Finance Committee on Feb. 5th, 2019

[Blake Richards]

Yes, the ones that were chosen at the later date.

[Stephanie Smith]

One of the provisions that was not in the initial provisional notifications is article 4 on dual resident entities. A decision was made by the government to adopt this provision. It was generally in line with the policy and with a number of prior tax treaties that had been negotiated by Canada. Adopting such provision will allow us to have a greater consistency across our tax treaties for resolving cases of dual resident entities involving non-individuals.

There was also a decision in article 5 effectively to allow countries that currently have committed to providing for an exemption system to change that to a credit system to ensure that taxpayers are not inappropriately getting double tax or a lower rate of tax. It won't have an impact specifically on Canada's elimination of double taxation, because we currently, in our treaty policy and in all of our tax treaties, already provide for foreign tax credit, but it was viewed that allowing other countries to ensure such similar protection was desirable.

Article 8 was another provision that was proposed to be included. Article 8 applies to dividend transfer transactions. The way the tax treaty works is that it has two withholding rates. Our domestic rate would be 25%. Treaties generally reduce that rate to 15% or 5% if the particular corporation to which the dividend is paid has a certain threshold of holdings or control in the dividend-paying company.

The provision in article 8 provides that to obtain the lower rate, they must have exceeded the threshold of ownership or control for a minimum of 365 days prior to the payment of the dividend. This is to avoid artificial transactions in which they increase their ownership just prior to their dividend paying date. It was viewed as something that would be beneficial and that the CRA would be able to administer. It is something that we propose to include in the updated notifications.

Similarly, there is article 9, which deals with capital gains from alienation of shares or interests of entities that derive their value primarily from real property. Generally speaking, under a tax treaty, the source country in which the company that derives its value from real property exists would retain its right, on a disposition of those shares or other interests, to tax that disposition to the extent that the value of the shares principally derive their value from real property.

There were some abusive transactions in which companies, just prior to the distribution of those shares, put a lot of cash into the company such that the value of the real property fell below the threshold, or they sold a property prior to that specifically to avoid the source country having the right to tax. The treaty provision now would ensure that if that threshold were crossed at any time in the 365 days preceding the disposition, the source country would have the right to tax that provision. Including that in Canada's tax treaties was seen to be desirable.

[The Chair, Liberal, Wayne Easter]

We will have to cut it there and move to Mr. Fergus. Obviously, from the descriptions given, all kinds of games have been played to avoid taxes, and those folks should be nailed.

Mr. Fergus.

[Greg Fergus, Liberal, Hull—Aylmer, QC]

Thank you, Mr. Chair.

Ms. Smith and Mr. McGowan, thank you for your presentation and your honest answers. My fellow member Mr. Kmiec called the topic rather dry. Be that as it may, it's very important stuff. I very much appreciate the opportunity to review the legislation implementing the multilateral convention.

My first question builds on that of my honourable colleague, Mr. Fragiskatos, regarding mandatory arbitration. What are the advantages and drawbacks of the final-offer approach for the mandatory binding arbitration mechanism in the convention?

[Stephanie Smith]

Generally speaking, the benefit of the mandatory arbitration provision is that it provides certainty to taxpayers that their double taxation will be resolved. Without the finality of mandatory binding arbitration, the mutual agreement procedure itself only provides that the competent authorities, which in the case of Canada is the Canada Revenue Agency, endeavour to resolve the disputes. Inevitably there end up being a few cases where there is difficulty in resolving those disputes, or when the time frame can be quite long to resolve those disputes. One of the main benefits of tax treaties is to try to encourage trade and investment and to provide certainty for taxpayers and to ensure that they don't end up in a situation of double tax. Those are the significant advantages.

Canada has had mandatory binding arbitration in the convention with the United States since its 2007 protocol. The binding arbitration entered into effect in 2010. It has been considered by both the Canada Revenue Agency and taxpayers alike to be very advantageous in ensuring that disputes are resolved.

In terms of some of the disadvantages, not all of the countries—in fact, only a subset of the countries—are willing to sign on to binding mandatory arbitration. I think to date it's under 30, between 25 and 30, countries that have agreed to binding mandatory arbitration.

[Greg Fergus, Liberal, Hull—Aylmer, QC]

Have all signatory countries agreed to adopt mandatory arbitration?

[Stephanie Smith]

No, unfortunately. It is not a minimum standard provision. Therefore, countries have the option of whether to opt in or not to binding mandatory arbitration. Of the 87 signatories, I think it's 26, but I could be off by one or two. Between 25 and 30 signatories have agreed to binding mandatory arbitration.

[Greg Fergus, Liberal, Hull—Aylmer, QC]

Are any of the countries that have opted not to adopt the standard important for Canada from an investment standpoint?

[Stephanie Smith]

Generally speaking I would say that all of Canada's largest trading partners have agreed to binding mandatory arbitration. In particular, it was something that G7 countries are very supportive of. The countries with whom we have the largest number of MAP cases, mutual agreement procedure cases, generally speaking have agreed to binding mandatory arbitration.

[Greg Fergus, Liberal, Hull—Aylmer, QC]

I have one last question.

Could the provisions on the taxation of dividends and capital gains have a negative impact on foreign corporations establishing subsidiaries in Canada?

[Stephanie Smith]

I'm not sure I would describe it as a disadvantage, because this is a provision that will apply bilaterally. It will apply to dividends being paid both to and from Canada. Yes, if you're talking about a foreign parent company with a Canadian subsidiary, it would impose the discipline to receive the lower withholding rate. To get the lower withholding rate, they would have to have maintained that ownership threshold throughout the required period. It's the same thing with respect to the capital gains. That would work a little differently because that's about a source taxation. Yes, it is a bilateral provision: both Canadian and foreign entities would be expected to meet these conditions.

[The Chair, Liberal, Wayne Easter]

Mr. McGowan, do you want to add something?

[Trevor McGowan]

I would, if there's time.

Thank you for the question. As you pointed out, it's a very technical area, and so, I'm going to have to answer in English.

You mentioned not giving a disadvantage, and also building upon an earlier question by Mr. Julian,

When we talk about the principal purpose test or anti-treaty abuse rule, certain tax advantages are accorded to our treaty partners. For example, on capital gains, a treaty partner might be exempt on a disposition of shares of a Canadian entity. That's part of Canada's tax policy, and it's common throughout the world. Of course, there are jurisdictions, as we discussed earlier, such as the Cayman Islands, with whom Canada does not have a tax treaty. Tax planning strategies have been effected to achieve tax benefits that have been negotiated under a particular tax treaty, with one of our treaty partners, by entities resident in a country with whom Canada does not have a tax treaty.

When you're talking about the obtaining or losing of an advantage, part of the anti-avoidance, anti-treaty abuse rules in the multilateral instrument would have the effect of preventing non-treaty partners from accessing these treaty benefits. As between treaty partners, it might have a certain effect. In the broader context, where we don't have treaties with everyone and countries generally want to ensure that their treaty policies have force and are respected, it does have that additional benefit of not providing or extending treaty benefits beyond the intention for which they were negotiated and entered into. That applies on both sides of a bilateral agreement vis-à-vis third parties.

[The Chair, Liberal, Wayne Easter]

Thank you for that additional information.

Mr. Kmiec, you have about five minutes.

[Tom Kmiec, Conservative, Calgary Shepard, AB]

I want to go back to those optional components again. Thank you for the list you gave. It kind of corrected some of what I had here.

Thank you, Chair, for making them complete the list.

I wanted to talk about article 10, 12 and 13, which affect permanent establishments. What's the effect of Canada not participating in those three: article 10, the anti-abuse rule for permanent establishments situated in third jurisdictions; article 12, artificial avoidance of permanent establishment status through commissionaire arrangements and similar strategies; and article 13, artificial avoidance of permanent establishment status through the specific activity exemptions? What is the effect of Canada not participating?

[Stephanie Smith]

The effect of not participating means that those provisions would not apply to Canada's tax treaties through the MLI.

[Tom Kmiec, Conservative, Calgary Shepard, AB]

What is the tax effect? Why aren't we participating? What's the policy reasoning for it?

[Stephanie Smith]

The policy reason, in general, for not applying the permanent establishment provisions through the MLI is that they are very detailed, with very complicated compatibility clauses. Because Canada has such a large treaty network, we were concerned about the complexity and uncertainty it would create through its impact on the particular tax treaties. Because we have a large treaty network, with some of our treaties dating back to 1975, the permanent establishment provisions in particular differ significantly throughout our tax treaty network, and the impact on all those provisions was not clear.

Another reason was that, compared with the other provisions in the MLI, relatively few countries picked up these provisions, and so we would not have had a match with very many treaty partners in respect of these provisions. To the extent that we would have had a match, it may not necessarily have been in Canada's favour to have these provisions. In many cases we would have been the resident's country relative to the other country. That speaks mostly to articles 12 and 13. With respect to article 10 relating to permanent establishments situated in third jurisdictions, that is not a situation that Canada encounters very often. It's a function of how our domestic law works. This typically has not been a problem with respect to Canada's tax treaties.

The fact that these provisions are not incorporated via the MLI does not mean that at some point in the future Canada could not take a different decision and incorporate them through the MLI. It also does not preclude the integration of these provisions in a future bilateral update to the tax treaty.

I note that in respect of the OECD model tax convention, where these provisions are included, there are no reservations from Canada in respect of the policy of these provisions.

[Tom Kmiec, Conservative, Calgary Shepard, AB]

How much time do I have, Mr. Chair? Two minutes?

[The Chair, Liberal, Wayne Easter]

I could give you a couple of minutes. You only have one, but go ahead.

[Tom Kmiec, Conservative, Calgary Shepard, AB]

Okay. I just want to follow up on that. You said that in the future Canada could opt into some of these optional provisions. I guess you said the gist of it, but in summary, articles 12 and 13 are not very popular with a lot of countries. If we adopted these rules, they wouldn't give us much benefit in dealing with it.

What is the mechanism to join one of these optional ones after this treaty is ratified and put into force in Canada? Can we ever opt out? How is that done? Does it come back to Parliament for an opting out? Because you mentioned an order in council process, is it just by order in council?

[Stephanie Smith]

To address the last question first, the way the convention is structured, you cannot opt out once you have opted in. In part, that also part, influenced the prudent approach taken by the government with respect to adopting the provisions of the MLI. Once you choose them, you have them forever and cannot opt out. You can, however, withdraw reservations, which has the effect of opting into provisions at any time in the future. Such a process would be done through an order in council, and it would be an update to the reservations and notifications Canada would have deposited with the depositary.

[Tom Kmiec, Conservative, Calgary Shepard, AB]

Just so I'm clear, once Parliament passes this—if Parliament passes this—it goes to the Senate, gets royal assent, and the order in council is issued. Then we become a party to all of the articles the government has indicated that it wishes to be a party to. Then in the future, by the ministry's going back to cabinet, by order in council, it can say that we will then opt in to articles 10, 12 and 13, for example. It would not come back to parliamentarians to have a debate or conversation about it. Is that what I'm to understand?

[Stephanie Smith]

That is correct, because it would be the entire convention itself that Parliament would adopt and Canada would ratify.

[Tom Kmiec, Conservative, Calgary Shepard, AB]

This is for all of the optional components? On them, you're saying that you can only opt in by withdrawing your reservation. Wouldn't the wiser policy choice, then, have been to keep our withdrawal from all of the optional things and see how they work out before opting into them? Wouldn't it have been the wiser, more prudent choice to see what the effect is and then choose which ones to participate in?