Combatting Global Profit Shifting

Canada’s signature on an OECD instrument to fight BEPS will carry a “level of uncertainty”
WHEN SOME 68 countries signed the OECD’s Multilateral Convention to Implement Tax Treaty Related Measures to Prevent BEPS on June 7th, the international community managed to avoid years of bilateral negotiations aimed at amending as many as 1,100 of the 3,000 tax treaties that currently exist.

The multilateral instrument (MLI) is an important step forward in the OECD’s base erosion and profit shifting (BEPS) initiative. When the Convention comes into effect, it will apply to the various tax treaties that Canada has designated as Covered Tax Agreements (CTA).
 
“The MLI’s purpose is to implement a wholesale amendment of bilateral tax treaties that result in mismatches and allow abuses including ‘treaty shopping’,” says David Rotfleisch of Rotfleisch & Samulovitch Professional Corporation, a Toronto tax boutique. “Treaty shopping has allowed taxpayers to create multi-jurisdictional structures that benefit from the different rates of taxation that exist among a nation’s various tax treaties.”

The Convention, which Canada expects to ratify and implement by 2019, deals primarily with anti-treaty shopping rules and dispute-resolution procedures. Some eight other countries are expected to sign on in the near future, though the United States is a notable exception. 

“It’s not clear how the refusal of the US to sign will impact MLI’s future,” says Patrick Marley, a tax lawyer at Osler, Hoskin & Harcourt LLP in Toronto. “It’s conceivable that some countries will see it as giving the US a competitive advantage, and those countries could refuse to ratify and incorporate MLI into their domestic law.”

The US maintains that adopting MLI is unnecessary because its treaties already comply with the Convention’s minimum standards. But Marley says that’s not completely accurate. He notes, for example, that US treaties do not include the mandatory preamble imposed by MLI that evinces an intention for tax treaties to eliminate double taxation without creating opportunities for non-taxation or reduced taxation through tax evasion or avoidance.

“Still, many countries may go ahead and ratify because they recognize that it’s just about impossible to get support for any kind of tax treaty in Congress right now,” Marley says.

 The MLI will allow for countries to sign up in the future. Indeed, the OECD expects some 100 countries (about 30, in addition to the original signatories) to have joined the pact by year’s end.

But even in Canada there are skeptics.

“I would describe MLI as inserting a significant level of uncertainty — one that’s very poorly timed — into international trade, and especially so in a world that’s looking to develop third-party economies,” says Claire Kennedy, a tax lawyer in Bennett Jones LLP’s Toronto office.

At the heart of the uncertainty is the principal purpose test (PPT) that forms MLI’s core. “Tax treaty benefits will be denied where one of the principal purposes of a transaction is to, directly to indirectly, obtain the benefit, unless granting the benefit would be in accordance with the object and purpose of the Covered Tax Agreement,” Marley explains.

“Unfortunately, the broad wording of the PPT, together with the limited interpretive guidance provided by the OECD to date, will result in uncertainty regarding whether treaty benefits will apply in a variety of situations.”

Compounding the uncertainty is the fact that domestic courts will be the ultimate arbiters of the PPT’s interpretation. Common law countries, for example, might interpret the PPT differently from civil law jurisdictions. “Whether or not one of the principal purposes of a transaction is to get an unwarranted benefit from a tax treaty is very much in the eyes of the beholder,” Kennedy says.

At particular risk are collective investors such as private equity, corporate securitization vehicles and real estate funds. “Although the OECD has acknowledged that it is important to provide treaty benefits to private equity and other collective investors in appropriate circumstances, the OECD has done very little to provide such investors with the certainty they need at the time investments are made,” Marley says.

According to Kennedy, the difficulties arising from an inevitable increase in the number of disputes relating to tax treaties will not be resolved by the binding arbitration process that the OECD has formulated to resolve these disputes. “Binding arbitration is certainly a welcome addition to the playing field, but it’s an ex post facto remedy that doesn’t resolve the conundrum resulting from the uncertainty, and one that will still create delays and significant costs for investors,” she says.