The Organisation for Economic Cooperation and Development’s action plan on domestic tax base erosion and profit shifting, known as “BEPS,” is coming into force among countries that have signed on to it — and Canadian taxpayers are now grappling with it.
The action plan was launched in 2013; a policy note released in January 2019, dubbed “BEPS 2.0,” included new proposals to combat BEPS activities of multinationals. The OECD project aim is to stop billions of dollars being lost annually to tax avoidance by multinational companies operating in foreign jurisdictions, particularly in developing countries, which suffer from BEPS disproportionately owing to their higher reliance on corporate income tax.
On Jan. 1, the Multilateral Instrument, known as “MLI,” entered into effect in Canada. It is just one of 15 of the OECD’s “BEPS Actions.” More than 135 countries and jurisdictions are now collaborating on the implementation of the BEPS package, with more than 90 having signed the Multilateral Instrument on BEPS, according to the OECD.
The Multilateral Instrument
The MLI is a multilateral treaty that modifies existing bilateral tax treaties to implement international tax measures developed by the OECD’s BEPS project; this includes rules relating to treaty abuse and improving the dispute resolution process between participating jurisdictions.
The MLI works by allowing signatory countries such as Canada, Australia and the United Kingdom (notably not the United States) to adopt a variety of new tax rules into existing bilateral tax treaties in one fell swoop, says Robert Kreklewetz, a partner in tax firm Millar Kreklewetz LLP in Toronto. “They do that by ratifying a single agreement rather than renegotiating dozens of amendments to existing tax treaties.”
The framework is designed to be flexible, and beyond certain rules — such as mandatory binding arbitration, treaty abuse prevention and changes to preambles of tax treaties — countries can choose to implement a variety of additional, optional measures, Kreklewetz says.
The MLI received royal assent in Canada on June 21, 2019, and it entered into force on Dec. 1, 2019. It applies to withholding taxes that start on Jan. 1, 2020, and, for all other taxes, for taxation years that begin on June 1, 2020 or after.
“Starting Jan. 1, 2020, any Canadian taxpayer making payments to a non-resident will now need to ask whether the changes to Canada’s treaties, as a result of the MLI, will result in different withholding tax rates applying,” says Darren Hueppelsheuser, a tax partner in Norton Rose Fulbright Canada LLP’s Calgary office.
An example of that might be in the context of dividends, he says, “where you may have previously been able to rely on a treaty-reduced rate to five per cent or 15 per cent; the appropriate withholding [tax] now may be 25 per cent.” In that context, as a payor, i.e., the Canadian party paying the dividend, “you’ll need to do further diligence to see if the treaty rights you previously relied on are still available. If it’s in an international company structure, you’d want to be considering whether you want to be restructuring or reorganizing your business if those treaty rights have changed.”
Of the provisions in in the MLI, the one that may get the most attention is the broad anti-avoidance rule, or the Principle Purpose Test, under which treaty benefits can be denied if one of the principal purposes for the transaction is to avoid the relevant Canadian tax, says Patrick Marley, a tax partner at Osler Hoskin & Harcourt LLP in Toronto.
However, the treaty benefit may still be obtained if the person or corporation owing the tax can establish that obtaining the benefit would be in line with the object and purpose of the tax treaty.
“The big issue that Canadian taxpayers face is the uncertainty that’s been added,” Marley adds. Canada’s General Anti-Avoidance Rule, known as “GAAR,” applies for the purposes of tax treaties, and GAAR states that where a transaction or series of transactions results in a reduction, avoidance or deferral of taxes owing, and the transaction or series of transactions are being attempted only for the tax benefits, the transaction or transactions themselves may be invalidated.
“So, now, we have a second broad anti-avoidance rule [under the MLI’s Principal Purpose Test] that applies, or that could apply,” Marley says. “And while our domestic General Anti-Avoidance Rule has a few decades of case law and interpretation that have built up that allows a fair degree of certainty in terms of how that rule will be applied and administered, we have no precedent or history on this new anti-avoidance rule in the tax treaties.”
If the Canada Revenue Agency were to provide guidance consistent with Canadian law, “the ambiguity would go away,” Marley says. Instead, the CRA will use GAAR but also the MLI Principal Purpose Test, he says. “That’s wrong and costly.
“Over time, we’ll eventually get certainty when cases go to court or if we see how broadly or narrowly the CRA decides to interpret the rule,” he says.
The upshot is that more diligent assessment will be required of taxpayers to show that the principal reason for being resident in another jurisdiction is not simply to pay less or avoid taxes.
“From a taxpayer perspective, [the MLI] will involve a lot of diligence on their side to collect, retain and review . . . information,” says Hueppelsheuser.
Tax authorities are also becoming more sophisticated with data collection and using that data to identify tax risks. There has been a recent trend among tax authorities, particularly the CRA, to take better advantage of information already at their disposal and to tap into sophisticated data collection performed by third-party businesses, says Kreklewetz.
For example, he says, in May 2019, the CRA announced the creation of a Real Estate Task Force designed to combat tax evasion in the Greater Toronto and Greater Vancouver areas. In a backgrounder to the release, the CRA announced that this program had the ability to track “correlations” between a taxpayer’s reported income and their lifestyle. For taxpayers with expensive lifestyles without a corresponding income to match, this was possibly indicative of unreported income.
The CRA also has the capability to compile property transfer data from across Canada and compare it to an individual taxpayer’s returns, again with the aim to uncover unreported income, Kreklewetz adds.
The past year also saw the CRA’s high-profile use of Requirements for Information — or “RFIs” — on large third-party construction material suppliers such as Roofmart Ontario Inc.
“Using the RFI provisions under either the Income Tax Act or Excise Tax Act, the CRA has successfully compelled those businesses to disclose their customer data, namely identities and purchase history,” says Kreklewetz.
The CRA then compares those purchase histories with the returns of individual taxpayers (typically commercial contractors) to determine if the quantities of materials purchased are consistent with the reported income of those taxpayers. A similar approach can be taken for GST/HST audit purposes, to ensure that reported Sales Revenues and Input Tax Credit claims are appropriate, he says.
“While some businesses are fighting this, others may just be willingly complying,” Kreklewetz adds. For example, PayPal announced in 2018 that it was subject to an RFI and would be complying with the order.
Marley notes that “Canada is certainly at the high end” of where tax disputes are seen among multinational corporations.
“Countries like India or Canada tend to be quite aggressive from an audit perspective, which tends to then lead to more tax disputes than in a number of other countries,” Marley says. This may be due to the complexity of the Canadian tax regime, the aggressiveness of auditors or an intransigence to settle disputes with other countries, he says.
Transfer pricing — an accounting and taxation practice that allows for pricing transactions internally within businesses and between subsidiaries that operate under common control or ownership — is a way in which companies can shift tax liabilities to low-cost tax jurisdictions. It has recently come under increased focus from global tax authorities.
“The genie has really escaped from the bottle on that,” says Kreklewetz, as governments and regulators review and challenge transfer pricing decisions that were made as long ago as 1997, “when most of the current rules were put in place.” Recent events such as the Panama Papers scandal have elevated the importance of how taxable income is treated across the globe and has led to increased public pressure on the authorities to act, he adds.
“I guess you can say that governments, while slow moving at times, are not completely oblivious to what is going on around them,” Kreklewetz says.
“Canada, and its MLI partners, are keenly aware of the size of potential revenues that come with stopping this form of tax loss,” he adds. “The OECD has conservatively estimated that annual losses range from four per cent to 10 per cent of global corporate income tax revenue, between $130 [and] $313 billion per year — and Canada and CRA want their slice of the pie!"