Thank you for having me here today. I just want to start by saying that I, too, generally support Bill C-82 and the ratification of the MLI in Canada. However, I do have some important concerns that I want to mention to you with respect to the process and manner in which it's ratified and adopted in Canada. I'm going to break that down into four points. I'll touch on each of them in more detail.
The first is on the principal purpose test, which I think is one of the most significant aspects of the multilateral instrument. We're in dire need of more guidance on how that's going to apply in Canada. Because it's the result of an OECD project, where they strived to get consensus among a broad group of nations, the text is very broad and ambiguous, and the examples that the OECD has provided give very little practical guidance as to how it's going to work in practice.
In contrast, when Canada introduced the general anti-avoidance rule domestically, the CRA, at the same time, came out with a detailed information circular, going through different examples in how they would apply in Canada. I think more guidance is needed on the principal purpose test, particularly with respect to private equity and other collective investments, which is an area that the OECD has struggled with in terms of how that test should apply to collective investors. Really, there's a huge amount of capital that gets invested into Canada that way.
The second point is that I think Canada should be opting into article 7(4). We've currently reserved on that. I'll touch on why it's inappropriate to not have article 7(4) applying, and, really, the double tax or the unfairness that could result without that.
My third point is that Canada should continue to reserve on all of the changes to the permanent establishment threshold. I think that's consistent with the approach Canada has taken to date, and it's really for two reasons. One is that what we have now, in terms of when you have a permanent establishment, is effectively a bright-line test. It's easy to understand. It's well recognized. What the changes bring in the permanent establishment test is a lot of uncertainty, ambiguity, and, really, the ability for countries to argue that there's a permanent establishment when otherwise there might not have been. That, again, can lead to a potential explosion in tax disputes among countries, and could have negative implications for Canadian revenue.
The last point I was going to make is with respect to binding arbitration. I think we should continue to push for binding arbitration in as many treaties as we can. Our firm is perhaps the largest tax litigation disputes firm in the country. I can say, from working at Osler for the past 20 years, the amount of tax disputes in the country have really continued to expand year after year. Binding arbitration is really an effective process for resolving disputes among countries on allocating taxing rights and who should have the right to tax different countries.
To turn back to my first point on the need for more guidance on the principal purpose test, again, the test applies if one of the principal purposes of an investment is to avoid tax. It's often difficult to determine what is a purpose versus a principal purpose, let alone what all of the principal purposes are and whether tax avoidance was a principal purpose. Particularly, as I said, with private equity or other investments, I'll just give a quick example, obviously oversimplified, to illustrate that, together with, in my view, the need for article 7(4) to be applicable.
If you have two investors, one in the U.S. and one in India, each wanting to invest collectively into different countries, including Canada, what will generally happen in this example is the U.S. investor would not want to invest through an Indian company, the Indian investor would not want to invest through a U.S. company. What they would often do is form a holding company, in a third country, to invest collectively. That serves a number of business purposes, including raising larger pools of capital to make larger investments in, say, mines or other development projects.
In my example, if the U.S. and the Indian companies invest, say, in a Luxembourg holding company, the Luxembourg holding company, in turn, could invest in Canada or other jurisdictions around the world. In that simple example, under our current system, if Canada pays a dividend to the Luxembourg company, we would have a 5% withholding tax, which is the same withholding tax that would apply if the Canadian company paid directly to the U.S. company. However, it's different from what would apply if it paid a dividend directly to the Indian company, because we have a 15% withholding tax rate under the Canada-India treaty.
What happens under the MLI is that if the principal purpose test applies—if you determine, in my example, that tax avoidance was the purpose of using this Luxembourg company—then treaty benefits are denied. There's a 25% withholding rate applicable on dividends out of Canada, which is more than what would have applied if either the Indian or U.S. companies had invested directly. Article 7(4) turns off that tap, or allows Canada, in this example, to apply a 5% or 15% withholding tax rate rather than revert to a 25% rate, particularly if it was as a result of commercial reasons that the Indian and U.S. companies invested together.
Admittedly, that's an overly simplified example. What typically would happen is that you'd have a larger number of jurisdictions of investors. Obviously, the U.S. is a major capital-exporting country, so it's not uncommon for large pools of U.S. investments to come into Canada. It's often commingled with investors in Europe or Asia or other jurisdictions. Because we have 93 tax treaties, in most cases the ultimate investors are in one of those 93 countries. That's where the largest capital pools are.
I'll turn now to the “permanent establishment” changes. As I mentioned, if we opt in to that change, it would have a permanent effect, because the election is irreversible, and it would apply to a vast number of treaties. As I believe Stephanie and Trevor mentioned two days ago, Canada might win or lose on that. To give a quick example, in the resource sector right now, resource companies in Canada can sell their resources around the world and pay taxes in Canada based on not having permanent establishments in those other countries. If we were to opt in to that test, it would allow foreign countries in Asia or Europe or other jurisdictions to potentially tax some of Canada's resource profits by arguing that those resource companies have permanent establishments around the world in their jurisdictions based on facilitating contracts or facilitating access to the local markets. It creates significant uncertainty. The taxpayer will always lose, because they'd have to file returns in more jurisdictions, and potentially pay taxes in more jurisdictions, but Canada could lose because it could be ceding taxing rights to other jurisdictions.
As well, because it's such a fundamental change and is irreversible, in my view it should have parliamentary approval; an order in council and subsequent governments should not be allowed to make those changes. As we stand now, any significant changes to tax treaties go through Parliament. In my view, removing that reservation on the permanent establishment changes is of such significance that it should be something for Parliament to decide, and not be done by order in council.
Thank you.