proposal, although five examples are included for comment (and three are based on facts similar
to those in mil, Prévost, and Velcro). However, the examples provide little guidance
and share the deficiencies of those in the oecd report relating to the ppt, which
have been discussed earlier.
The domestic proposal is potentially broad in scope for a number of reasons,
including the use of the “one of the main purposes” test, the breadth of the conduit
presumption, the unavailability of the safe harbour presumptions when the conduit presumption applies, the absence of an express saving provision for non-abusive
transactions, and the uncertain application of the relieving provision.51
49 Ibid., at 352.
50 Ibid.
51 For a more detailed discussion of the domestic proposal, see Steve Suarez, “Canada To
Unilaterally Override Tax Treaties with Proposed New Anti-Treaty Shopping Rule” (2014) 73:9
Tax Notes International 797-806; Michael N. Kandev, “Canada Intent on Stoppin’ the Shoppin’
and More” (2014) 73:13 Tax Notes International 1201-7; Brian J. Arnold, “OECD BEPS Treaty
Abuse Proposals,” The Arnold Report 064, April 16, 2014 (www.ctf.ca); and Jack Bernstein,
“Canada’s Proposed Anti-Treaty Shopping Rule: A Practitioner’s Dilemma” (2014) 74:9 Tax Notes
International 845-48. See also the Joint Committee on Taxation of the Canadian Bar Association
and Chartered Professional Accountants of Canada, “Submission on the Consultations
Regarding Treaty Shopping,” submission to the Department of Finance, May 16, 2014.
1108  n  canadian tax journal / revue fiscale canadienne
(2014) 62:4
Concluding Comments
The oecd and Canada have released proposals to address treaty-shopping arrangements, and presumably the Department of Finance is reconsidering the domestic
proposal in light of the proposals in the oecd report. Two main considerations will
play a role in the direction that Canada may ultimately take to counter treaty
shopping.
First, while the oecd report focuses on the oecd’s recommendations regarding
changes to the model convention and the oecd commentary, it also notes that
countries (including Canada) have agreed that a minimum standard of protection
against treaty shopping is required. The oecd appears to prefer that countries
adopt the lob provision, the ppt, or both in their treaties. The coordinated response
envisaged by the beps initiatives depends in large part on countries being able to
adopt these treaty amendments in a timely and synchronized fashion. Action 15 of
the action plan contemplates the development of a multilateral instrument that can be
used by countries to adopt the treaty-related recommendations stemming from the
action plan, including the recommendations in action 6; this instrument is expected
to have the same effect as the simultaneous renegotiation of thousands of bilateral
tax treaties.52 The instrument is paramount in achieving the swift and efficient
adoption of treaty-related beps measures. Whether it will deliver the anticipated
results may not become clear until 2017.
Second, the oecd notes in its report that its preferred treaty-based approach may
not be appropriate for all countries. As a result, countries will have some flexibility
in the approach that they adopt to satisfy the minimum standard. For example, the
oecd report notes that the ppt may not be required when a country has domestic
rules or judicial doctrines to deal with treaty-shopping arrangements or when the
modified ppt may be preferred. It is currently unclear what approach Canada may
take and whether Canada would satisfy the minimum standard if, for example, it
simply adopted the domestic proposal (or a modified version of this proposal). In the
event that the domestic proposal is acceptable, the oecd report notes that consideration must be given to whether such a domestic rule would conflict with existing
treaties. The oecd indicates that generally no conflict should arise when either the
domestic rule denies treaty benefits only if a treaty has been abused (consistent with
the principle in paragraph 9.5 of the oecd commentary on article 1) or the treaty
expressly permits the application of the domestic rule.53
52 On September 16, 2014, the OECD released Developing a Multilateral Instrument To Modify
Bilateral Tax Treaties (Paris: OECD, 2014), a report in which it concluded that a multilateral
instrument was both feasible and desirable, and that negotiations of the content and text of such
an instrument should begin in early 2015 and be limited to a period of no more than two years.
53 For commentary on the minimum standard in the Canadian context, see Brian J. Arnold,
“BEPS and Treaty Abuse I,” The Arnold Report 070, October 20, 2014 (www.ctf.ca), and Ken
Snider, “Policy Forum: Canada’s Anti-Treaty-Shopping Proposals and International Treaty
Obligations” (2014) 62:3 Canadian Tax Journal 705-28.