On June 21, 2019, one year after it was tabled in the House of Commons, Bill C-82, An Act to implement a multilateral convention to implement tax treaty related measures to prevent base erosion and profit shifting, received Royal Assent and became law. By way of background, Canada had signed the Multilateral Instrument (the “MLI”) on June 7, 2017 and had then announced its intention to adopt the minimum standards proposed by the Organisation for Economic Co-operation and Development (the “OECD”) under the Base Erosion and Profit Shifting project, as well as mandatory arbitration for tax treaty disputes.
The next step for Canada is to notify the OECD through the deposit of its instrument of ratification which is likely to be done before the end of the year. The MLI will then enter into force for Canada on the first day of the month following the expiration of a three-month period from the date of notice to the OECD. For example, if the notice is sent in October 2019, the MLI will enter into force for Canada on February 1, 2020.
The MLI provisions on withholding tax will then take effect between Canada and a treaty partner where the MLI is already in force on the first day of the next calendar year, i.e. January 1, 2021. For other taxes, such as the capital gains tax on shares meeting the real property asset valuation threshold (discussed below), the MLI will have effect for the taxable periods beginning after a six month period (or a shorter period if the contracting states notify the OECD that they intend to apply such a period), i.e. for the taxable periods beginning August 1, 2020.
As of July 4, 2019, out of the 89 countries who signed the MLI, 29 have deposited their instrument of ratification with the OECD, including Australia, Finland, France, India, Ireland, Luxemburg, Japan, the Netherlands, New Zealand, Sweden and the United Kingdom.
As indicated, Bill C-82 confirms the adoption of the minimum standards, along with other measures for which Canada had initially registered a reservation, including the two following measures which are noteworthy.
1. MLI – Article 8, paragraph 1: Dividend Transfer Transactions
Most tax treaties signed by Canada call for a reduction in the domestic withholding tax rate on dividends from 25% to 5% when the beneficial owner of the dividends is a corporation subject to corporate tax in the contracting jurisdiction that directly or indirectly holds at least 10% of the voting rights (and, in some cases, of the capital) of the Canadian corporation paying the dividend. Fulfillment of the 10% ownership test is determined when the dividend is paid.
By adopting the restriction described in paragraph 1 of Article 8 of the MLI, Canada agrees to apply the reduced withholding tax rate of 5% only if shares granting voting rights (and capital, where applicable) of at least 10% are owned throughout a 365-day period, including the day on which the dividend is paid. For the purpose of computing that period, no account shall be taken of changes of ownership that are a direct result of a corporate reorganisation, such as a merger or divisive reorganisation, of the corporation that holds the shares or the Canadian corporation that pays the dividend. This amendment will block surplus exit planning strategies where the shareholding of a Canadian corporation was modified within days prior to the payment of a dividend, which was generally easy to achieve from a Canadian tax perspective as the gain on the sale of the shares of a Canadian corporation is not taxable unless more than 50% of the value of the shares is derived directly or indirectly from real or immovable property, resource property or timber resource property situated in Canada.
2. MLI – Article 9, paragraph 1: Capital Gains from Alienation of Shares or Interests of Entities Deriving Their Value Principally from Immovable Property
Canadian domestic law stipulates a five-year test to determine taxation of a capital gain from disposition of shares or other interests in entities whose value is or was mainly (i.e. more than 50%) derived from immovable property in Canada. Thus, if, at any time during this 60-month period ending on the date of disposition of the shares, more than 50% of their value was derived directly or indirectly from an immovable property located in Canada, the capital gain from the disposition is taxable in Canada. In comparison, most tax treaties signed by Canada do not include a retroactive test. In fact, the value test is generally applied at the time of disposition. It was therefore possible, subject to the general anti-avoidance rule, to proceed with an asset “stuffing” to decrease the relative value of the immovable property in Canada below the 50% threshold before the sale.
With paragraph 1 of Article 9 of the MLI, Canada is adopting a one-year retroactive look back, i.e. Canada is reserving the right to tax the capital gain if the 50% value threshold is exceeded at any time during the 365 days preceding the disposition.