2019-0819351I7 Barbados Treaty Limitation Period

Principal Issues: Does Art. IX(2) impose a limitation upon Canada's ability to reassess a Canadian corporation in respect of transactions with a Barbados International Business Company.

Position: No.

Reasons: The purpose of Art. IX(2) and (3) is to provide times limits to reassessments when both parties are entitled to the benefits of this Article.

Author: Taylor, Charles
Section: Canada-Barbados Tax Agreement, Articles IX and XXX(3)

Marie-Hélène Chouinard
Senior Technical Field Advisor                                                  Income Tax Rulings
International Risk Analysis and Workload Development Section         Directorate
International Tax Operations Division                                        Charles Taylor

                                                                                                    2019-081935

Scope of Articles IX(2) and (3) of the Canada-Barbados Tax Convention in the context of a transfer pricing adjustment

This is in reply to your request to obtain the opinion of our Directorate on the limits imposed by Article XXVII(3) of the Canada Barbados Tax Agreement (footnote 1) (“Convention”) to the right of a Contracting State to include in the tax base of a resident of either Contracting State items of income which have already been taxed in the other Contracting State.

In the context of the review of a transaction undertaken by a corporation resident in Canada (“Canco”) and its wholly-owned subsidiary resident in Barbados (“BarbadosCo”) with terms and conditions that did not reflect the ones that would have prevailed between arm’s length persons, CRA auditors (“Audit”) had to consider whether Article IX(3) of the Convention prevents the CRA from making a transfer pricing adjustment under section 247 of the Income Tax Act.

References in this memo to an Article are references to an Article of the Convention.

Articles IX and XXX(3)

Article IX

Article IX(1) states that the profits of an enterprise of a Contracting State (footnote 2)   (“Enterprise”) that participated in the management, control or capital of an enterprise of the other Contracting State (“Associated Enterprise”) can be adjusted upward by a Contracting State (“Primary Adjustment”) where the terms of their commercial relations differ from those which would have prevailed between independent enterprises (“Arm’s Length Principle”) (footnote 3) .

A Primary Adjustment may give rise to tax in the hands of different persons where tax is charged by both the Contracting State and the Other Contracting State on the same profits of the Associated Enterprise (“Double Taxation”). In such circumstances, Article IX(2) provides that the Other Contracting State shall make an appropriate adjustment to the amount of tax charged on the profits of the Associated Enterprise to relieve the Double Taxation (“Corresponding Adjustment”) (footnote 4) :

“ As a rule, profits derived by an enterprise of a contracting State are taxable only by the contracting State in which the enterprise has its residence (Art. 7(1)). That State determines such profits by applying the general rules of its domestic tax law (income or corporate tax; see supra Art. 7, at m.nos 57ff). Art. 9(1) allows that State to depart from these general rules by adjusting the profits accruing to a domestic enterprise, which is associated with a foreign enterprise, to the extent that the business profits concerned were affected by (commercial) terms and conditions differing from those customary between enterprises independent of each other. However, Art. 9 allows such a rewriting of accounts (reallocation of profits) to be made only according to the arm’s length principle […] Art. 9 does not create any legal basis for such rewriting of accounts. All that it effects is to restrict domestic law to the extent that the latter provides for profit adjustments between associated enterprises beyond those permissible under the arm’s length rule.” (footnote 5)

Despite the administrative issues that may result from an open-ended commitment to relieve Double Taxation, Article IX(2) does not include any time limitation for the Other Contracting State to proceed with the Corresponding Adjustment (footnote 6) .

Article IX(3) states that a Contracting State shall not change the profits of an enterprise in the circumstances referred in Article IX(1) after the time limitation provided in its domestic laws and, in any case, after the Limitation Period.

The Corresponding Adjustment that is imposed on the Other Contracting State under Article IX(2), or a Contracting State’s prohibition from making a Primary Adjustment beyond the Limitation Period under Article IX(3), are instrumental to relieving Double Taxation. The overall operation of Article IX appears to suggest that its purpose is to provide relief from Double Taxation through a common quantification of profits between Associated Enterprises in their commercial and financial relations, and then provide each of the Contracting States with taxing rights according to the distributive articles of the Convention.

For that reason, the scope of Articles IX(2) and (3) is limited to the transaction or series of transactions undertaken by both enterprises in each of the Contracting States in breach of the Arm’s Length Principle (“Disputed Transaction”):

“Art. 9 differs from Art. 7 and the other MC (Model Convention) distributive rules in that it deals with the relations of two States of residence and the taxation of legally independent taxpayers, each of them by his State of residence […] Art. 9 is designed to avoid economic double taxation. This can be achieved only if delimitation of profits is subjected to a firm rule, i.e., one which is binding on both States.” (footnote 7)

Article XXX(3)

Prior to the Protocol amending the Convention (“Protocol”) (footnote 8) , Article XXX(3) denied the benefits of the Convention to companies entitled to any special benefit under the Barbados’ International Business Companies Act (“Barbados IBC Act”) or entitled to any special tax benefit under any similar law enacted by Barbados. (footnote 9)

The Protocol amended Article XXX(3) in connection with entities entitled to any special tax benefits under the Barbados IBC Act or any substantially similar law. More specifically, Article XXX(3) now states that the provisions of Articles VI to XXIV shall not apply to any person or other entity entitled to any special benefit in Barbados under the Barbados IBC Act, the Exempt Insurance Act, the Insurance Act, the International Financial Services Act, the Society with Restricted Liability Act, the International Trust Act, or any substantially similar law subsequently amended (“Special Barbados Entity”).

The interplay of Articles IX(2) IX(3) and XXX(3) as amended by the Protocol (footnote 10) :

Pre-Protocol

Article IX(3)

According to Article IX(3), a Contracting State cannot make a Primary Adjustment more than 5 years after the end of the taxation year in which the transaction under review was undertaken (“Limitation Period”), subject to fraud, wilful default or neglect.

For the Article IX(3) Limitation Period to apply, the enterprise whose profits were subject to the Primary Adjustment cannot be denied the application of the Convention pursuant to Article XXX(3) and each of the participants to the Disputed Transaction has to qualify as an enterprise of a Contracting State as that term was defined in Article III of the Convention.

As confirmed in the case of Alberta Printed Circuits v. Queen 2011 DTC 1177 (TCC), Article IX(3) did not apply to prevent a Contracting State from making a Primary Adjustment outside the Limitation Period because the IBC did not qualify as an enterprise of a Contracting State under the Convention on the basis that it was specifically excluded from the application of the Convention:

“In the matter of Sundog Distribution Inc. v. R. […] Rip C.J. decided that the five-year limitation period in Article IX(3) did not apply since the wording of IX(1) requires that , for its application, there must be “an enterprise of a Contracting State” from each of the states concerned , being Canada and Barbados, and that, since the appellant therein was a Barbados International Company (“IBC”) which Article XXX(3) specifically excludes from the application of the Treaty, it could not as an IBC, be an “enterprise of a Contracting State” for the purpose of Article IX of the Treaty.

Frankly, I am in full agreement with the decision of Rip C.J. on this issue and adopt his reasoning on the non-applicability of the limitation period in Article IX (3).” [Our underline]

Post-Protocol

Article 5(2) of the Protocol amended Article XXX(3) to read as follows for taxation years beginning on or after January 1, 2014:

The provisions of Articles VI to XXIV of this Agreement shall not apply to any person or other entity entitled to any special benefit:

(a) In Barbados, under the International Business Companies Act, the Exempt Insurance Act, the Insurance Act, the International Financial Services Act, the Society With Restricted Liability Act, or the International Trusts Act, or any substantially similar law enacted […]

Article 5(2) of the Protocol changed the manner in which Canada and Barbados make certain Articles of the Convention inapplicable to a Special Barbados Entity while other provisions of the Convention remain applicable to a Special Barbados Entity.

Where the Enterprise whose profits are subject to the Corresponding Adjustment or the Primary Adjustment is not subject to the Safeguarding Clause, we must determine whether the provisions of Article IX(2) and (3) may apply after the entry into force of the Protocol when such provisions would not have been applicable prior to the introduction of the Protocol, and the Disputed Transaction may not result in any Double Taxation.

There is no indication that the Contracting States intended to change the scope of application of Article IX with the adoption of Article 5(2) of the Protocol considering that it is part of the list of provisions excluded from the scope of the Convention for a Special Barbados Entity.

A Special Barbados Entity only being denied the application of the provisions of Articles VI to XXIV of the Convention by Article 5(2) of the Protocol, it may now qualify as an enterprise of a Contracting State as defined in Article III whereas before the introduction of that provision, it would not have been viewed as such an enterprise.

One possible reading of Article IX(2) would be that the CRA is required to make a Corresponding Adjustment and reduce Canco’s tax when the BTA makes a Primary Adjustment to BarbadosCo’s income in the circumstances described in Article IX(1). Conversely, the BTA would not be required to make a Corresponding Adjustment and reduce BarbadosCo’s tax despite CRA’s Primary Adjustment to Canco’s profits since BarbadosCo is excluded from the application of Article IX.

This reading of Article IX(3) would achieve asymmetrical outcomes.

On the one hand, Canada would always be prohibited pursuant to Article IX(3) from making a Primary Adjustment beyond the Limitation Period to Canco on the basis that BarbadosCo qualifies as an enterprise of Barbados despite the fact that it is a Special Barbados Entity. Conversely, the BTA would never be prohibited from making a Primary Adjustment on the profits of BarbadosCo beyond the Limitation Period since BarbadosCo is excluded from the application of Article IX under the Safeguarding Clause. On the other hand, Double Taxation would never be relieved when the CRA makes a Primary Adjustment on Canco’s profits before the expiry of the Limitation Period as the BTA would never be required to make a Corresponding Adjustment under Article IX(2).

Canada however would have an open-ended obligation to make a Corresponding Adjustment under Article IX(2), which is precisely what Canada intended to avoid when Article IX(3) was added to the Convention

Under this reading Article IX(3) would only apply where the enterprise whose profits are subject to the Primary Adjustment is resident in Canada, and only Canada would be required to provide relief from Double Taxation associated with a Disputed Transaction.

Each of the CRA and the BTA has an obligation under Articles IX(2) and (3) to provide relief from Double Taxation resulting from a transfer pricing adjustment made in the circumstances described in Article IX(1). However, such an obligation must be reconciled with Article XXX(3), which denies the benefits of Articles VI to XXIV of the Convention to any Barbados enterprise that is entitled to a special tax treatment in Barbados.

The intent of the contracting parties to substantively deny the benefit of the Convention to a Special Barbados Entity remains. Such reading would have to be rejected on the basis that it is irreconcilable with the intent underlying Article XXX(3), which is to limit access to the benefits of the Convention by a Special Barbados Entity.

Articles IX(2) and (3) are different tools under Article IX to prevent Double Taxation. They should be interpreted in a manner that yields consistent results. Because Article IX is intended to prevent Double Taxation through a common quantification of profits between associated enterprises in their commercial and financial relations in their respective jurisdictions, a reading leading to the conclusion that only one of the Contracting States is required to apply the provisions of Article IX has to be rejected.

The purpose of Article IX is arguably to provide certainty to enterprises described in Article IX(1) that their profits will not be subject to double taxation in the absence of fraud, wilful default or neglect. By providing such certainty, it enhances the ability of such enterprises to structure their business affairs without excessive focus upon tax risks. To the extent that one of the enterprises in question does not have a right to benefits under the provision, the better view is that the article is not applicable to transactions between them.

Conclusion:

The CRA is not precluded from assessing a Primary Adjustment after the end of Limitation Period if a Special Barbados Entity is a participant to that transaction.

We trust that these comments will be of assistance, and thank you for your enquiry.

Yours truly,

Charles Taylor
Section Manager
for Director
International Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch

FOOTNOTES

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

1 Agreement Between Canada and Barbados for the Avoidance of Double Taxation and the Prevention of Fiscal Evasion with Respect to Taxes on Income and on Capital, signed on May 23, 2002, as amended by the Protocol Amending the Canada-Barbados Tax Agreement signed on November 8, 2011, collectively, “the Convention”

2 The term enterprise of a Contracting State is defined in article III as an enterprise carried on by a resident of a Contracting State. According to article III(2) of the Convention, the term enterprise shall have the meaning which it has under the laws of that State since it is not otherwise defined in the Convention. In addition, article IV(1) of the Convention states that the term resident of a Contracting State means any person who is liable to taxation therein by reason of his domicile, residence, place of management or any criterion of a similar nature.

3 The wording of article IX(1) of the Convention is modeled on article 9(1) of the Organization for the Economic Cooperation and Development, Model Tax Convention on Income and on Capital (“OECD Model Convention”), which is intended to provide the taxation authorities of a Contracting State with the authority to re-write the accounts of an enterprise when they do not reflect the true taxable profits arising in that State. The function of article 9(1) is to raise the Arm’s Length Principle at the Convention level.

4 See paragraph 5 of the Commentary on article 9(2) of the OECD Model Convention, version 2017.

5 Klaus Vogel, “Klaus Vogel on Double Taxation Conventions”, 3rd edition, 1997, page 517 at paragraph 7.

6 See paragraph 10 of the Commentary on article 9(2) of the OECD Model Convention, version 2017.

7 Klaus Vogel, “Klaus Vogel on Double Taxation Conventions”, 3rd edition, 1997, page 518 at paragraph 10 and page 522 at paragraph 17.

8 The Protocol was signed on November 8, 2011 and entered into force on December 17, 2013 generally applicable to taxation years commencing on or after January 1, 2014.

9 See paragraphs 82 and 83 of the Commentary on article 1 of the OECD Model Convention, version 2017, which address the logic of such restrictions in general terms.

10 On November 21, 2018, the government of Barbados introduced significant legislative changes intended to comply with Action 5 of the BEPS initiative dealing with harmful tax practices (“Legislative Amendments”). Effective January 1, 2019, the special tax treatment granted to the companies governed by the laws listed in article XXX(3) of the Protocol will be largely eliminated since they will essentially be taxed like a regular Barbados company at income tax of 1-5.5% depending on the level of taxable income earned by such companies. Although this may put into question their inability to claim the benefit of article VI to XXIV of the Convention, we have assumed that article XXX(3) still applies to any person governed by the Barbados laws listed in that provision.

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