Ongoing developments involving Canada’s international tax treaties should be closely followed, as they may impact the structuring of cross-border transactions.
Capital gains—business property exception
One of these changes concerns the capital gains exemption found in Canada’s tax treaties with several European countries, including the United Kingdom, the Netherlands, Germany, Luxembourg and other jurisdictions (though notably, not the United States).
Each of these European treaties contains the usual Article 13 provision whereby gains realized by a resident of the other state (for instance, the U.K.) from disposing of shares of a Canadian company will not be taxable in Canada unless the value of those shares is derived principally from Canadian real or immovable property. In these treaties, real or immovable property is defined narrowly to exclude property (other than rental property) in which the business of the company was carried on.
Thus, for example, if a U.K. company realizes a gain from selling shares of a Canadian manufacturing company, the value of the shares being derived principally from land, building and fixtures used in the manufacturing business, that gain would normally be exempt from Canadian tax under these specific treaties (though notably, not under other treaties such as the United States treaty). This provision also can be used to exempt a foreign seller from Canadian capital gains tax on a sale of shares of a Canadian mining company, provided the real or resource property in the company is held in connection with a working mine. This “business property” exception is not found in the Organization for Economic Cooperation and Development (OECD) Model Convention, and has been used quite effectively in structuring many inbound Canadian investments.
Unfortunately, the “business property” exception appears destined for eventual extinction. At the International Fiscal Association Canadian Branch Seminar held in May 2012 in Ottawa, an official from the Department of Finance announced a change in Canada’s treaty policy. Specifically, in future treaties, Canada’s position will be to eliminate the “business property” exception. Instead, Canada will seek to negotiate a broader definition of real or immovable property more consistent with Canadian domestic law and the OECD Model.
Under this broader definition, Canada would reserve the right to tax a foreign seller of shares of a Canadian real-property-rich company even if the real property is used in a business. The treaty with the U.K. is currently under renegotiation, and it is reasonable to expect that the renegotiated treaty will no longer contain the “business property” exception. Nonetheless, it is likely to take some time before all of the treaties that contain this helpful provision are renegotiated. In the meantime, careful planning is recommended in order to mitigate the impact of these future changes.
Targeted anti-abuse provisions
In another development, several recently negotiated treaties contain targeted anti-abuse clauses.
For example, the treaty signed in May 2012 with New Zealand includes new provisions which would deny treaty-reduced withholding tax rates on dividends, interest and royalties in circumstances where “one of the main purposes” of a particular structure was to obtain these treaty benefits. Similar provisions were included in the new treaty with Poland. A differently worded but generally similar anti-abuse rule was also included in the new treaty with Colombia.
While none of these treaties adopts a comprehensive “limitation on benefits” rule such as that found in the U.S. treaty, it appears that Canada’s treaty policy has become more sympathetic to the inclusion of codified anti-treaty shopping rules. This may have implications for the interpretation of other treaties that do not contain specific anti-treaty shopping provisions, particularly in view of recent trends in Canadian tax jurisprudence, including the MIL Investments case. In addition, of course, it is always necessary to consider whether otherwise available benefits may be denied under Canada’s general anti-avoidance rule.
The foregoing are but two of the recent trends in Canadian tax treaty law and policy. With the upcoming re-negotiation of Canada’s tax treaties with major trading partners, such as the U.K., China, the Netherlands, Australia, Spain, Israel and other countries, these and other trends may present new issues or opportunities for structuring cross-border transactions.