moved that Bill C-10, an act to implement a convention between Canada and Sweden, a convention between Canada and the Republic of Lithuania, a convention between Canada and the Republic of Kazakhstan, a convention between Canada and the Republic of Iceland and a convention between Canada and the Kingdom of Denmark for the avoidance of double taxation and the prevention of fiscal evasion with respect to taxes on income and to amend the Canada-Netherlands Income Tax Convention Act, 1986 and the Canada-United States Tax Convention Act, 1984, be read the second time and referred to a committee.
Mr. Speaker, I intend to be very brief this morning.
We intend to enter into three new tax treaties with Lithuania, Kazakhstan and Iceland and we are making revisions to four existing taxation treaties, those with the Netherlands, Denmark, Sweden and the United States.
Canada currently has 61 treaties for the avoidance of double taxation and the prevention of fiscal evasion. With these three new treaties we will be up to 64. This is very important for Canada as a nation which is outward looking and which depends on 40% of its economic wealth in any one year on its exports, on its commerce abroad, on its foreign direct investment and the flows of information, capital, technology, royalties, dividends and interest.
In five of the treaties, those with Ireland, Denmark, Lithuania, Kazakhstan and Iceland, the major provisions, apart from avoiding the double taxation of income, i.e., deciding that if income flows from one country to another, which country has the right to tax it. Obviously both countries cannot if we are to have a modern world. Otherwise the rates of tax would easily exceed 100% of that income.
Through these treaties one country foregoes the right to tax in certain circumstances. For purposes of simplicity we have countries of source and we have countries of destination, usually where the recipient is resident. Will it be the country where the income is owned or the country where the recipient is resident that will determine the primacy of taxation? In this exercise we have followed the general outlines set out in the OECD model convention for the avoidance of double taxation.
In five of these treaties, those of Ireland, Denmark, Lithuania, Kazakhstan and Iceland, one of the main provisions involves reducing the withholding tax that would otherwise be payable by the source country, in this case Canada, 25% under the Income Tax Act, reducing it down to a level which is far less punitive. In most of these cases we have reduced it to 5% where the foreign resident has a controlling or major interest in a Canadian corporation. The rate is often reduced to 10% where interest payments go abroad. In many cases where there are payments on government debt, there is no withholding tax whatsoever.
One of the main concerns in bilateral negotiations has been to try to reduce the withholding taxes to zero, where they deal with royalties on scientific know-how, computer software and things which are necessary to produce a modern industrial state.
I regret that in some of these five treaties we are not able to get that rate down to zero on such royalties. However, in the treaties with Sweden and Netherlands we have confirmed that we will have a zero withholding rate on those types of payments. This is significant progress in a world which is increasingly dependent on the flows of information and technology.
Perhaps the most important change being made today is with respect to the tax treaty with the United States. Its main provision deals with social security benefits which flow across the Canada-U.S. border: a person resident in the United States who receives Canada or Quebec pension plan or old age security benefits or a person resident in Canada who receives from the United States its social security benefits.
Just so we understand these provisions I would like to go back to the law as it existed prior to 1996. At that time the country paying the benefit did not exercise any taxing jurisdiction or taxing power. That taxing power was exercised only in the country of residence. Therefore a person resident in Canada who was receiving U.S. social security was taxable in Canada. The rule was that only half of that social security benefit went into the resident taxpayer's income but it is obvious to members on all sides of the House that this produced unfairness.
For example, if persons resident in Canada were receiving social security from the U.S. of say $8,000 they were taxable on only $4,000 of it, whereas if they were receiving $8,000 of old age security they were taxable on all of it. This was not equitable and not fair.
Therefore we entered into negotiations with the United States to change that law as of January 1, 1996. We said that rather than the country of residence taxing the pensions or the social security it would be the country of source. If a resident of the United States received Canada pension plan or OAS, Canada would withhold 25% on those payments to the resident in the U.S.
If the U.S. person was a low income taxpayer and his or her marginal rate of tax was either zero or less than the 25%, Canada gave that person the option of filing a tax return in Canada. To the extent that the tax would have been less than that 25% withheld by Canada, Canada would give a refund. It worked well for a person resident in the U.S. receiving pension benefits from Canada. On the other hand it did not work so well going the other way.
The U.S. withheld 25.5% on social security payments going to a resident of Canada but it did not allow the Canadian who was in a low income or no income bracket to file a U.S. tax return and be taxed on a net basis; i.e., to be taxed at less than 25.5%.
Accordingly, negotiations were entered into with the United States and that is the result of this protocol. We are saying that the country of residence of the taxpayer or the recipient now has the exclusive right to tax. The country paying the social security, the United States will forgo its withholding tax or Canada will forgo its withholding tax when paid to the United States.
Second, the resident of Canada will include only 85% of U.S. social security in their Canadian income, and a reciprocal right applies to residents in the United States receiving pensions from Canada. This means that low income taxpayers are in effect going to be taxed on a net basis and it will not be punitive. This is a desirable and hopeful result.
In order to protect those who might have already suffered or paid their taxes, this law, when in effect, will be retroactive to January 1, 1996. To help in the transition, if someone has already paid their taxes for 1996 or 1997, we have said that they will pay no more taxes than they otherwise would have. Therefore if a person is in a higher bracket than the 25.5% withheld, they will not have to pay that for the years 1996 and 1997. It will only be on an ongoing prospective basis that these full rates of tax, applicable to domestic or resident taxpayers, are going to be applied.
There is also one other amendment that deals with capital gains. We know that if a U.S. resident owns real estate or resource properties in Canada and disposes of them they would be subject to Canadian tax. Suppose they own those properties through a corporation resident in the United States and sell the shares in that corporation. It would seem natural that they should not be able to get away with something by doing it indirectly through a corporation, that they could not get away with it even if they owned those properties directly. This is why Canada has always had a law in its books which states that where one owns those Canadian assets indirectly through a U.S. corporation, they will be taxable as if one owned those assets directly.
However, the U.S. does not tax Canadian residents on this basis. Accordingly, we have amended the tax convention with the United States in order to reflect that both of our laws be brought into this more modern mode. Quite frankly, in terms of administering a law when a resident of the U.S. sells the shares of a particular company it is very difficult to look behind that corporate shell and find out what all the assets are. In a modern world this does not make a lot of sense.
I am very pleased to say that we have settled this issue of transporter pensions or social security in a way that is fairest to those who have the lowest income and whose tax rates would otherwise be under the 25.5% U.S. rate or the 25% Canadian rate when they are taxed on a net basis. This is a desirable result. It is fair and is evidence of the ongoing good co-operation and strong relationship between our two countries.