2018-0749181C6 IFA 2018 Q. 2 – Principal Purpose Test in MLI

Principal Issues: Request for guidance on the application of the Principal Purpose Test under the MLI.

Position: Comments provided.

Author: Thomson, Sherry
Section: -

IFA 2018 International Tax Conference
Canada Revenue Agency Roundtable

Question 2 - Principal Purpose Test in MLI

In Question 8(d) at the 2017 Canadian Tax Foundation Annual Tax Conference CRA Roundtable, the CRA refrained from commenting on the examples set out in paragraphs 182 and 187 of the Commentary to Article 29 of the then draft 2017 OECD Model Tax Convention (“OECD Model”) with respect to the “object and purpose” clause within the principal purpose test (“PPT”) of the Multilateral Convention to Implement Tax Treaty Related Measures to Prevent Base Erosion and Profit Shifting, commonly referred to as the Multilateral Instrument (“MLI”).

(a)   Now that the OECD Council has approved the contents of the 2017 update to the OECD Model, will the CRA comment on what weight it will give to the examples in paragraphs 182 and 187 of the Commentary on Article 29 of the 2017 OECD Model in determining whether a particular structure or transaction satisfies the object and purpose clause within the PPT of the MLI?

(b)   As it is our understanding that Canada intends to ratify the MLI in 2018, what additional guidance does the CRA intend to provide in 2018 (on a unilateral or bilateral basis with specific treaty partners) to provide investors with sufficient certainty/clarity in determining when the PPT of the MLI may apply, particularly with respect to private equity and other collective investors?

(c)   Once the MLI becomes effective, there will be increased uncertainty with respect to the application of treaty benefits under its PPT.  In order to allow investments and distributions to be made on a timely basis, will the CRA commit to providing rulings on the PPT of a particular covered treaty on an expedited basis?  If so, can the CRA provide an estimate on how long it expects that it would take between when a completed PPT ruling is submitted to the time that such a ruling is issued (assuming timely responses by the taxpayer to any factual queries that may be raised by the CRA)? 

Background

The minimum standard under the Base Erosion and Profit Shifting (“BEPS”) Final Report on Action 6, Preventing the Granting of Treaty Benefits in Inappropriate Circumstances, requires that jurisdictions adopt either, a) a PPT rule, b) a PPT rule, along with a limitation on benefits (“LOB”) provision, or c) an LOB provision, along with anti-conduit measures.  Paragraph 1 of Article 7 of the MLI sets out the PPT rule for the MLI.

Under the rules of the MLI, the MLI will enter into force once five jurisdictions have deposited notices of ratification with the OECD.  With the deposit of the fifth notice of ratification by Slovenia on March 22, 2018, the MLI will enter into force for those five jurisdictions on July 1, 2018, and will have effect for existing covered treaties commencing in 2019.

The Government of Canada began its domestic procedures to ratify the MLI by tabling the MLI in the House of Commons on January 31, 2018.  The next step is to introduce an Implementation Bill, which must be debated in both the House of Commons and the Senate.  The CRA is not aware of when the Implementation Bill may be tabled. 

Once all Canadian domestic procedures are complete, the final step will be for Canada to deposit a notice of ratification with the OECD.  The portion of the MLI adopted by Canada will enter into force on the first day of the month following the expiration of a period of three calendar months from the date of deposit.  For withholding taxes, the MLI will have effect vis-à-vis a particular covered treaty on or after the first day of the next calendar year that begins on or after the latest of the dates on which the MLI enters into force for both treaty partners.  For all other taxes, the MLI will have effect for taxable periods beginning six months (or sooner if the necessary notifications have been made by both parties) on or after the latest day that the MLI enters into force for both treaty partners. 

CRA Response

a)    The 2017 update to the OECD Model was approved by the OECD Council on November 21, 2017.  New Article 29, Entitlement to Benefits, was added to the OECD Model in response to the recommendations in BEPS Action 6.  Paragraph 9 of new Article 29 contains the bi-lateral “principal purpose test” and is virtually identical to paragraph 1 of Article 7 of the MLI (i.e. the PPT of the MLI).

Paragraph 182 of the OECD Commentary on Article 29 provides 13 examples that illustrate the application of the bi-lateral “principal purpose test” in new Article 29.  It further states that the six examples in paragraph 187 of the OECD Commentary on Article 29 should also be considered when determining whether the “principal purpose test” would apply in the case of conduit arrangements.  Paragraph 182 emphasizes that in reading the examples, it is important to remember that the application of the “principal purpose test” must be determined on the basis of the facts and circumstances of each case.

Canada has not placed a reservation on Article 29 of the OECD Model, or an observation on the Commentary on Article 29.  The Supreme Court of Canada in Crown Forest (footnote 1) observed that the OECD Model “has world-wide recognition as a basic document of reference in the negotiation, application and interpretation of multilateral or bilateral tax conventions” and was “of high persuasive value in terms of defining the parameters” of the tax treaty under consideration in that case.

Whether the CRA will apply the PPT of the MLI to situations that are similar to the examples in paragraphs 182 and 187 of the OECD Commentary on Article 29 must be examined in light of the facts and circumstances in each case, the relevant Canadian statutory law, jurisprudence, and the wording, object and purpose of the particular covered treaty.  Once the MLI is in effect vis-à-vis a particular treaty, taxpayers who would like certainty with respect to the application of the PPT of the MLI to a proposed transaction are welcome to request an advance income tax ruling.

b)    Given that each situation is likely to be unique, we suggest that the best way to obtain guidance on whether the PPT of the MLI will apply to any particular set of facts is by means of an advance income tax ruling.

Whether the PPT of the MLI will apply to prevent foreign collective investment vehicles (“CIV’s”) or their investors from obtaining treaty benefits will depend on the facts of each case.  It is not the intention of the CRA to frustrate the ability of taxpayers to access the benefits agreed to in a particular treaty.  However, situations where preferential treaty benefits can be accessed by means of a CIV that would not be available if the investors held the underlying investments directly would suggest an examination of whether the PPT of the MLI applies.

The tax treatment of certain CIVs under a particular treaty has been addressed as follows:

*     Articles in a bilateral treaty – e.g. Paragraph 7(a) of Article 29 of the Canada-France Tax Convention; Paragraphs 7(b) and (c) of Article X of the Canada-U.S. Tax Convention;

*     Competent Authority Agreements – e.g. Canada-Netherlands agreement regarding closed funds for mutual account (besloten fonds voor gemene rekening, or FGR); Canada-Switzerland agreement regarding Canadian collective investment vehicles; (footnote 2) and

*     Advance Income Tax Rulings – e.g. Luxembourg fonds commun de placement; Switzerland contractual investment funds; Ireland common contractual funds.

These agreements will be taken into account when determining whether the PPT in a particular covered treaty would apply to deny a treaty benefit.

c)    The CRA is very sensitive to the need for taxpayers to receive a response to a request for an advance income tax ruling as quickly as possible, however, it currently has no plans to give priority to rulings involving the PPT over ruling requests involving any other provisions administered by the CRA.  The CRA continues to explore methods of addressing the PPT in order to promote consistency.  Similar to ruling requests on the application of the GAAR, this may include consultations with various stakeholders/areas before a ruling could be issued.

Sherry Thomson / Lori M. Carruthers
2018-074918
May 16, 2018

FOOTNOTES

Note to reader:  Because of our system requirements, the footnotes contained in the original document are shown below instead:

1  Her Majesty the Queen v. Crown Forest Industries Limited and The Government of the United States of America (Intervener), 95 DTC 5389.
2  https://www.canada.ca/en/revenue-agency/services/tax/international-non-residents/competent-authority-agreements-notices.html

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