The MLI entered into force for Canada on Dec. 1, 2019. As a result, the MLI has entered into effect for Canada’s tax treaties:
- On Jan.1, 2020, for withholding taxes
- For other taxes (including capital gains taxes), in tax years beginning on or after June 1, 2020
A major international tax agreement, the Multilateral Convention to Implement Tax Treaty Related Measures to Prevent Base Erosion and Profit Shifting (MLI), is currently working its way toward ratification in Canada. Businesses with international footprints may be impacted if they rely on tax treaties to determine tax consequences such as withholding tax rates, dispute resolution procedures, allocation of taxing rights, and general eligibility for treaty benefits.
BPS and the MLI Convention
As money has become increasingly easy to move across borders, tax authorities have become concerned with artificial shifting of profits to lower tax jurisdictions, a practice known broadly as Base Erosion and Profit Shifting (BEPS). In a move to prevent BEPS and address tax avoidance, the Organisation for Economic Co-operation and Development (OECD) undertook a project (the BEPS Project) to study how disjointed tax rules can be exploited and to improve the coherence of the international tax system.
One result of the OECD’s BEPS Project was the MLI, a multilateral instrument that allows for rapid implementation of a series of tax treaty measures. Canada is one of eighty-seven signatory countries to have signed the convention to date, along with some of its largest trading partners like China, the United Kingdom and all of the European Union countries. Noticeably absent from the signatory list is the United States. Under the MLI, signatories would be required to implement certain minimum standards with respect to international tax issues identified by the BEPS Project. The minimum standards of the MLI are mandatory, but countries are free to choose among other optional provisions.
The MLI is not a stand-alone treaty. Instead, if two countries have an existing bilateral tax agreement and both of those countries have ratified the MLI, then the MLI applies as an overlay to that existing bilateral treaty, or Covered Tax Agreement. Seventy-five of Canada’s ninety-three bilateral tax agreements are listed as Covered Tax Agreements under the MLI.
The two main, mandatory, minimum standards that Canada will adopt relate to (1) treaty abuse and (2) dispute resolution procedures. Canada also intends to adopt certain of the MLI’s optional provisions to avoid or reduce taxation in inappropriate circumstances; these optional provisions relate to withholding tax rates, capital gains exemptions, dual residency, and allowing treaty partners to move to a foreign tax credit system.
Minimum Standard - Treaty Abuse
Treaty abuse can occur when a multinational business takes advantage of favourable tax treaties available in other jurisdictions to minimize its tax liability with the home country. The treaty abuse measures are meant to eliminate any opportunities for zero and/or reduced taxation not in accordance with the treaty, while also preventing double taxation. To implement the rule, Canada intends to amend the preamble of Covered Tax Agreements and adopt a Principal Purpose Test (PPT) as an interim measure to implementing a more comprehensive Limitation-on-Benefits (LOB) rule where possible. The PPT is a way for governments to deny treaty benefits to a business if the principal purpose of a business arrangement or transaction was to directly or indirectly obtain a tax benefit. Canada hopes to eventually implement LOB rules which mimics the spirit of the PPT and formalizes it into a set of clearer, more targeted, laws.
Minimum Standard - Dispute Resolution
These measures include fully implementing mutual agreement procedures requiring the relevant tax authorities to make attempts at resolving disputes in a timely manner. Further, Canada has opted into mandatory arbitration such that if Canada and a treaty partner (that has also opted into the mandatory arbitration) cannot agree within a specified time, the matter will be submitted to an arbitration panel whose decision will be final and binding.
Update on Canada’s MLI Implementation and Timeline
The MLI is being domestically ratified in Canada under Bill C-82. As of end of May, the bill has passed through the House of Commons and both readings in the Senate and is currently being reviewed by the Senate’s Standing Committee on Foreign Affairs and International Trade. Once the bill passes the Senate Standing Committee, it will get a third and final reading in the Senate before being submitted for royal assent and made into law.
The last sitting day of the Senate is June 28, 2019 ahead of the summer recess. If the bill does not make it past the Senate’s third reading by June 28, 2019, it will likely not become law in 2019.
While both the House and the Senate are normally due to return from recess on September 16, 2019, it is very likely that the government will not resume in 2019 due to it being an election year. Thus, unless Bill C-82 is given royal assent before the Senate breaks for summer recess and the election, the legislative process through the House (three readings and committee approval) and the Senate (also three readings and committee approval) will need to be restarted after the election. Although not guaranteed, Bill C-82 has thus far enjoyed bipartisan support giving it a high chance of being reintroduced and passed even under a new government.
Despite this, restarting the legislative process under a new government would likely delay the entry into force of this agreement to 2020 or even 2021 given that the bill initially took almost a year to get to the Senate. Notwithstanding these observations, Finance has stated that it is hopeful that Canada will be among the additional jurisdictions that will deposit their MLI instruments of ratification by the end of 2019.
Companies should be aware of the potential timelines for when the MLI may come into effect. Given its uncertain ratification timeline, taxpayers may be reluctant to significantly change any business practices but should continue to monitor the progress of Bill C-82 as it moves through the legislative process. The period prior to definitive ratification is an opportune time to revisit existing cross-border arrangements.